Moderating negative trends already modeled in Casual Dining. Year-ago
comparisons eased materially throughout 2008. According to Knapp Track data, 1Q08
was down approximately 1.1%, 2Q08 down 1.0%, 3Q08 down 3.9%, and 4Q08 down
5.8%. We expect a 1-3 points 3Q09 to 4Q09 improvement in Casual Dining, with
overall company expectations ranging from a 3% to 10% decline in 2H09. In C10, we
expect comps of down 1% to up 2%.
As comp expectations already express stabilization, margin improvement is again
key to operating income growth in C10. 2009 has been the year of margin recovery
in casual dining with most companies showing estimated restaurant margin growth
(including pre-opening) despite estimated annual negative comps ranging from down
2-10%. The combination of less direct and indirect costs from new unit openings,
specific focus on cost control, lower commodity costs, and residual pricing taken in
2008 caused major margin recovery for most companies. Operating income growth in
2010 will be largely dependent on traffic driven comp growth as contribution from
new units is minor and further cost cuts are unlikely.
FCF generation to become a major part of shareholder value creation, especially
as debt for most (excluding DIN and RRGB) approaches sustainably low levels.
FCF yields range from 3% to 14%. We recommend OW-rated EAT and DRI for lowset
expectations and below average PE multiples; we also recommend OW-rated
TXRH given COGS-driven earnings benefit near term, fairly low sales expectations,
and longer term growth opportunity.
Total employment is a coincident indicator of QSR sales, and y/y declines are
probably peaking. We track US total employment, which was down an average of
0.4% in 2008 followed by 3.2% decreases in 1Q09, 3.7% in 2Q09, and down 3.8%
QTD 3Q09. These trends correspond to un-weighted US QSR comps of down 0.9%,
down 2.3%, and an estimated down 2-3% over the same period vs. 0.1% for the entire
year of 2008. J.P. Morgan economists do not expect total employment to bottom until
1Q10, and we therefore expect traffic pressure on the need/convenience based nature of
QSR sales until then. We caution investors against assigning too low a multiple on
globally oriented QSR chains with properly low-set expectations such as MCD and
YUM, both OW-rated stocks. In domestic QSR, our favorite is JACK based on low
expectations and a sound brand and corporate strategy.