This may sound hyperbolic. But a revolution on the horizon is changing the entire restaurant industry and will have far-reaching effects on myriad companies.
In this special investing webinar, Hedgeye Restaurants analyst Howard Penney discusses sweeping changes shaking up the Restaurant space with CEO Keith McCullough.
He also explores the various winners and losers from this change and identifies specific stocks which stand to benefit most.
CLICK HERE to watch this entire webcast.
Below are three key takeaways from the conversation.
1. IS CASUAL DINING DEAD?
A debate is raging in the restaurant industry: Is casual dining dead?
The industry has been plagued by aggressive promotions, lagging traffic, and precipitous declines in same-store sales. But the U.S. economy is accelerating, says McCullough. Average hourly earnings rose to 2.9% year-over-year, the highest rate of growth since June 2009.
That’s bullish, Penney says.
“Typically 5% of your disposable income goes to eating out. So, if more people are working, and wages are going, up that’s good for eating out."
Also, before you declare the death of casual dining dig a little deeper, Penney says.
“If you look at independent food distributors like U.S. Foods, and use case volume as a proxy for same store sales to independent casual dining, these operators are growing 3% to 4%. The casual dining industry is seeing a -3% to -4% decline in the business. So there’s this shift going from the big chains to the independents.”
The big question for investors is how do you invest in publicly-traded restaurant companies and make money?
“You’ve got to find the management teams that are pivoting to adjust to the environment they’re operating in. Some are adjusting and some aren’t, and those are the ones you want to avoid,” Penney says.
Who’s adapting best? Brinker (EAT)… (it owns Chili’s, Maggiano’s, Roman’s Macaroni Grill and On the Border)
“There’s significant change underway,” Penney says.
Here are his key takeaways on the company:
- The best operators in the space have about 75 menu items ensuring consistency of operations, profitability of service. Brinker just cut Chili’s menu items from about 100 to 61.
- Traffic trends have already started to turn around. “They’re only three months into this turnaround and the numbers are improving. Six months out and they go from losing market share to gaining market share.”
- The stock is cheap. It’s trading around 9 times next twelve month earnings estimates versus the 10-year average of about 13 times (which would imply 40% upside).
2. TECHNOLOGY IS REVOLUTIONIZING RESTAURANTS
Delivery is a “massive change for the industry,” Penney says.
Companies like Grubhub (GRUB) and Just Eat are changing the game. Penney compares this paradigm shift to Netflix changing the way consumers consume their entertainment.
And while some Restaurant executives are taking a "wait-and-see" approach, Penney thinks the companies who fall behind on delivery now are next year’s dinosaurs. “Delivery is a $30 billion market today. In five years it’s going to be $200 billion,” Penney says.
"If you think about that change in how we consume content. It’s going to be no different for delivery. It’s so easy to just pick up your phone and buy food. And while there is concern over the big transaction cost today. This is where the consumer is going. You can’t not be involved.”
3. DELIVERY: RESTAURANT STOCK WINNERS & LOSERS
Long Grubhub (GRUB)…
Short Domino’s Pizza (DPZ)…
In early February, Yum!Brands (YUM) purchased a $200 million stake in GrubHub (GRUB) to among other things “drive more orders to YUM restaurants.” Yum owns KFC, Taco Bell and, importantly, Pizza Hut.
"The interesting piece of this transaction is that the president of Pizza Hut U.S. joined the board of Grubhub. Yum is basically saying to Domino’s, ‘We’re coming after you,’” Penney says.
“Domino’s goes to investor conferences and tries to sell investors that they have 600 people in their corporate offices, 400 of which work on its technology. But the reality is they sell pizzas not technology."
So, while Domino’s has been ahead of this delivery trend, the gap between the pizza delivery company and everybody else is going to close. The Grubhub and Yum (read: Pizza Hut) announcement is just one example of this. “If Domino’s had a technology advantage, everybody else is coming up.”