010716 Casual Restaurants Seen Beating Rising Costs

Chicago - U.S. casual dining and fast-food restaurants face higher food and energy costs, and continued tight labor markets, but will likely weather those difficulties fairly well in coming months, analysts said.

Even after sluggish sales increases in April and May at restaurants open at least one year, the casual dining sector will likely have a strong earnings season overall, judging from those companies that have already reported, analysts said.

“With some margin pressures out there, there have been a couple of stumbles, but for the most part, most of these companies will be in their range for earnings growth,” said Andrew Barish, restaurant analyst for Banc of America Securities.

This year's income tax rebates, next year's tax cut and a possible minimum wage hike might affect earnings in coming months, analysts said.

“Looking ahead, recent reversals in fuel costs and upcoming tax rebate checks have positive implications for consumers' disposable income,” Bear Stearns restaurant analyst Joseph Buckley wrote in a report. “In our view, the casual dining sector is best positioned to maintain positive same store sales growth at a strong enough rate to counter cost pressures.”

The Standard & Poor's Restaurant index has underperformed the S&P 500 index by about 4.4% since the start of the year, slumping back some since late May after two strong months of growth. The index includes fast-food giants McDonald's Corp. and Wendy's International Inc. and the casual dining chain Darden Restaurants Inc., parent of Red Lobster and Olive Garden restaurants.

SAME-RESTAURANT SALES WILL DETERMINE PROSPECTS

The second half outlook depends on whether same store sales stay firm or improve from the current levels, which would bring continued sales growth of 15- 20% in casual dining and about 10% in quick service, Barish said.

Buckley called Darden's earnings report impressive and wrote that he expected solid reports from Ruby Tuesday, Applebee's International Inc. and Brinker International Inc., which runs the Chili Bar & Grill restaurant chain.

Darden said strong sales at Red Lobster and Olive Garden restaurants open at least one year paced a 12% rise in fourth-quarter earning and announced a national expansion for Smokey Bones BBQ restaurants. Ruby Tuesday said net income rose 21% in the fourth quarter largely on sales growth at its company- owned restaurants open at least one year.

Barish said Brinker should have a solid quarter also and said regional casual dining and fast-food chains are expected to report better earnings than some large national chains.

Sales in the casual dining sector slowed in the second quarter to more normal growth for restaurants open at least one year after high growth levels from 1998 through 2000, he said.

Sales at fast-food restaurants were consistent the last two months, but never reached the above average spending levels that casual dining had the last two years, Barish added.

Most restaurant companies budgeted for high energy costs after pressure in recent quarters and margins could improve if those costs decline later this year, analysts said.

RETURNS SEEN MIXED

Casual dining and fast-food restaurant companies expect to report varying returns, even as the segments as a whole appear likely to continue growing, analysts said.

Outback Steakhouse Inc. warned that quarterly earnings would not meet estimates due to slower-than-expected same-restaurant growth and high domestic rib costs during the U.S. ban on European meat imports that included Danish ribs.

McDonald's warned that a strong U.S. dollar and lingering concerns over mad cow disease in Europe would continue to hurt results while Tricon Global Restaurants Inc. expects second-quarter profits to meet forecasts amid moderate sales improvement at its KFC, Taco Bell and Pizza Hut chains.

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