NEW YORK Some of the largest public casual-dining companies took hits on Wall Street the week of March 12 as two analysts cast doubt on the sector because of low price-point promotions that could eat into margins and possible belt-tightening among consumers in the wake of the sub-prime lending bust.
Securities analysts Joseph Buckley at New York-based Bear, Stearns & Co. Inc. and Matthew DiFrisco at Thomas Weisel Partners, also in New York, said margins among the already struggling bar-and-grill chains could face added pressures heading into the summer. Many in the bar-and-grill group have posted negative sales trends for more than two years, and most are in the midst of turnaround efforts to regain consumer traffic.
Buckley highlighted the recent value-centric television campaigns at Applebee's Neighborhood Grill & Bar, Chili's Grill & Bar, T.G.I. Friday's and O'Charleys. The new promotions feature meals for under $9 – an aggressive price point even for the bar-and-grill segment that typically records lower average checks, Buckley contended.
"This aggression is a sign of growing industry concerns about negative same-store traffic," he said. "The heightened value offering will have to drive traffic to counter what we expect to be a negative impact on check."
Chili's is featuring "fire-grilled specialties" that start at $7.99; Applebee's new lunch offering, the Pick 'N Pair menu items, starts at $5.99; and as first reported in Nation's Restaurant News, Friday's new Right Portion, Right Price offerings are priced between $6.99 and $8.99. O'Charley's is offering "bottomless" soup, salads and bread for $6.99.
"There is a risk to margins," Buckley said. "A lower check implies pressure on labor, occupancy and fixed costs ratios."
Even more, because certain casual-dining stock prices currently are buttressed by the possibility of restructuring - like a possible sale of Applebee's, potential investor activism at Ruby Tuesday and a pending acquisition by Darden - if and when the "restructuring theme" fades, dinnerhouse stocks are "vulnerable," Buckley said.
Analyst DiFrisco downgraded his investment rating on the restaurant sector amid a different set of pressures, mainly the recent news of sub-prime mortgage defaults. Sub-prime is a term used to describe less creditworthy borrowers or lending terms.
In recent weeks, reports have shown increased default rates in the sub-prime segment of the U.S. mortgage market as the housing industry slowed and home prices dropped. More than 20 lenders that focus on the sub-prime mortgage sector have gone out of business as a result.
"The turmoil of the sub-prime lending market suggests the lower-income, casual-dining consumer is feeling pressure," DiFrisco said.
O'Charley's, based in Nashville, Tenn., could be one of the chains most affected by the lending bust, DiFrisco said.
According to his research, O'Charley's customers overlap, both geographically and demographically, with those consumers who would typically receive sub-prime mortgages. In addition, a majority of O'Charley's restaurants are located in areas with the highest proportion of sub-prime mortgages, he said.
"Part of [O'Charley's] strategy to turn around operations has been to increase its average check," DiFrisco said. "This transition now appears more difficult as [O'Charley's] faces a more cash-flow-constrained consumer."
O'Charley's countered that claim and highlighted its efforts to seek out less price-sensitive consumers by eliminating its Kids Eat Free program and reducing coupon usage during the past 18 months.
"O'Charley's core guests are smart with their money and financially savvy investors," said chairman and chief executive Greg Burns. "We believe these core guests are less susceptible to financial difficulties resulting from mortgage rate increases typically associated with sub-prime mortgages defaults."
