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Restaurant Nightmares Linger

Posted: Apr 13, 2009 02:54 AM by Eugene Bukoveczky

Tickers in this Article: DIN, EAT, DRI, RT

Mid-tier restaurant chain Ruby Tuesday (NYSE:RT) saw its shares jump by more than 55% in one trading session following the release of quarterly earnings results that beat analyst expectations.

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While the entire restaurant sector continues to struggle in the face of sluggish consumer demand, Ruby Tuesday managed to impress investors with evidence that it was managing to control costs while boosting sales at its established restaurants thanks to
a bevy of promotions.

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Early Results Encouraging
These results echoed similarly encouraging numbers that recently emerged from the battered restaurant sector. Last month, casual-dining operator Darden Restaurants (NYSE:DRI) also saw its shares spike by 20% when it released better than expected results despite a drop in revenue. More recently, Brinker International (NYSE:EAT), the operator of Chili's Grill & Bar among others, disclosed in a pre-announcement that it also would be disclosing expectations-beating results. Its shares also moved higher on the news.

So, is the worst now over for the embattled restaurant industry?

Looking at the recent data points, it is clear that cost cutting measures are largely behind the better than expected numbers. Food costs are way down and high unemployment is keeping employee turnover low, which cuts staffing costs.

Low Hanging Fruit Already Picked
But what we're seeing here might only be the quick and easy early victories. Notably profane celebrity chef, Gordon Ramsay, has built an entire cable channel series called "Kitchen Nightmares" around doing one-week turnarounds of failing restaurants, simply by deploying easier to prepare, tastier and less costly menus and remotivating staff. While usually enough to stop the hemorrhaging of the businesses willing to undergo Gordon's unique version of restaurant makeover, lasting success only comes when the tables start filling up on a regular basis, at regular rates. And not all of Ramsay's interventions successfully make it to that stage.

Overexpansion And Excessive Debt
Like so much else during the last few years of the "bubble" economy, the U.S. restaurant sector went through its own bout of overexpansion. Much more cost cutting and downsizing may be required before the industry hits the reduced level of capacity to match the notably slower traffic numbers, which have become the new normal despite the heavily promotional environment. As of the most recent quarter, Ruby Tuesday had closed 43 of its restaurants already.

Rating agency Fitch continues to predict no recovery in traffic numbers this year and remains cautious on those chains that grew too aggressively, loading up on debt in the process. Applebee's and IHOP operator DineEquity (NYSE:DIN), which now holds nearly $2.4 billion in long-term debt on its books, is one such example. However, any closures by weak operators would likely benefit the remaining players.

The Bottom Line
Even after the recession ends, annual spending by U.S. consumers could experience a permanent downshift of as much as $1 trillion. That suggests significantly fewer meals will be eaten out by the average family. Only those restaurants that can aggressively manage costs and still remain profitable at a lower price point will survive the current environment. If the current exuberance shown by some investors in this sector is based on an assumption of a return to the way things were, those investors will be sorely disappointed. (Learn more about investing in companies such as these in our related article Sinking Your Teeth Into Restaurant Stocks. )

By Eugene Bukoveczky

Eugene Bukoveczky is a freelance writer and investment researcher. He holds a CFA designation and has spent several decades working in the investment business in places like Toronto, New York, London and Dubai. He currently resides in Nova Scotia, where, when not writing, he devotes his time to chopping wood, growing his own vegetables, riding his bike to the store, and thinking about other ways to reduce his carbon footprint.

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