The casual dining sector has fallen on hard times. Hit by a triple whammy of consumer burnout, lack of innovation, and improving value and quality at fast food outlets, this once-thriving sector is in need of life support.
Despite a bustling economy, casual dining sales are forecasted to climb only 1.7% in 2016, after advancing 2.9% in 2015 and 5.1% the previous year. A recent report by IBISWorld showed that the industry has been impacted by consumers seeking convenience and lower-cost meals.
As you know, I love to see stock pullbacks, as a strong one can be a splendid time to go long. However, not all stocks in the casual dining sector represent value. In fact, I expect one company's shares to continue lower this year. DineEquity (NYSE: DIN) shares have fallen from a double top in the $87.00 per share zone to close to $76.00, and their final bottom is unclear.
At the same time, there is another firm in the same sector whose pullback represents a solid buying opportunity despite the industry's malaise. But let's first take a look at why DineEquity sold be sold if you own it, or even shorted if your risk profile allows for it.
DineEquity owns casual dining chains IHOP and Applebee's, for a total of over 3700 restaurants across the world. The once-popular Applebee's chain has fallen on difficult times, with the last five quarters' same-restaurant sales trending downward. Same-store sales plunged another 5.2% in the third quarter of last year. It appears that the only thing supporting the stock is investor interest in the dividend yield of just under 5%.
99% of all Applebee's are based on the franchise system, which allows individual owners to use the brand name and system. The company provides marketing plans, training software, manuals, support, and logo rights to the franchisee. Franchising is a highly successful method of expansion, as exemplified by McDonald's (NYSE: MCD), perhaps the most successful example of the franchise model.
At the same time, the franchise model makes it difficult to turn things around once the ship starts to sink. It is hard to institute radical changes across the board when the restaurants are owned independently. The Applebee's concept has simply become stale, and the herculean effort needed to improve matters is unlikely to occur.
The company has attempted to spice things up by adding a wood-fired grill concept. The changes have been expensive for franchisees but have failed to improve sales, further decreasing the odds of a turnaround.
Now, Applebee's is going low-end with a buy one, get one entrée special for $12.49. This tactic, which could theoretically help boost sales, is unsustainable over the long term. It also has the unintended effect of hurting the perception of the company among its diehard supporters.
But despite the overall headwinds in the industry, there is a well-diversified casual restaurant company that has set up to be a solid long-term investment. That company is Darden (NYSE: DRI).
Boasting a market cap of nearly $9 billion, Darden is capable of weathering most downturns in the marketplace. Unlike the two-horse show of DineEquity, Darden is diversified across seven brands including The Olive Garden, The Capital Grill, Long Horn, Bahama Breeze, Seasons 52, Eddie V's, and the Yard House. As you can see, the Darden family of restaurants features some of the most recognizable names in full-service dining. Through subsidiaries, Darden owns and operates more than 1,500 restaurants, employs 150,000 people, and serves more than 320 million meals a year.
The company reported a strong fiscal 2017 second quarter, with total sales from continuing operations increasing 2.1% to $1.64 billion.
DRI's earnings per share came in at $3.46 for the most recent quarter, representing a 28.2% increase over the past year. The company repurchased approximately $19 million of its outstanding common stock during the quarter and same-restaurant sales increased 1.7%. Broken down by brand, all brands except Seasons 52 posted sales gains in the second quarter.
Darden President and CEO Gene Lee commented, "We had another strong quarter with same-restaurant sales growth significantly outperforming the casual dining industry benchmarks, especially at Olive Garden. We remain laser-focused on our operating philosophy rooted in food, service, and atmosphere, and creating memorable experiences for our guests."
Its recent performance shows that Darden is succeeding in meeting the needs of diners. Darden's diversification across food styles, the stock repurchase plan, and the performance in the face of the overall downturn in the sector make it a winning pick.
Risks To Consider: The overall market is soft for casual dining. While I expect well-diversified companies to continue to thrive, the risk remains that the market may continue to suffer, bringing every concept down over the long term.
Action To Take: Sell Dine Equity if you currently own it. Risk-embracing investors may look to short the shares now. At the same time, Darden appears to be a solid, long-term buy in the $72.00 per share zone.
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This article originally appeared on StreetAuthority.com: "A Better Bet In The Declining Restaurant Sector"