Discount Dining Offers No Free Lunch For Investors

By Eugene Bukoveczky | July 13, 2009 AAA

While there still may be no such thing as a free lunch, the price of lunch (and for that matter, dinner) has come down quite a bit in recent months, as struggling restaurants have deployed all sorts of promotions and other incentives to coax budget-conscious consumers to get back in the habit of dining out. And, given the surprisingly strong results just released by sit down casual restaurant chain Ruby Tuesday (NYSE:RT), it would appear that the strategy is working - at least for now.
The company surprised investors by reporting fiscal fourth quarter results of 28 cents per share, well ahead of the 20 cents analysts had been expecting. While total revenues fell by 7.1%, same store sales dipped by only 3.2% compared with 6.8% the previous quarter, as customer traffic increased during the quarter, reversing a three-quarter trend. (Learn more about the use of same store sales and retail data in our article, Using Consumer Spending As A Market Indicator.)

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Price War Dominates Casual Dining Market
But this uptick in customer traffic doesn't guarantee that the company can continue to maintain its earnings momentum going forward. Right now, casual dining restaurant chains are locked in the most intense price-based competition in years. Rival operators like Applebee's, owned by Dinequity (NYSE:DIN), and Brinker International (NYSE: EAT) operator of Chili's Bar & Grill, have effectively halved their prices with promotions featuring two-for-one entrée offers and some entrées as low as $7. Such deals are boosting customer traffic, but putting a serious dent in margins. Some analysts are even concerned that the current discounting strategy could result in a long term drop in margins as the current promotions trains customers to eat out only when offered a bargain. Some franchisees, who suffer more than the franchisers as food prices are cut, have already started complaining about the wisdom of this traffic focused strategy.

Over expansion and Overpricing
As with a lot of other sectors in the current economy, the roots of the problem rest in the over expansion and rapid price increases that took place in recent years. Casual dining restaurants topped more than 10,000 last year, up from 7,000 in 1995. Fueling that expansion was the ease with which consumers could be convinced to shell out $18 or more for a basic grilled chicken breast. Now that they've turned their noses up at such prices, the overcapacity in the industry is likely to keep the price war drums beating for quite a bit longer.

Some Operators Still Doing Well
To find any sort of silver lining among the dark clouds of this sector, you literally have to move down the food chain to the lower-priced segment. That sub-set appears to include the likes of Bob Evans Farms (Nasdaq:BOBE) with its diner-style format that seems to be holding up relatively well, reporting only a 1.6% drop in same store sales. Cost cuts and retail sales of the company's signature meat products recently helped it report a better than expected 81% jump in earnings per share.

Shares of Cracker Barrel (Nasdaq:CBRL), another "down home" style eatery, are up 42% so far this year. With most of its locations near interstate highways and offering a low-cost menu that results in an average customer check of about $8-9 dollars, the company recently announced a sale lease-back plan to lower its debt burden. While some analysts view this as dilutive of future earnings, others see this as a effective way for the company to realize some of its hidden real estate value, which could potentially be worth about $1-1.5 billion. Net of the $770 million in debt on its books, the high end of this estimated value implies a per share value of over $32 alone on top its value value as a operating business. The shares recently traded in the $29 range.

The Bottom Line
Apart from a few special situations, the casual dining shares look somewhat overextended at this juncture, as there's a good chance that the current price war will last a lot longer than most investors are betting.

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