Everybody and their brother know that restaurants are facing very easy comparisons in 4Q09 and that the stocks should react favorably in that environment. This is consensus thinking at its best.
To see the magnitude of the improvement in profitability, we added together the bottoms up reported/expected earnings for the FSR sector and charted the sequential quarterly improvement. As seen in the chart below, earnings have gotten better each quarter since 3Q08 on a YOY basis with the declines moderating through 2Q09. Based on current street estimates, investors are expecting nearly 10% EPS growth for the FSR group in 3Q09 and about 38% growth in 4Q09.
As I pointed out in an earlier post, investors are reacting differently to 2Q09 earnings reports relative to what we saw following 1Q09 results. In both quarters, we have seen continued sales weakness combined with significant cost cutting translate into big earnings surprises. Following 1Q09 earnings reports, we saw a big positive move in most restaurant stocks whereas post 2Q results, we have seen stocks move lower (please refer to my July 24 post titled “Restaurants – Earnings Fatigue” for more details).
Part of this varying stock performance can be attributed to the changing trend in top-line numbers from 1Q09 to 2Q09. In 1Q09, most of the FSR companies experienced a significant improvement in comparable sales growth from 4Q08. In 2Q09, although earnings continued to get sequentially better, sales deteriorated somewhat from the prior quarter and on a 2-year average basis did not look much better than 4Q08.
Even with most FSR stocks declining on the day following their reporting 2Q09 numbers, FSR stocks, on average, are up 13% in the last month and 2% in the last week. As we get through 2Q earnings, investors are looking past recent sales trends to 2H09 and consensus has built in significant sequential improvement in profitability for the FSR sector. My guess would be that most analysts have “positive” same-store sales growth built into their earnings models for 4Q09.
What if that does not happen? We will learn more as we hear more from the companies that have yet to report 2Q earnings but the early read on 3Q is less than positive. For most companies thus far, sales slowed sequentially through the second quarter and have remained soft into the early part of 3Q. In 2Q, some companies blamed sales weakness in May and June on the fact that we were lapping the stimulus money from 2008. This stimulus impact decreases going forward. For reference, same-store sales growth for the FSR group as measured by Malcolm Knapp was +0.6% in May 2008, -1.9% in June 2008 and -3.9% in July 2008. The current comparable sales outlook for July is similar to that of June and that is on easier comparisons, which points to continued deterioration in 2-year average trends.
Based on recent company commentary about July, positive comparable sales growth in 4Q09 is not a given. In this type of environment, easy comparisons are no longer meaningful so current earnings expectations may be aggressive. That being said, the significant cost cutting initiatives for the FSR group were implemented largely in 1Q09 and will benefit earnings for the balance of the year. This combined with the expected commodity deflation will help to offset sales misses. But, as we are seeing following 2Q09’s better than expected earnings, restaurant stocks will react also to top-line trends as comparable sales growth is a significant indicator of a concept’s health. And, I am not sure positive same-store sales growth is in the cards for the balance of the year.
Also, I’m going out on a limb and saying that the “cash for clunkers” car program is a net negative for the restaurant industry. If consumers are taking on more debt to buy a new car than there is less money for them to spend elsewhere like eating out.