The short-term pressures on casual dining operators are currently evident. Fears of a recession are growing. Consumer confidence is down. Labor shortages have pushed up wages and in some cases forced operators to limit take-out orders.
Commodity inflation means owners need to raise prices to protect margins – but the move clearly risks deterring cost-sensitive customers.
These pressures have been reflected in stock prices across the space. By my definition, there are eight US-based casual dining stocks that are down an average of 30% so far this year. That’s about five percentage points lower than the restaurant industry as a whole (again, by my definition, a narrower than might be used elsewhere) and 12 points behind the 18% drop displayed by the Standard and Poor’s 500 index.
The declines are not surprising, but they should still be of concern to investors and these traders.
After all, a consolation for most sectors is that this year’s weakness follows years of strength. This is not the case for the casual dining sector, which had mostly struggled heading into 2022. The sell-off therefore raises a big question: whether the industry has been unable to generate returns to shareholders looking back, how can it do it looking forward?
Over the past five years, an equally weighted portfolio in eight casual dining stocks would have shrunk about 13%, even including dividends. To be fair, this somewhat overestimates the pressures on the industry. The two big winners in this stretch are the two most valuable companies: Darden Restaurants, owner of Olive Garden, and Texas Roadhouse. (Disclosure: I’m short on Texas Roadhouse shares in my personal account, for reasons I’ve detailed elsewhere — including precisely the pressures on the casual dining space going forward.)
While the average return for individual stocks has been negative, the industry’s overall equity value has at least increased.
But while Darden and Texas Roadhouse have performed well relative to the industry, neither has topped S&P 500 returns in the past five years. And it’s too simplistic to blame weak trading this year — or even the novel coronavirus pandemic — for the sector’s inability to generate acceptable returns for shareholders.
Even before this year’s sell-off, the sector had underperformed. From 2017 to 2021, Darden nearly matched the index, but five of the eight companies posted negative total returns for all five years. Run the same exercise from 2015 to 2019 and the trend continues, with all five stocks down, although Darden and Texas Roadhouse over this period have at least beaten the market.
Again, an optimist might respond that the industry as a whole has seen its equity value rise, thanks to the outperformance of the two leaders and the drag of the smaller, long-struggling Red Robin. on the group averages.
But that relative performance might be precisely the point.
Texas Roadhouse was led by a charismatic founder, the late CEO Kent Taylor, who installed an impressive system of relentless quality. And unlike more mature rivals like Chili’s owner Brinker International or The Cheesecake Factory, this chain has enjoyed steady expansion into new markets.
Darden stock, meanwhile, was helped by financial engineering, including the sale of declining Red Lobster. An activist effort in 2014 also breathed new life into the company’s operations.
But without specific catalysts, casual dining operators have struggled. Brinker was unable to generate consistent growth from the same property at Chili’s. Dine Brands never solved the Applebee problem; the same goes for Bloomin’ Brands and Outback Steakhouse. Ruby Tuesday is no longer public, but it sold in 2017 for just $2.40 a share and then filed for pandemic bankruptcy three years later.
The struggles have not been limited to traditional brands. The new concepts – Maggiano’s for Brinker, Carraba and Bonefish for Bloomin’ Brands – did not achieve the growth required to continue growing the footprint. Potential leaders like Red Robin, Chuy’s and BJ’s also disappointed.
So what recent history tells us is that it’s not enough to run a varied casual dining operation.
That too shouldn’t come as a surprise, as the same trend holds throughout the consumer industry. More than a decade ago, Citigroup called this the “consumer hourglass theory”: the coming shrinkage of middle-class-focused options that offer quality and price that are both “good enough.”
Essentially, the bank argued that being in the middle was the worst place to be. It’s not hard to see this argument play out in the restaurant space. Consumers have been willing to pay a few dollars more for more local, unique and upscale seating experiences – or to save money (and time) in the ever-expanding universe of fast-casual alternatives.
Indeed, the performance of most casual dining stocks proves just how tough the middle really is. Without a major differentiator – the scale and leadership of Olive Garden, the tight execution of Texas Roadhouse – steady casual dining growth was nearly impossible to drive when times were good. This is the main reason why investors are so worried about what performance will look like when times aren’t.
Vince Martin is an analyst and author whose work has appeared on several financial industry websites for over a decade. He is the main author of Neglected Alphawhich offers weekly analysis of the entire market and a single security