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Despite an improving economy and increasing consumer confidence, the restaurant sector has been reporting weak results, mainly driven by weak top-line performances.

Weak Industry Trends

In the first half of 2016, the same-store sales growth has been dreary in the restaurant space, given a continuing difficult sales environment.

Due to the decrease in energy prices and a rise in wages, household wealth has increased considerably. This in turn has boosted consumer spending. However, consumers’ spending on dining out has not increased in the same proportion. Moreover, higher health care costs and tightened credit availability in the U.S., only adds to the woes.

Restaurateurs with diversified presence across international markets received no respite either. An unfavorable currency, a cooling Chinese economy and a tightening labor market add to the worries.

RETAIL-FOOD & RESTAURANTS Industry Price Index

What Do the Numbers Say?

The industry metrics provide us with inconclusive forecast for the rest of 2016.

Same-store sales for August declined 0.6%, marking the sixth month since the beginning of 2016 with negative same-store sales growth, per TDn2K’s Black Box Intelligence. However, the fall compared favorably with the decline of 1.4% recorded in July.

However, same-store traffic declined 2.7% in August, compared with a decline of 3.9% in July. Average guest checks increased by 2.3% year-over-year in August, as compared to a 2.8% increase in July.

Moreover, at the end of August, quarter-to-date sales growth for the third quarter had fallen 1%. If the pace continues, it would be the worst quarter in over five years for restaurant stocks.

Thus, while the industry faces challenges to its top line due to sales slowdown, the bottom line is also adversely affected by a sharp increase in labor costs. Considerable costs continue to be incurred from the rising turnover levels and also from the hiring of new employees.

Companies Facing the Brunt

Based on the above factors, Sonic Corporation (SONC - Free Report) recently reported lower-than expected preliminary fiscal fourth quarter results. Both the top and bottom lines were hit, with the earnings per share of 43–45 cents, lower than the Zacks Consensus Estimate of 48 cents. The company cited “lower-than-expected traffic, reflecting lower consumer spending in restaurants and continued aggressive competitive activity” as the driver of earnings and revenue shortfall.

Apart from pizza giants like Domino’s Pizza, Inc. (DPZ - Free Report) and Papa John’s International, Inc. (PZZA - Free Report) , most of the restaurant stocks posted weak second quarter results. These pizza stocks rode on digital ordering platforms and lower ingredient costs.

On the other hand, Starbucks Corporation (SBUX - Free Report) lost investor confidence when it posted a same-store sales growth of 4% in the U.S. in the second quarter, thereby ending its streak of 25 consecutive quarters of above 5% growth.

Other stocks that suffered from weak previous quarter results are McDonald’s Corporation (MCD - Free Report) and Restaurants Brand International, Inc. (QSR - Free Report) , to name a few.

Our Take

Nevertheless, most of the restaurateurs are undertaking various sales building as well as digital initiatives to drive traffic and comps. For example, McDonald’s all-day breakfast offerings could help it boost sales. Further, increased focus on the refranchising model undertaken by many restaurateurs like The Wendy’s Company (WEN - Free Report) and Papa John’s could bode well for them going forward. Moreover, re-imaging of stores being done by food chains like Carrols Restaurant Group, Inc. (TAST - Free Report) has received overwhelming response from guests.

McDonald’s, Wendy’s, Papa John’s and Carrols Restaurant are thus carrying a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

As of now, the Restaurant Industry ranks at 192 (bottom 28%) out of the 265 Zacks Industry Ranks. Unless companies find ways to reverse the continually declining traffic trends, sales and earnings expectations are to remain modest.

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