Investors Feast on Restaurant Stocks

Restaurant stocks have become the flavor du jour on Wall Street, with shares of the companies that own such eateries as California Pizza Kitchen, Cheesecake Factory, Macaroni Grill and Olive Garden outpacing the broad market in recent weeks.

Several of the stocks have hit 52-week highs in the last week, and many are up more than 20% year to date--while major market indexes are still in the red.

The hottest restaurant sector with investors has been the casual-dining category, as investors focus on strong growth at key franchises where the typical patron check ranges from $10 to $15.

But some less expensive restaurant chains, including pancake standby IHOP Inc. and fast-food giant Jack in the Box Inc., also are getting fresh attention on Wall Street.

In part, restaurant stocks have benefited from the flight of money from the battered technology sector in recent months, analysts say. Investors hunting for decent earnings growth--and perhaps less share-price volatility--have zeroed in on some eatery stocks.

But attractive fundamentals in much of the restaurant business also are luring investors. Many chains have seen several years of improving profit as Americans eat out more frequently and spend more when they do.

“The [casual-dining] industry is concentrating on the right things,” said David Overton, chief executive of Calabasas-based Cheesecake Factory. “What you are seeing is a combination of hard work in both food and service, and efforts to modernize their decor,” Overton said.

Cheesecake shares have rocketed 95% so far this year, closing up 94 cents at $45.50 on Nasdaq on Monday.

By contrast, the blue-chip Standard & Poor’s 500 index is down 3% this year, while the Nasdaq composite index is down 16%.

Overton credits competing chains such as Olive Garden (owned by Darden Restaurants), P.F. Chang’s China Bistro and Chili’s Grill & Bar (owned by Brinker International) for paying greater attention to their menu offerings and raising industry standards.

Frederick Hipp, chief executive of Los Angeles-based California Pizza Kitchen, said the chain is seeing people eating out more during the course of the week rather than saving a trip to a restaurant for a special occasion. CPK’s business is now split evenly between dinner and lunch, he said.

Shares of the wood-fire oven pizza specialist have more than doubled from their initial offering price of $15 in August. They fell $1.50 to $31.88 on Nasdaq on Monday, after hitting a new high of $35 last week.

Increase in Dining Out

The percentage of Americans who have visited a casual-dining establishment three or more times in a month climbed from 61% in the first half of 1998 to 63.3% in the first half of this year, according to a study of 11 urban markets nationwide by Bob Sandelman, a Villa Park restaurant consultant. The average spending per person during that same period rose 4.6% to $12.39.

Increases in dining and the average check are even more pronounced in Southern California, according to Sandelman.

The percentage of people who have visited a casual-dining establishment three or more times in a month jumped from 59.3% to 67.1% during the same time period. The average check rose 7.5% to $11.96.

CPK’s Hipp attributes increased dining and spending to the growth in two-income households and to hectic family schedules that have resulted in people eating fewer home-cooked dinners.

A strong economy hasn’t hurt, of course.

Even so, Wall Street has a history of being suspicious of restaurant stocks, and for good reasons, analysts say. Consumer tastes are fickle, after all.

What’s more, such “theme” restaurant chains as Planet Hollywood and Rainforest Cafe have been big flameouts in recent years.

But investors’ lack of interest in many restaurant stocks has made them bargains, some experts say.

“What’s happened is that restaurants have had several years of good operating results but little attention from Wall Street, which has been focused on technology and biotechnology,” said analyst Andrew Barish of Robertson Stephens in San Francisco.

“The fundamentals of this industry are strong,” said analyst Greg Schroeder at Josephthal & Co. in New York. “There’s been no food inflation for many years and that has allowed the chains to improve profit margins.”

There’s also room for growth--at least in the casual-dining category--because the industry is highly fragmented, with no single player or even a handful of chains that dominate.

Moreover, casual-dining chains often start out regionally, honing their concept and business skills. That leaves plenty of room for expansion, their fans say.

CPK, which has 80 sit-down restaurants, plans most of its expansion in markets where it already operates.

“We want to take advantage of our brand name as long as we don’t cannibalize sales,” Hipp said. But the company is also looking for new markets such as Denver, where it is about to open its third restaurant.

Strong Growth Expectations

Cheesecake Factory, long a fixture in Southern California and now going nationwide, operates 38 Cheesecake Factory sites and one Grande Lux Cafe, leaving it with plenty of good growth potential, Overton said.

Investors also have strong growth expectations for Phoenix-based P.F. Chang’s, a Chinese-themed chain.

Indeed, shares of Cheesecake, P.F. Chang’s and CPK now trade at lofty levels typically reserved for very-high-growth businesses. Cheesecake’s price-to-earnings ratio based on estimated 2001 earnings per share is 40. CPK’s 2001 P/E also is 40.

Wall Street expects both Cheesecake and CPK to post 2001 earnings growth of about 23%.

“It is all based on growth projections. People are buying into the future of CPK,” Hipp said. “If we were out there by ourselves it would concern me, but we are in good company.”

Still, most restaurant chains don’t get those kinds of P/E valuations from Wall Street. Fast-food and family-dining chains tend to have much lower valuations, in part reflecting their lower growth rates.

Shares of Glendale-based IHOP have risen 28% this year thanks to the chain’s strong brand backed by predictable growth, Barish said.

But the stock’s P/E based on 2001 earnings estimates is about 10.

Likewise, Jack in the Box shares are up 23% this year, making it one of the stars of the fast-food industry. But the stock is priced at 11 times estimated 2001 results.

Barish said San Diego-based Jack in the Box has benefited from smart advertising and has a focused and efficient business that has achieved five consecutive years of growth in same-store sales--a key measure in restaurants and retailing.

And with 75% of its outlets in California and Texas, Jack in the Box arguably has plenty of room for growth. It has concentrated lately on expanding its business in the Southeast. Barish believes the company is still a good buy, given its P/E ratio.

On Monday, Jack in the Box said operating earnings in its fiscal fourth quarter rose 18% from a year earlier. For the full year operating earnings rose 21.5%, to $1.97 a share.

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Chowing Down

The restaurant industry has turned in some healthy sales and earnings growth this year, and investors finally are noticing: Amid a weak stock market overall, Wall Street suddenly has a voracious appetite for shares of such restaurant chains as Cheesecake Factory and Chili’s Grill & Bar parent Brinker International.

Weekly stock closes and latest for Brinker International and Cheesecake Factory

Cheesecake Factory Monday: $45.50, up 94 cents

Brinker International Monday: $39.25, up 31 cents

Source: Bloomberg News

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A Menu of Restaurant Stocks

Here’s a look at major restaurant chains in three dining categories. Shown is each stock’s price change year to date, analysts’ consensus estimate of earnings per share (EPS) for 2001, and the stock price-to-earnings ratio (P/E) based on the 2001 earnings estimate.

Casual Dining

*--*

Ticker Mon. YTD 2001 2001 Stock symbol close change est. EPS P/E Calif. Pizza Kitchen CPKI $31.88 +113%* $0.79 40 Cheesecake Factory CAKE 45.50 +95 1.14 40 P.F. Chang PFCB 41.94 +69 1.19 35 Brinker International EAT 39.25 +63 2.09** 19 Darden Restaurants DRI 23.50 +30 1.60*** 15 Outback Steak OSI 27.69 +7 2.17 13 Applebee’s APPB 30.69 +4 2.71 11 Landry’s Seafood LNY 8.69 0 0.90 10 Ryan’s Family RYAN 8.13 -4 1.38 6

*--*

Family Dining

*--*

Ticker Mon. YTD 2001 2001 Stock symbol close change est. EPS P/E CBRL Group CBRL 17.94 +85% 1.51 12 IHOP IHP 21.38 +28 2.10 10 Quality Dining QDIN 2.31 +9 NA NA Sizzler SZ 1.88 -25 NA NA Luby’s LUB 5.31 -53 0.78 7

*--*

Fast Food

*--*

Ticker Mon. YTD 2001 2001 Stock symbol close change est. EPS P/E Jack in the Box JBX 25.50 +23% 2.25 11 Sonic SONC 33.50 +18 2.10 16 Wendy’s WEN 23.06 +11 1.68 14 McDonald’s MCD 32.00 -21 1.67 19 Tricon Global YUM 30.56 -21 3.29 9 CKE Restaurants CKR 2.31 -61 -0.04 NM S&P; 500 index 1,432.19 -3 63.54 23

*--*

* change from initial offering price in August

** for fiscal year ending May 2001

*** for fiscal year ending June 2001

NA = not available; NM = not meaningful (can’t be calculated)

Sources: Bloomberg News, Zacks Investment Research (earnings estimates)

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MEAL DEAL?

Debating the pluses and minuses of investing in Darden Restaurants. C8