The fare in restaurant stocks is a bit short on the A-1 just now
Sesame-seed buns. Whoever heard of a sesame-seed bun before McDonald's made it big? But last year a mere 7,577,000 pounds of sesame seeds passed through the Golden Arches.
Impressed? No? OK, did you realize 15 million people stop in at Ronald's diner -- every day. That's more than 6 percent of the United States population dashing in for a Big Mac, McNuggets, or fries.
Unfortunately, word of this kind of volume has leaked out before now. ``The restaurant industry is overbuilt in the short term,'' says Dean Witter Reynolds analyst L. Keith Mullins. ``And consumer demand is lackluster at best.'' So, there's something of a McShakeout going on.
Earlier this year, restaurant stocks outperformed the market. The group climbed about 22 percent in the first seven months of 1985, vs. a 14.2 percent rise in the Standard & Poor's index. These issues tend to be high-beta stocks, meaning that when the market jumps, they soar. But lately these stocks are becoming harder to swallow.
``Over the last 13 weeks they've been underperforming relative to the S&P 500,'' says Ricard E. Pyle, taste-tester of restaurant stocks at Piper, Jaffray & Hopwood in Minneapolis.
And earnings estimates are being slashed. Church's Fried Chicken -- the No. 2 chicken chain -- took a dive last week when several analysts cut third-quarter earnings predictions.
(In fact, investors found stocks generally displeasing to their palates last week. The Dow Jones industrial average closed on Friday at 1,318.32, up only 5.60 points in five trading sessions.)
In addition to the problem of too many restaurants chasing too few consumers, the economy's low growth has slowed sales. ``Growth in personal income is one of the major, if not the major, determinants of sales growth in these stocks,'' says Mr. Pyle. In June and July, personal income had negligible real growth.
The dinner-house segment -- including Bennigan's, Chi-Chi's, T. G. I. Fridays -- is most sensitive to personal income growth (or lack thereof), Pyle says. And alcohol sales, a key profit source, have fallen at these restaurants because of anti-drunk-driving campaigns. So he recommends steering clear of this group now.
Pyle and most other analysts have no appetite for the smaller fast-food franchises, either. ``Many of the upstart chains got going a few year ago when McDonald's, Burger King, Wendy's, Kentucky Fried Chicken, and Pizza Hut were relatively laid back about promoting themselves,'' Pyle says.
Now, the slumbering giants are awake. The big boys are advertising heavily and pushing new products. This summer Wendy's rolled out a breakfast menu. And a couple of weeks ago, K mart agreed to let Wendy's set up a test restaurant in one of its stores. Pizza Hut has introduced a new deep-dish pan pizza. Kentucky Fried Chicken has its own poultry nuggets now and has beefed up advertising.
The result: ``The big chains are really able to inflict damage on the smaller start-ups,'' says Pyle.
Because of the state of the industry, Pyle is recommending only one stock -- Vicorp Restaurants. This Denver-based company sticks to family-oriented sit-down dining. It has about 500 units roughly split between Village Inn Pancake Houses and Bakers Square dessert shop/restaurants. Pyle likes the company as a two- to three-year investment. ``This is basically a stable operation,'' he says. ``No fads. It's a local coffee shop operation with a stable customer base.''
Vicorp ``got a good deal'' in 1984 when it picked up some tax-loss carry-forwards and 175 restaurants from Sambo's bankruptcy estate, says Pyle. Once these units are converted to Village Inns and Bakers Square shops -- in about a year -- they should start adding to the bottom line.
Dean Witter's Mullins also has but one stock he'd put the bite on now: McDonald's. ``Their performance has been superior. They've weathered through a pretty choppy market fairly well. They're the only company where the average customer counts per unit are up over the last six months. In short, it's one of the better quality growth vehicles in the market today,'' he opines.
McDonald's is in a very secure position, too. With more than 8,300 outlets in the US and abroad, the company isn't running around bidding for costly new store sites, Mullins points out. In most towns, it already has the best site. The company already gets 21 percent of its revenues from overseas and ``the international market offers very attractive growth,'' he says. The lower dollar should help the earnings, too.
Finally, in this competitive period, where marketing muscle is crucial, McDonald's spends twice as much on advertising as its closest rival, Burger King.
The No. 3 burgermaker, Wendy's International, has a place on many brokerage buy lists. But neither Pyle nor Mullins would buy now. Mullins says Wendy's customer counts have declined and he is concerned about whether its breakfast menu will catch on. Pyle adds, ``Wendy's has done so well over the last year and a half, I think they're going to have a difficult time with year-over-year earnings comparisons.'' Chart: Interest Rates. *Yields; Source: Bank of Boston.
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