RESTAURANTS - A SAFE HAVEN?

There is not a restaurant company that would is not worried about the current reading of consumer confidence.  

 

The Conference Board index of Consumer Confidence fell by 3.2 points in June to 58.5 on top of the 4.3 point decline in May.  Over all the consumer fundamentals remain soft and, at least judging by the market’s reaction, confidence missing the consensus number of 61.0 is consensus.  The two-day rally in the S&P 500 and, more pertinently, Restaurant stocks, of 1.80% and 2.82%, respectively, is indicative of that. 

 

Restaurant stocks continue to perform well in both and up and down tapes.  Over the past month, the QSR and FSR sectors have outperformed the S&P 500 by 5.5% and 4.1%, respectively.  The average EV/EBITDA multiple for the QSR and FSR sectors now “not cheap” at 10x and 7.4X, respectively.  Relative to other sectors that are slightly more cyclical or are driven by the wild swings in commodities, the restaurant industry as a whole is serving as somewhat of a safe haven.  The industry is not overly levered and the cash flow generation and dividend yields of some of the more mature companies are very attractive.    

 

Industry demand is improving, but not all concepts are created equal.  Malcolm Knapp recently reported that estimated comparable restaurant sales growth in May was 2.2%.  Final accounting period April comparable restaurant sales growth was +1.5% (versus the prior estimate of +1.6% based on weekly data).  The sequential acceleration from April to May, in terms of the two-year average trend, was +50 basis points.  Comparable guest counts for the casual dining industry, according to Knapp Track, grew +0.4% in May on a year-over-year basis.  The final April guest counts growth number was -0.1% (versus the prior estimate of +0.2%).  The sequential acceleration from April to May, in terms of the two-year trend, was +15 basis points. 

 

As we head into earnings season, it will be important to keep a close eye on movement in top line trends.  There appears to be a cultural shift to the fast casual segment, as younger consumer prefers the “overall” environment of the fast casual store design.  I will be exploring this theme in the coming days.    

 

All the good news aside, an erosion of consumer confidence is concerning and expected amidst concerns over declining asset values, inflation, rising energy costs, geopolitical flashpoints, the availability and cost of credit, and rising unemployment.  The Conference Board Consumer Confidence Index is at its lowest level since November 2010, when Knapp Track was reporting a 1.6% decline in traffic for the casual dining industry.  Even more concerning is that the expectations component once again led the decline in the overall index, falling to 72.4 from 76.7 (previously 75.2); the present situation component dipped to 37.6 from 39.3.

 

Declining house prices continues to be another burden for the consumer to bear (despite today’s seasonal uptick which looks to be temporary and scant consolation for homeowners).  Today, the Case-Shiller 20-City Home Price Index increased 66 bps in April to 138.84 on a non-seasonally-adjusted basis.  On a YoY basis, however, prices fell -4.0% YoY in April versus -3.8% YoY in March.  As our Financials team noted today “there is a strong seasonal aspect to home prices, with the greatest increase in prices occurring in April, May, and June … Thus, expect to see two more months of improvement (May and June) before the downtrend resumes.  As a reminder, we use the NSA YoY data instead of the seasonally adjusted series because S&P noted last year that their seasonal adjustment factor had become unreliable.”  Housing is slowly capturing more attention in the media, particularly as other bearish data points emerge and resonate with what has been playing out in housing – in line with Hedgeye Financials’ call – for some time.

 

Without the corporate sector adding any significant contribution to payrolls, wage income is growing at an all-too-anemic pace.  Disposable income is holding up, but only due to the temporarily reduced payroll tax withholdings, offset by the “gas tax” Gasoline prices remain a constraint, although recent trends are making life a little easier.  Over the last week, gas prices have dropped by 2.4% and 11% from the high set back in early May.  Year-over-year gas prices are now up 29%.  The consumer’s response to increasing gas prices, declining equity markets, and the disappointing trend in home prices reduced real spending in both April and May.

 

In today’s environment no one is immune from some sort of economic malaise:

  1. High energy prices particularly hurt “lower-income” households as they spend a disproportionate share of their income on energy needs.
  2. The decline is housing seems to hurts everyone but the “middle-income” are likely effected the most.
  3. The recent stock market weakness hurts “high-income” households

 

In the world of Restaurants, the Hedgeye virtual portfolio we are currently LONG COSI and SBUX and SHORT CBRL.  I’m nervous about the DRI quarter to be reported on 7/1 - it’s a consensus long and its core consumer for both Red Lobster and 

Olive Garden fall in the sweet spot of those hurting the most in the current economic environment.  Although, Long Horn is killing it! 

 

I am negative on CAKE and PFCB, also.

 

 

RESTAURANTS - A SAFE HAVEN? - hrm vs spx

 

Howard Penney

Managing Director


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