Are Restaurant Chains Serving Up an Earnings Feast?

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Americans love to eat out, which makes restaurant companies' financial results a useful barometer of the state of the general economy. The National Restaurant Association reported that the average household spent $2,620 on food outside the home in 2011. But when consumers' budgets are tight, they don't dine out as often. By taking a look at how restaurant chains are doing, we can get some clues about how strong this recovery really is.

The National Restaurant Association's
Restaurant Performance Index crested to a 14-month high in May, having risen three months in a row. Its Expectations Index reached its highest level in a year, reflecting restaurant operators' optimism that they will see sales increases in the near-term. 

Ruth's beefs up its bottom line

Ruth's Hospitality Group, Inc. (NASDAQ: RUTH) owns Ruth's Chris Steak House, Mitchell's Fish Market, Mitchell's Steakhouse and Cameron's Steakhouse -- all upscale dining concepts. If they are doing well, it would indicate that consumers have regained their optimism, at least to a degree, and are willing to spurge on a relatively expensive meal.

Ruth's is in fact doing very well. The company's first-quarter revenue, for the period ended March 31, was up 7% compared to the same period last year, topping $107 million. It achieved net income of $7.7 million after incurring a loss the same period last year.

Comparable-restaurant sales (restaurants that were in operation both years) for the 63 company-owned Ruth's Chris Steak House locations rose nearly 7% as guest traffic increased 2.9% and the average guest spent 3.6% more per meal. Their 73 franchise properties showed only a 1% sales increase compared to 2012. In the company's press release, CEO Michael P. O'Donnell cited Ruth's Chris brand generating 12 consecutive quarters of positive comparable sales.

Is that Superman at the table by the window?

IHOP, or International House of Pancakes, along with Applebee's Neighborhood Grill & Bar are owned by DineEquity, Inc. (NYSE: DIN). This company is the one with more than 3,600 locations. The recently released
Hollywood blockbuster "Man of Steel" includes scenes at an IHOP restaurant. This is clever restaurant concept repositioning for a chain whose concept may seem a bit dated -- an attempt to appeal to the film's youthful audience.

Now let's see whether DineEquity could vanquish its own powerful adversaries in the first quarter of 2013. Applebee's domestic same-restaurant sales unfortunately decreased 1.3% compared to the same quarter last year. They reported a decrease in guest traffic that was only partially offset by a higher average guest check. IHOP's results were much the same, a decrease of 0.5% in same-restaurant sales.

Adjusted net income of $21.8 million was down from $24.6 million in the first quarter of 2012. But this may be comparing apples to oranges, or in this case hotcakes to quesadillas, because the company refranchised 154 formerly company-owned Applebee's properties in the course of 2012, which reduced the segment profit even though there were considerable savings in general and administrative expenses and interest costs.

In the company's press release, CEO Julia A. Stewart said they are "laser focused on managing their capital structure and G&A."  She also said the company still faces "a challenging consumer environment."

At least these competitors can agree on something...

Darden Restaurants (NYSE: DRI) owns and operates more than 2,100 restaurants under the well-known brand names Red Lobster, Olive Garden and LongHorn Steakhouse.

In the announcement of their fourth quarter results and fiscal year ending May 26 results, Darden CEO Clarence Otis described them as reflecting "an encouraging end to a difficult year." To cope with sluggish same-restaurant traffic growth, the company implemented measures to match competitors' promotions and to revise their core menus to be more affordable for the average guest. They expect fiscal 2014 to be pretty much the same: "with slow and uneven recovery in both the overall economy and our industry," as CEO Otis stated.

Let's look at Darden's quarterly numbers. Same-restaurant sales increased only 1.1% at Olive Garden. Red Lobster did better with a 3.2% increase, and LongHorn Steakhouse managed a 3.5% increase. These results represented a rebound from earlier quarters, when the company's brands fell behind the industry averages for same-restaurant sales growth. Fourth-quarter net earnings from continuing operations were $133.3 million, down from $151.6 million in the fourth quarter in 2012.

Olive Garden's food and beverage expenses and labor expenses were higher on a percentage-of-sales basis than they were in the same quarter of 2012. G&A expenses were basically unchanged. The result: lower operating profit than the previous year. The story was exactly the same for Red Lobster. LongHorn Steakhouse experienced unchanged food and beverage expenses, higher labor costs and lower G&A expenses. The net result here was higher operating profit for the quarter.

Now, about the stocks...

When you look at these companies side-by-side, you clearly see the struggle to maintain a healthy pace of growth.  Here's how I would rank the stocks:

My second choice would be DineEquity. Evolving more into a franchise company makes great strategic sense. They will be able to operate leaner and deliver more earnings to shareholders. They are also unleashing the entrepreneurial spirit in their franchise operators which makes these managers more driven to succeed.

Regarding Darden, my third choice, Olive Garden may be a brand that is nearing the maturity stage, despite the enduring appeal of free breadsticks. 

I like Ruth's Hospitality Group the best of the three. Their niche market is willing to pay a premium for premium quality food. In most metro areas, there are a limited number of high-end steakhouses but a virtually endless number of family-style dining establishments. They expand their number of company-owned restaurants cautiously, with a sharp eye on that key metric, same restaurant sales growth. They are taking full advantage of franchise opportunities in foreign cities where the appetite for their steak house brand is strong.

In looking at each of these companies, keep an eye on the same-restaurant sales growth, not just total revenue growth. Restaurant chains can "buy" revenue growth by acquiring other chains, which can make the year-to-year revenue comparisons misleading.

Brian Hill has no position in any stocks mentioned. The Motley Fool owns shares of Darden Restaurants. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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