Ms. Meyer: Restaurant stock performance has been a mixed bag this year, with some stocks doing well and others not. This comes on the heels of a good performance for many in 1998 and late 1997. That period of time was characterized by improving same-store sales and margins because supply growth slowed, while demand growth stayed strong. This year, those fundamentals have remained in place, but the shares have weakened despite that. So as we sit here at the end of the year, the stocks, for the most part, have been disappointing, but the fundamentals have not been. There has been a disconnect between the stocks and the fundamentals. The disconnect has come, in our view, because investors are looking into the future and projecting that same-store sales will slow, labor costs will increase from a rising minimum wage, and food cost pressures will escalate, especially beef. We believe there is truth to some of these issues, such as the rising minimum wage, but all are not apt to occur. Therefore, we think the market is discounting an overly negative scenario.
TWST: Paul, what stands out most clearly in your mind as you review the
performance of the restaurant stocks through '99 and compare it with the
performance of the stocks over the last several years?
Mr. Westra: What sticks out the most is a false turnaround in the group
after several years of poor performance during most of the mid-1990s.
Specifically, most restaurant stocks were up 50% or more from October
1998 through April 1999. However, since April 1999, most restaurant
stocks have now retraced and are back to near their mid-1998 levels. As
a result, today's investors currently do not have a lot of buy-in into
our 'this time is different' bullish thesis on the group. In short, we
are telling investors to significantly overweight restaurant stocks. Our
thesis is that historically restaurant stocks have only statistically
outperformed the market during recessions, and that the restaurant
industry's business cycle has de-coupled from the overall U.S. economy
and it is now in a theoretical recession. Restaurant stocks typically
outperform during recessions because capital markets and restaurateurs
normally overreact to an economic downturn, which results in near-zero
net restaurant supply growth. However, real demand usually remains
positive during a recession. Therefore, during recessions, restaurants
typically enjoy real same-store sales growth, real pricing power and,
most importantly, significantly reduced management turnover as thousands
of existing managers are not quitting their jobs to join hot, startup
concepts. This fact results in much better industry-wide execution
during recessions that, ultimately, can drive 20%-plus expansions in
industry-wide margins. To note, the number one determinant of a
restaurant's profitability is the tenure of its general manager. Our
thesis is simply that supply growth is now near zero in 1999, a level
never before achieved other than during a recession. As such, we see the
restaurant industry in a unprecedented period of collusion. The result
is restaurateurs are now enjoying recession-type benefits of zero supply
growth without actually having to pay for such benefits in the form of
slower demand growth. This is a very bullish scenario, in our opinion.
Tickers included in this excerpt: BOBE, CAKE, CBRL, CKR, DRI, EAT, MCD, OSSI, PFCB, SBUX, WEN, YUM
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