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Barclays: 2011 a good year for restaurants

The past quarter’s rebound in sales, traffic and stock prices across the restaurant industry should continue through 2011, albeit at a slow, steady pace, securities analyst Jeffrey Bernstein of New York-based Barclays Capital said in a report Tuesday.

Even more, restaurants could realize a greater upside in the coming year if they sustain traffic-driving momentum and take appropriate pricing measures to combat wage and commodity inflation, he said.

“Over the past three to six months, we have seen a sequential improvement in traffic trends across the broader restaurant segment, albeit still negative,” Bernstein said. “Looking to 2011, we are expecting a continued slow but steady improvement in such trend, likely turning positive for the broader category as we move through the year, though still modest.”

Finding the right price point

The key challenge next year likely would be maintaining improved traffic without getting too aggressive in menu price increases, Bernstein noted.

“Looking to 2011,” he said, “we expect a return to modest menu price increases, in the 1-percent-to-2-percent range in an effort to protect restaurant-level margins against a return to commodity cost inflation. … Importantly, we believe commodity cost inflation will be more modest than feared and manageable with a modest menu price increase.”

MORE: Restaurant to gain pricing power in 2011

Restaurant chains that took price increases in the most recent third quarter did so modestly, at around 1 percent to 2 percent. P.F. Chang’s China Bistro raised prices by that much in May and expects that to carry over into 2011, while McDonald’s kept its prices flat from a year earlier. However, management hinted during McDonald’s last earnings call that the nation’s largest quick-service chain would have the flexibility to raise prices slightly next year.

Industry still oversupplied

One of the biggest pressures to comparable-sales growth the past few years was a supply-demand imbalance “with unit growth well ahead of comp growth,” Bernstein wrote. Many chains tried to mitigate that volatility by refranchising corporate stores, but “such efforts have proven challenging of late with available credit for such franchisee acquisitions limited in the current environment.”

“Looking to 2011, we have seen a bifurcation in the restaurant industry as it relates to unit growth,” he wrote. “Several of the historic high-growth concepts have re-accelerated their unit growth, and such has been justified with strong comps. With that said, many of our restaurants have opted to maintain a much more modest unit growth rate, preferring to drive incremental sales to existing stores rather than aggressively opening new stores.”

Of the companies Barclays tracked, Chipotle Mexican Grill grew the most in its most recent quarter, at a 12.5-percent rate, which the brand expects to maintain in 2011. The chain has called for the opening of 135 to 145 units, though Bernstein noted that “a lack of new development sites limits further reacceleration in unit growth.”

Texas Roadhouse, which grew its unit count 3.7 percent in the third quarter, is calling for 20 new locations next year, which would be a 6-percent increase.

Costs a continued concern

Of the industry’s two main expense drivers, commodity and labor costs, Bernstein called commodities the “primary concern of late” for restaurants.

“Commodity cost trends have been volatile over the past few years, most recently to the benefit of our restaurants, with deflation prevalent over the past couple of years,” he wrote.

However, commodity inflation is expected to return next year, he said, though at lower levels than previously thought, which could be managed with modest menu price increases.

“Most restaurants have much more limited visibility relative to prior years, with suppliers offering much shorter-term contracts at variable rates relative to year past, where most offered longer-term contracts at fixed rates,” Bernstein wrote.

As for labor costs, their pressure on the bottom line had been pronounced the past few years due to minimum-wage increases at the state and federal levels, which restaurants tried to mitigate through new scheduling systems. Health care costs would continue to stress profitability, Bernstein noted, though restaurants could benefit from low turnover and pricing flexibility.

“Interestingly, over the past couple of years, any residual pressure from increases in the minimum wage have been offset by employee turnover at historic lows, with unemployment concerns prevalent for the lower-income worker,” Bernstein wrote. “While the broader macroeconomic environment is showing signs of improvement of late, such has been relatively slow to develop. We therefore expect turnover to remain relatively low in 2011, with overall labor inflation likely to be offset by modest menu price increases.”

Two standouts

Two companies under Bernstein’s coverage universe he identified as having higher potential for sales and traffic improvements include Brinker International Inc. and Wendy’s/Arby’s Group Inc. He noted those companies are beginning to shift pricing and marketing efforts away from short-term discounting toward more long-term everyday-value strategies.

While Brinker reported that Chili’s traffic declined 8.1 percent for its most recent third quarter, Bernstein noted that the casual-dining brand did post sequential improvement within the quarter. Meanwhile, Wendy’s rolled out its “My 99” everyday-value menu to build traffic up over the long term, and sister brand Arby’s drove a 15.9-percent traffic increase in October by advertising its $1 Value Menu nationally.

EARLIER: Wendy’s/Arby’s look to menu to drive sale

Contact Mark Brandau at [email protected].

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