CASUAL DINING – DIGGING DEEP INTO CURRENT TRENDS

Continuing our theme of a potential silver lining in Casual Dining!

Casual Dining operators on average are facing a much easier EBIT comparison in the current quarter as 4Q07 marked the first quarter of significant YOY declines, with margins on average down over 200 bps. Although same-store sales growth started to taper off in 2006, the casual dining companies saw a dramatic fall off in growth in 4Q07 when comparable sales growth fell 2.4% and traffic declined 4.2%. Trends have obviously deteriorated further since then but that sequentially more substantial decline in top-line growth in 4Q07 coincided with a sequential and YOY spike in both food and labor costs, which put increased pressure on EBIT margins.

This easier margin comparison in 4Q08 will not be enough to offset the significant same-store sales declines. We already know that October casual dining same-store sales declined 6.1% with traffic down 8.2% and we are expecting November to not get any worse. However, should top-line growth start to stabilize in December and early 2009 as a result of Obama’s expected fiscal stimulus program, the YOY comparisons could finally start to play in these companies’ favor. Casual dining operators are lapping both higher food and labor costs in 4Q08 and 1Q09 so the YOY pressure on margins should start to moderate, particularly with the recent declines in commodity costs. Most of the companies are forecasting that their cost of sales will be up in FY09 but at a much more manageable pace relative to the increases experienced in FY08 with the biggest YOY benefit expected in the back half of the year. Lower gas prices (down nearly 45% YOY) should help margins both from a cost and demand perspective.

Although the timing around when top-line results start to stabilize remains the number one question, I would not be surprised to see this group rally in early 2009. Any incremental lift to same-store sales growth in 2009 will coincide with moderating food costs on a YOY basis and should improve margins from their current depressed levels.

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