Wall Street applauds brands’ candor about tough times

Wall Street applauds brands’ candor about tough times

As public restaurant companies ride out the violent swings of the rattled stock market, operators are changing the way they speak to Wall Street, laying bare faults that a few years ago would have been viewed by investors as the kiss of death.

Call it a new kind of transparency. Instead of focusing on growth as the Street traditionally has demanded, restaurateurs who answer to shareholders today are highlighting painful steps being taken to position their companies for future prosperity when the economy and stock markets regain positive momentum.

(To view charts featured in this week's financial pages, click here.) [3]

Whether such operators are closing a slew of underperforming units to boost cash flow, or electing to take a hit on profit margins today by maintaining low prices so customers will come back tomorrow, all eyes appear focused on the negative. In any case, it’s nearly impossible, some say, to mask a company’s warts in the current environment.

“It’s been very difficult for restaurants for two years now…and there is just nowhere left to hide,” said Sharon Zackfia, lead restaurant industry analyst and principal at William Blair & Co. “There are very few rose-colored glasses in the room.”

Zackfia’s observations were made June 30 at the Nasdaq Food and Restaurant Industry Forum in New York, sponsored by the National Restaurant Association [4].

Any kind of insight into a company’s operating plans can help observers piece together an accurate picture of the returns a business can produce in this uncertain economy, she said.

“It’s hard to get investors excited because there is no visibility to the bottom line,” Zackfia said. “Valuations are tough; there is a lot of uncertainty out there.”

When any ounce of visibility is granted—even through bad news like restaurant closures, reduced growth plans or employee firings—it has been met with kudos from analysts or rising share prices.

For example, when Starbucks [5] said July 1 it would close a total of 600 U.S. locations—a 500-unit increase from the previous target and a figure representing 8 percent of its U.S. chain—its stock price increased and most analysts praised the decision.

After an analyst upgrade based on Brinker International [6] Inc.’s stated plan for “slower growth, asset divestitures and refranchising opportunities,” that company’s stock price jumped 2.5 percent.

“Almost all investors are looking to 2009,” said Bruce Aust, executive vice president of the global corporate client group at Nasdaq, “and until then, they’re really just minding the store.”

Aust added that there was a large pipeline for capital-raising activities once the market turns—it’s just that no one knows when that will occur. However, restaurants may be one of the first industries to rebound once the market does turn, he added.

Aust is responsible for the development and relationship management of all Nasdaq-listed companies, meaning he works to match public companies with investors.

Restaurant operators, just like their investors, are minding the store as well. Companies large and small are closing units, reducing staff and even accepting reduced profits for increased traffic in the short term by keeping menu price hikes below the level of inflation.

Caribou Coffee Co. [7] Inc., operator or franchisor of about 440 locations, closed about 28 coffeehouses in 2007 and plans to close about the same number this year, said chief financial officer Kay O’Leary.

“We’re contracting to better prepare for growth when the market gets better,” she said.

In addition to closures, Caribou is looking to ramp up its franchise growth, like many restaurant companies have decided to do in the down market.

“All chief financial officers love franchising,” O’Leary said. “It’s the ‘other people’s money’ principle.”

The CFO of Sonic [8] Corp., parent of the 3,400-unit drive-in brand, said that chain will continue focusing on value-oriented specials, like its Happy Hour promotion of fountain drinks, to encourage customer visits.

The drink specials had reduced profit margins in the latest quarter, Sonic said, but boosted traffic as much as 20 percent in some markets. The chain is now focused on upselling snack items with a drink purchase to help boost the check average.

“Anyone would take that kind of traffic boost today,” said Todd Townsend, Sonic’s marketing chief. “Value cannot overtake your brand in the long term, but it is what consumers want today.”

Finding the right pricing structure is more art than science, as a boost in pricing to cover today’s higher costs may alienate guests. Ruby Tuesday [9] conceded as much when it said its restaurants would offer more value-focused items on its higher-priced menu, which was part of an overall brand reinvention that led to traffic deterioration.

Yet Panera [10] Bread said the 5-percent menu price increase it took during the last 12 months hasn’t affected traffic at all, and it remained positive through June.

“We believe many chains may sacrifice some menu pricing and profitability,” said Bob Derrington, an analyst at Morgan Keegan & Co. in Nashville, Tenn., “opting instead for traffic-building promotions, versus the risk of alienating consumers with overly aggressive pricing.”