This story is part of NRN's "2011 Forecast & Trends" special report.
After years of chilly sales and icy credit conditions, analysts and industry watchers are expecting a thawing of sorts in 2011, with private-equity players continuing to inject much-needed heat into the restaurant sector.
Several firms went shopping in 2010, including 3G Capital with its $4 billion purchase of Burger King and, more recently, the Catterton Partners-led acquisition of Noodles & Company. Industry observers expect the spree to gather momentum in 2011.
That’s good news for restaurant chains looking to restart stalled unit growth, said Darren Tristano, executive vice president at research firm Technomic Inc.
Many private-equity firms may also need to invest their capital commitment money before it expires, observers say. If private-equity funds were raised in 2006, for example, there may be only a five-year window before the commitment to invest expires and the funds can no longer be used. Given the dearth of private-equity activity for the past several years, most analysts believe firms are sitting on large amounts of uninvested funds that may soon expire.
Morningstar analyst R.J. Hottovy noted that investors likely want to invest their funds before interest rates increase. Economists predict the Federal Reserve will likely hold interest rates steady until 2012 given the high unemployment rate and low inflation. The Fed funds rate — considered a benchmark for all loans — is currently at 0 percent.
“Private-equity companies are probably looking to make a move … before that window of cheap debt expires,” Hottovy said.
Both Hottovy and Tristano predicted that the future will bring more initial public offerings, and at least one recent deal shows the tide may have turned. Columbus, Ohio-based Bravo Brio Restaurant Group Inc. raised $140 million in its IPO in October 2010. The deal was the first restaurant IPO in four years.
“In the short term, more public companies will be going private,” Tristano said. “But three to five years out, there will be more IPOs.”
Restaurant sales are also on the rise. Morgan Keegan analyst Bob Derrington said in a December note to investors that the back half of 2010 has shown a “stronger and more widespread” rebound in sales.
“Improving restaurant sales trends have been a consistent theme in the restaurant industry over the last several weeks and months,” he wrote. “Based on our conversations with industry participants and other recent data points, we believe this positive momentum is likely to continue.”
The most recent earnings report from Darden Restaurants Inc. seems to bolster Derrington’s view. Darden, which operates the Olive Garden and Red Lobster casual-dining chains, among others, is among the first to report earnings each quarter and is regarded by analysts as a harbinger of industry performance. On Dec. 20, 2010, the chain reported a fiscal second-quarter same-store sales increase of 2 percent at Olive Garden and 6.8 percent at LongHorn Steakhouse, even as same-store sales dipped 1.6 percent at Red Lobster.
Darden chief executive Clarence Otis said on a conference call with investors that the sales increases are likely to continue.
“As the economy recovers even at a pace that is much slower than any of us would like, we’re increasingly confident we can sustain same-restaurant sales growth going forward,” he said.
Analysts also warn investors not to turn a blind eye to some potential pitfalls. Most notably, commodity prices have increased in 2010 and could continue to do so in the upcoming year.
Derrington said most restaurant companies have now contracted for their commodity needs at “manageable levels” of low- to mid-single-digit increases. But even those low levels could inhibit profit.
In addition, rising share prices could turn out to be too high. Derrington said his 45-company Morgan Keegan restaurant index is trading up 37 percent for 2010 — far higher than other major indices, which are up 9 percent to 21 percent for the year.
Hottovy noted that valuations “do tend to get ahead of themselves” when the economy begins to recover. “It’s tough to say exactly when, but we may see some unrealistic expectations reflected into stock prices,” he said.