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On Queasy Street

WALL STREET, CALIFORNIA | SECTOR SPOTLIGHT / JAMES
F. PELTZ

Investors lose their appetites for most restaurant stocks as competition, rising expenses produce skimpy earnings. A few firms show promise, however.

February 11, 1997|JAMES F. PELTZ

Many restaurant stocks have left investors with a bad case of nausea lately, forcing Wall Street to pick carefully at its plate in search of winning food servers.

Already one of the market's weaker groups since last summer, restaurant stocks came under renewed pressure recently after some of the industry's major players--such as Brinker International Inc. (ticker symbol: EAT)--unexpectedly posted lousy results for the final three months of 1996.

Brinker, which operates the Chili's Grill & Bar outlets, is among several restaurant chains whose stocks have plunged 30% or more since May. Others include Outback Steakhouse Inc. (OSSI), Apple South Inc. (APSO), which owns Applebee's and Harrigan's, and Shoney's Inc. (SHN).

"The restaurant industry operating environment remains very challenging," analyst David Adelman of Dean Witter Reynolds wrote recently when he dropped his "buy" rating on Outback.

Consumers are still eating out as much as ever, analysts say. The culprits are stiff competition among the chains, an oversupply of restaurants, certain store or menu "concepts" and themes that aren't working, and rising food and labor costs. The minimum wage, for instance, was raised in Oct. 1 to $4.75 an hour from $4.25.

The massive number of restaurant seats has created virtually a zero-sum game for restaurateurs, so "it seems as if growth by one operator means declines for another," as analyst Marc Gerstein of the Value Line Investment Survey said in a recent report.

The damage is afflicting restaurants of all types, from ubiquitous hamburger chains like McDonald's Corp. (MCD), to casual-dining outlets such as the Red Lobster and Olive Garden units of Darden Restaurants Inc. (DRI), to quick-serve specialty shops such as New York Bagel Enterprises Inc. (NYBS).

Small wonder that PepsiCo Inc. (PEP) recently announced plans to spin off its struggling restaurant group, which includes the Taco Bell, Pizza Hut and KFC chains.

And because those negative trends aren't expected to dissipate soon--indeed, the minimum wage is set to rise an additional 40 cents an hour Sept. 1--analysts are generally bearish on the restaurants, except for a few that continue to flourish despite the industry's problems.

The restaurant stock that's been getting the coldest reaction on Wall Street is giant McDonald's. The stock has lost 13% in the last 12 months. In contrast, the Dow industrial index, of which McDonald's is a component, is up 23% in that time.

McDonald's still enjoys strong overseas results, but its 12,000-store U.S. business has been struggling for several quarters amid the white-hot rivalry among fast-food chains.

In October, McDonald's tapped its chief financial officer, Jack Greenberg, to take over and revive its U.S. operations, and he has his work cut out for him. Last month, McDonald's said its same-store sales--sales at outlets open at least a year--fell in both the fourth quarter and for all of 1996.

Greenberg took over a few months after McDonald's brought its new Arch Deluxe hamburger to market, a project that reportedly cost more than $100 million but that generated mostly lackluster sales.

Analysts said the continued slump in McDonald's domestic same-store sales shows the Arch Deluxe sandwich has not set McDonald's apart from its rivals and that it may be cannibalizing sales of its other offerings. That's prompted speculation that McDonald's will resort to massive price-cutting to recapture customers who have flocked to other chains for 99-cent hamburgers and other "value" meals.

"Because McDonald's does not really compete on quality, I believe it's going to have to compete on price," said Lynne Collier, analyst at brokerage Rauscher Pierce Refsnes in Dallas.

Among the rivals causing McDonald's heartburn is Burger King, a unit of British conglomerate Grand Metropolitan (GRM), and Anaheim-based CKE Restaurants Inc. (CKR), which runs the 665-store Carl's Jr. chain.

CKE's profits, sales and stock have risen briskly, and analysts such as Robert Derrington of Equitable Securities Corp. in Nashville give part of the credit to Carls Jr.'s ad campaign correlating its hamburgers' messiness with their taste.

Regardless, CKE's stock got caught in the sell-off of restaurant shares in late January when other chains posted their poor results. The stock tumbled from $23 a share to $19; it now is at $21.50.

Another McDonald's rival, Wendy's International Inc. (WEN), is also on the upswing and, at a recent $22.75 a share, is also among the few restaurant stocks that are ahead since last May, up 19%.

Wendy's is benefiting from its image as a leader in freshness and quality among fast-food preparers, and new products such as its spicy chicken and stuffed pita sandwiches get high marks, analysts said.

Although Wendy's is one of Collier's favorites, her strongest recommendations focus on selected small casual-dining chains that she believes have strong management, good cost controls and an ability to overcome the problems facing the industry in general.

Her picks include Logan's Roadhouse Inc. (RDHS), a Nashville-based concern that runs 16 restaurants, and Houston-based Landry's Seafood Restaurants Inc. (LDRY), which has 56 outlets.

Times staff writer James F. Peltz can be reached at james.peltz@latimes.com

(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)

Hard to Swallow

Many restaurant stocks have badly lagged the broader market as the chains wrestle with stiff competition and rising costs. A look at some of the industry's players:

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Recent % Change Stock Ticker price since May 1996 Apple South APSO $14.50 --44% Brinker International EAT 11.25 --35 CKE Restaurants CKR 21.50 +62 Darden Restaurants DRI 7.25 --48 McDonald's MCD 45.75 --6 Outback Steakhouse OSSI 25.25 --37 Shoney's SHN 7.50 --36 Wendy's International WEN 22.75 +19 Standard & Poor's 500 +20

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