This Week in Food and Restaurants
by Aristotle Munarriz (MF Edible)

Miami, FL (April 5, 1997) -- There was a time when earnings reigned paramount. Every quarter, the masses would gather as companies perched high on their thrones would wave to the crowd, utter their earnings per share (eps), and let the market react accordingly. Of course the same store sales figure, the comparable revenue growth or decline per unit, has also weighed heavily in the restaurant sector court and it seems as if it has recently staged a coup d'etat and snatched the crown from eps.

The initial reaction is that the figures should zig and zag collectively. However, with so many cash-rich companies red-dotting the landscape with their eateries it is common to find companies with lower unit sales and strong revenue growth, which often translates into higher earnings. Again, this is old school. One does not buy DAVE & BUSTERS <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: DANB)") else Response.Write("(Nasdaq: DANB)") end if %> expecting the chain's dozen units to grow sales at each restaurant 30% a year. If CHHESECAKE FACTORY <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: CAKE)") else Response.Write("(Nasdaq: CAKE)") end if %> is always packed, where's the room for unit sales improvement beyond hiking menu prices or adding restaurant seats in the bathroom? The answer is that one buys these chains hoping for steady performance at the individual units, with the real wager being on the successful rollout of the young concept elsewhere.

So analysts look at their crystal balls, take out slide rules and talk to management in hopes of getting a firm grasp on unit economics and expansion plans. Again, don't doze off if you have heard this before. Lately the analysts are messing up on both counts and it is interesting to see the market reaction. In recent cases with Edible Eight entries LONE STAR STEAKHOUSE <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: STAR)") else Response.Write("(Nasdaq: STAR)") end if %> and RAINFOREST CAFE <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: RAIN)") else Response.Write("(Nasdaq: RAIN)") end if %>, analysts have underestimated quarterly earnings at the same time they underestimated the severity of same store sales declines. Earlier this week, Lone Star reported earnings of $0.44 a share, a full two cents ahead of consensus pegs, yet were shocked by a 5.1% same store sales decline. The stock tanked in the process, after falling plenty since late-March in sympathy with OUTBACK STEAKHOUSE <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: OSSI)") else Response.Write("(Nasdaq: OSSI)") end if %> and its announcement of soft earnings.

Why does the stock react to the unit sales decrease and not the bottom line increase? Simply put, it questions the sustainability of the concept, short-term. Every restaurant chain goes through periods of lagging sales. The world's largest company, MCDONALD'S <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: MCD)") else Response.Write("(NYSE: MCD)") end if %> is going through a slump right now and the entire restaurant sector had lower same store sales last year. By the same token even sleepy forgotten stocks manage same store sale hikes, like IHOP <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: IHOP)") else Response.Write("(Nasdaq: IHOP)") end if %> announcing on Thursday that unit sales for the month of March rose 3.8%. So tides will rise, tides will fall. Why are companies like Lone Star and Rainforest Cafe being beaten down for a cyclical rut when their managerial expertise is more than offsetting the slowdown? So, the puzzler is, if sales fell more than expected, and earnings rose more than expected, is there anybody left to reward the company for the unexpected margin improvement? Any takers? Or will Wall Street wait for sales to increase at the unit level and earnings to underperform to begin courting the sector and its reduced margins once again?

THE EDIBLE EIGHT

During a rough week, where Dramamine was required medicine, the E8 sunk into negative territory but still well ahead of the 143-stock restaurant index tracked by Investors Business Daily, which extended its annual losses now to double-digits.

1997 Returns To Date:

The Edible Eight      -1.8%
NASDAQ                -4.2%
S&P 500               +2.3%
Fidelity Sel: Food    +3.5% (as of Thursday)
IBD: Restaurants     -11.0% (as of Thursday)

Until next week, Digest Foolishly,

MF Edible

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