Commodity inflation, tepid consumer confidence and onerous year-earlier same-store sales comparisons could complicate public restaurant companies' quests to grow earnings in 2013, according to one analyst's projections.

As a result, restaurant companies will need to demonstrate proactive traffic-driving efforts as they reveal fourth-quarter results, wrote Andy Barish, a San Francisco-based securities analyst with Jefferies & Company Inc., in a research note previewing the coming earnings results for many restaurant companies.

"With increased competitive activity, food inflation and difficult same-store sales comparisons ahead, investors are looking to the fourth quarter for additional comfort that initial 2013 outlooks remain intact," Barish wrote. "Given this backdrop, we think turnarounds will be difficult and favor visible earnings-per-share acceleration stories with strong same-store sales drivers and enough levers to offset pressure from food inflation and growth investments."

In addition to lapping strong sales caused by last year's unseasonably warm winter, restaurants also will contend with commodity prices rising between 3 percent and 5 percent this year, he added. Chains will not have much flexibility to cover that inflation with pricing alone, as the industry increased average menu prices around 3 percent in 2012, he wrote.

"Cost-cutting opportunities and self-help stories are now fewer and far between, and most of these efforts have run their course," Barish wrote. "Given the above average pricing taken during 2012, we think the category will likely restrain itself in 2013 in order to preserve traffic, which could pressure margins more than expected."

As such, he wrote, "only those companies with strong menu innovation and disciplined value platforms" — or other sales drivers like marketing campaigns, daypart expansion or unit remodels — "as well as those with certain cost tailwinds and savings potential, will drive relative upside" this year.

Barish's predictions were based on research for the 18 public companies included in Jefferies' coverage universe, which comprises some of the industry's largest chains but does not include other major players like Brinker International, Burger King, Darden Restaurants, Domino's Pizza or Wendy's.

Brands to bear heavy costs

Barish noted that several restaurant companies would have less room to fight food cost inflation in 2013 with pricing actions, as some brands already have indicated in previous calls with investors.

BJ's Restaurants Inc., for example, said last week that its expected increase of 3 percent in fourth-quarter same-store sales still indicates "choppy" performance in the near future. Barish added in his research note that Jefferies' estimate of a 3-percent same-store sales increase in 2013 for BJ's would be driven not from traffic growth but mostly from price increases between 2 percent and 3 percent. He noted that BJ's new menu, loyalty program and updated bar program could drive traffic and sales over the long term, but they likely would not produce same-store sales in mid-single digits "without sustained economic growth."

Similarly, Bravo Brio Restaurant Group projected taking price increases between 1 percent and 1.5 percent in 2013, but their expected commodity inflation would run 3 percent to 4 percent, Barish wrote. And The Cheesecake Factory is expected to partially offset inflation between 3 percent and 5 percent with approximately 2 percent of menu price hikes, he added.

Chuy's Holdings' food costs are projected to rise between 2 percent and 4 percent, Barish noted, but "the affordable menu keeps mix consistent and gives the company significant price flexibility." The company, which owns and operates 39 units, last week previewed a 5.2-percent increase in fourth-quarter same-store sales and projected 2013 same-store sales growth of 1 percent to 1.5 percent.

Texas Roadhouse Inc. and Ruth's Hospitality Group were much more vulnerable to sharp hikes for the cost of beef in 2013, expected to rise at least 10 percent, Barish noted. Last year, they benefited from favorable costs for produce and dairy offsetting beef inflation, but that will not be the case for 2013. "Ruth's management believes it can manage through these costs with traffic-driving initiatives, like maintaining brand messaging and not discounting like its peers," he wrote.

One chain that should see food cost pressures ease would be McDonald's Corp., which contracted its commodities and lowered the expected growth in prices to between 2 percent and 3 percent, Barish noted.

Kicking sales drivers into gear

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McDonald's biggest challenges in the fourth quarter and first part of 2013 would be difficult same-store sales comparisons to last year's winter-aided results, and the brand responded by shifting its marketing focus heavily to value. "We think the company is buying comps with the increased value push," Barish wrote, "and any same-store sales beat is likely to result in margin erosion."

Yum! Brands Inc. also had to give guidance for bad news in the fourth quarter as the fallout in its China division from bad publicity in its supply chain pressured same-store sales more than originally thought. However, Barish noted, one bright spot that might limit the damage to Yum's earnings in 2013 would be the sales growth Taco Bell has achieved in the United States through new-product news.

"Taco Bell momentum, driven by continued innovation like Doritos Locos Tacos flavors and Cantina Bell proteins, could be an offset," he wrote, "but it is still too early to tell, and we remain cautious until trends stabilize in China."

He also pointed to momentum with sales drivers for optimism with Bloomin' Brands Inc., Dunkin' Brands Inc., Einstein Noah Restaurant Group, Jack in the Box Inc., Panera Bread, Red Robin International Inc. and Starbucks Corp.

Barish wrote that Bloomin' Brands' core chains, Outback Steakhouse, Carrabba's and Bonefish Grill, "have consistently outperformed industry benchmarks and taken share in a tough category via incremental sales drivers" like lunch deals, more limited-time-offers, improved marketing and remodeling.

He would look to the consumer packaged goods channel for growth in Dunkin' and Starbucks, he added. Both companies reported strong sales of single-serving K-Cups over the holidays, while Starbucks' rollout of the Verismo brewing system "could be a meaningful driver," Barish wrote.

He wrote that he expected similar benefits from a new advertising push in 2013 for Panera. "[The brand has the] best top-line visibility in the category, with tangible same-store sales drivers," Barish noted, "including a national cable-TV launch, incremental media spending, new creative, and a broad menu with plenty of new news."

Conversely, he projected Chipotle Mexican Grill to underperform in 2013 because the brand has disclosed no plans for new products or daypart-expanding initiatives in 2013, leaving it only pricing actions to combat high food inflation.

"Chipotle is seeing competition from its highly promotional QSR peer, and we estimate it could see incremental traffic loss," Barish wrote. "The company has the best margins in the business but has no ability to lock food prices."

Contact Mark Brandau at [email protected].
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