High Food Prices, Budget Conscience Consumers Hurt Restaurants

LOS ANGELES – U.S. restaurant companies have struggled this year with soaring food costs and fewer customers, and many on Wall Street see tougher times ahead as prices of commodities remain high and cash-strapped consumers cut back on eating out.

Restaurant shares recovered somewhat earlier this month following a dismal July and August that saw profit warnings from chains including: Panera Bread Co.(PNRA), California Pizza Kitchen Inc.(CPKI) and P.F. Chang's China Bistro Inc. The Dow Jones U.S. restaurants and bars index was down more than 2 percent during the period.

But dour announcements from McCormick & Schmick's Seafood Restaurants Inc.(MSSR) and Ruby Tuesday Inc.(RT) this month helped temper investor enthusiasm for shares of sit-down restaurant chains, and several analysts expect things are likely to get worse before they get better.

Fast-food restaurants, on the other hand, have remained a bright spot among because they offer price-conscious consumers a good value, analysts said.

A RBC Capital Markets survey released earlier this month found that 54 percent of Americans said they would eat at restaurants less often over the next three months. Two of five respondents said they were already dining out less frequently than they were six months ago.

Analyst Larry Miller said declining home values, higher energy costs and overall economic concerns were reducing consumers' appetite for dining out.

Goldman Sachs lowered its earnings estimates for most casual dining companies on Thursday and said the Federal Reserve's aggressive half-point interest rate cut earlier this month was unlikely to help matters in the near term.

The Dow Jones restaurants index fell 0.9 percent on Thursday and has tumbled about 6 percent since the Fed's Sept. 18 rate cut.

"Our lowered 2008/2009 estimates reflect expectations for tougher times ahead in restaurants with consumer spending likely to remain weak and commodity headwinds making meaningful margin expansion unlikely," Goldman restaurant analyst Steven Kron said in a note to clients.

Kron downgraded Chili's parent Brinker International Inc

to "sell" due to particularly weak demand for and stiff competition among bar-and-grill chains, and the stock fell 1.2 percent.

Shares of coffee shop chain Starbucks Corp (SBUX) slid 4 percent after Bank of America downgraded the stock to "sell" on expectations of slowing growth, in part due to weakened consumer spending and high dairy costs.

Last month, the world's largest coffee shop chain tempered previous statements that it was resistant to blips in the U.S. economy by implying that its customers might actually be cutting back on that extra latte.

U.S. consumer spending jitters were also felt by high-end seafood chain McCormick & Schmick's earlier this week lowered its third-quarter outlook due to economic pressures, its first downward revision since becoming a public company in 2004.

Some think the recent weakness in many restaurant stocks represents a good buying opportunity. Earlier this week, J.P Morgan said casual dining stocks such as Brinker and Ruby Tuesday were becoming more attractive due to their strong free cash flow and slower restaurant development that should keep supply more in line with demand.

J.P. Morgan also said current lower valuations on Starbucks, Ruth's Chris Steak House Inc. (RUTH) and Texas Roadhouse Inc. made them good long-term bets.

Overwhelmingly, analysts agree that fast-food chains are the best bet among restaurants.

Earlier this month, McDonald's reported an 8.1 percent rise in August sales at stores open at least 13 months, easily beating analysts' expectations, and last month Burger King Holdings Inc. posted a better-than-expected quarterly profit. McDonald's shares have gained 8.5 percent in the last month, while Burger King's have risen 7.5 percent.

"While some consumers may reduce their fast food frequency to cut back on spending, other higher income consumers may increase their fast food consumption to save money," Friedman, Billings, Ramsey analyst Ashley Woodruff said in a client note earlier this month.