Building a case for Casual Dining in Early 2009

The casual dining stocks saw a little rally going into the Thanksgiving week. The rally is coming off a disastrous past three months, where the average casual dining stock has fallen about 25% more than the market. The decline in casual dining stocks is based in part by fundamentals, but the current valuations suggest that there are deeper issues, which we don’t believe to be case. Currently the average casual dining stock is trading at 4.4x NTM EV/EBITDA (not including SNS which is trading at 11xs). This is a tricky time of year as you have tax loss selling coupled with part of the investment community taking the rest of the year off. Some parts of the investment community don’t want to have these stocks in their portfolios or they are not placing any new bets to maintain performance for the balance of the year.
  • Stating the obvious, Americans have lost their appetite and ability to spend at the same rate as in the past. The underlying force limiting the consumer’s ability to spend is the precipitous decline in consumer credit. In addition, the decline in the stock market has reduced the value of every American’s retirement plan, and the decline in home prices has left millions of homeowners with a mortgage in excess of the value of their home. As a result, survey after survey we see shows us that the consumer is unwilling to buy a new car or new house and is going to reduce spending on eating out! Trading at 4.4x cash flow the industry is discounting most of the bad news.
  • What you are not going to read in the financial press is that it is time to be looking seriously at the carnage in the casual dining industry as an opportunity to make money in the early part of 2009. Here are the catalysts/themes that will work their way into the market in the early part of 2009:

    (1) Currently gas prices are nearly 40% below last year’s level and likely to stay there for some time. See our post (Smoldering Stimulant 11/29/08) for the chart of gas prices.

    (2) There is a broadly accepted and recognized need for massive fiscal stimulus in early 2009.

    (3) Reductions in restaurant capacity in 2009, especially in the bar and grill segment. See my post (Shrink to Grow 11/12/08).

    (4) The decline in commodity prices provides a backdrop that can help mitigate the decline in margins.

    (5) Valuation
  • Longer term the restaurant industry is a cash business, and deploying cash properly drives real incremental value for shareholders. If you think the U.S. is headed for a depression, don’t buy casual dining. In a mild recession, however, there is very little risk to the cash flows of the large national casual dining chains with strong balance sheets. In today’s environment, deploying cash to build a bunch of new stores is not going to create significant value for shareholders. Nonetheless, we are seeing more casual dining companies move into the international arena to create opportunities for growth. Importantly, this growth comes in the form of high margin, high return royalty payments.
  • As you can see from the chart, the analyst community is sufficiently bearish on the group. Except for some of the names in the “quick casual” segment, there are not many buys on the larger casual dining names. This leaves some room for some piling on as sales trends become less bad in early 2009. DRI and EAT are two names that have a national base of stores, well positioned concepts, strong balance sheets and great cash flows.