It pays to be picky when investing in U.S. restaurants, as an expected recovery is already priced into many of the segment's share prices after an epic beat down during the recession.
Shares in Olive Garden parent Darden Restaurants Inc. and Chili's Grill & Bar parent Brinker International Inc., two of the largest "casual dining" chains, are up 55 percent and 63 percent from their respective 52-week lows.
Such share price gains were not unusual in the last few months as investors bet an improving U.S. economy would spur diners to again venture out of their kitchens for meals.
"It does feel like they had gotten way too beaten down ... this run was to some extent playing catch up," said Bernstein Research analyst Sara Senatore. She added that future gains will not come from the simple act of "holding your nose" and buying with the knowledge that things would get better.
Darden and Brinker, which are almost halfway through their 2010 fiscal years, trade at 14.2 and 13.5 times 2011 expected earnings, respectively.
By the start of this month, restaurant stocks in a Standard & Poor's sub index were trading at 16.2 times earnings expectations for the coming 12 months, a 14 percent premium to the S&P 500, according to a Bernstein analysis.
Going forward, investors need to watch for growth opportunities as well as pitfalls that could erase gains.
Darden and Texas Roadhouse haven't exhausted cost-cutting options and are best positioned to add new U.S. restaurants, moves that analysts said could boost shares.
Likewise, the outcome of high-risk, and possibly high-reward, turnaround efforts at DineEquity Inc.'s Applebee's or Brinker's Chili's chains will be reflected in share prices.
Many restaurants have cut expenses to the bone, so the ones that have healthy same-restaurant sales growth will handily outperform those that don't.
To that end, Senatore, noted a growing divergence between Darden and Brinker.
Darden recently boosted its 2010 profit view on improving consumer sentiment, prompting Senatore to raise her 2010 profit target by 3 percent and her 2011 earnings view by 0.6 percent.
For its part, Brinker issued a 2010 profit outlook that missed expectations as it tries to improve Chili's operations. Senatore slashed her 2010 profit view by 13 percent and gave her 2011 view a 10 percent haircut.
Both companies continue to expect overall same-restaurant sales to fall for all of fiscal 2010.
But Darden's sales at established Red Lobster, Olive Garden and LongHorn Steakhouse restaurants recently have been trending flat to slightly higher, while Brinker's flagship Chili's chain has been posting declines that more than outpaced improvements from its smaller Maggiano's Little Italy business.
"That is potentially indicative of the type of gap we're going to see" ahead, said Senatore, who rates Darden "outperform" and Brinker "market perform".
As consumer companies fight for every discretionary dollar, top operators will widen their lead, experts said.
"When every dollar counts ... people are really, really careful about wanting a guaranteed experience," said industry consultant Malcolm Knapp.
Overall visits to U.S. restaurants have been flat to negative for nearly two years and are expected to remain negative through August, NPD analyst Bonnie Riggs said.
But visits to casual dining chains have been on a slow climb since last July, said Knapp, whose Knapp-Track monthly sales and guest count data is an industry benchmark.
"January and February were stronger than I thought they were going to be given the pent up demand for other retail goods," said Knapp. Recent job gains should help guard against another dip in casual dining, he said.
People with annual incomes of $40,000 or less on the low side and $150,00 and above have been spending more at casual dining chains, though overall spending remains frugal, said Bill Pecoriello, chief executive at Consumer Edge Research.
He sees Brinker, Darden, the Cheesecake Factory, P.F. Chang's China Bistro and Applebee's parent DineEquity Inc. as poised to benefit.
Casual dining executives are quick to temper enthusiasm with warnings about the volatile economy and high joblessness since the price for missing Wall Street expectations is high.
Brewery and restaurant operator BJ's Restaurants Inc. found that out last quarter when its profit missed Wall Street's view and shares dropped almost 13 percent.
Darden, Brinker, Cheesecake Factory, P.F. Chang's and BJ's are expected to match analysts' targets in their next quarterly financial reports, according to Starmine's SmartEstimate, which places more weight on recent forecasts by top-rated analysts.
But there are some wild cards.
According to SmartEstimate, California Pizza Kitchen could top Wall Street's call for a quarterly profit of 75 cents per share by 4 cents.
The outlook for DineEquity is much murkier. The average estimate from six analysts calls for a quarterly profit of 78 cents a share, but the top-rated analyst is predicting it will deliver a profit of just 62 cents a share.
DineEquity's shares closed at $41.86 on Wednesday, more than triple their 52-week low of $12.95.
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