Happy 10th National Pancake Day!
Although a fun day for the likes of pancake flippers IHOP, Denny's and countless roadside diners, there is more going on in the restaurant industry than free short-stack giveaways and lower gas prices spurring visits by hungry Americans. And the market knows there is more at play in the sector, sending shares of sit-down restaurants such as DineEquity (DIN) and Brinker International (EAT) surging in the past several months, along with further gains for pizza makers Domino's (DPZ) and Papa John's (PZZA) to better burger and hotdog purveyor Sonic (SONC), whose CEO I interviewed last November.
So what gives? The restaurant industry, excluding struggling McDonald's (MCD), is being reborn right in front of our very own eyes. The fundamental transformations I am seeing -- from how data are used to how menus are revamped -- are impressive. These structural changes will yield outsized earnings growth during pockets of improving U.S. economic conditions, as we are experiencing now.
I'm interviewing DineEquity CEO Julia Stewart later today (to be published Wednesday), and here are the three burning issues that I see facing the industry.
More effective marketing: Before 2013, restaurants would inundate TV with a single promotion -- for a specific new entrée at a specific point in the day (referred to by the industry as a "daypart"). Now, however, restaurants are spreading marketing investments out to different dayparts, which is creating a consistent stream of traffic. The impact of this could be seen at DineEquity's IHOP. In the fourth quarter, IHOP had positive same-restaurant sales in all dayparts, which is impressive considering its menu offerings for lunch and dinner are not as extensive as those of its breakfast offerings. That definitely highlighted how a revamped approach to marketing for restaurants, one also being seen at Brinker-owned Chili's, could yield tasty benefits.
A "golden age" of ingredients and flavor combinations: DineEquity just rolled out something called a "Pub Diet" at its Applebee's chain, highlighting shareable plates of interesting foods. An example: a churro with a chocolate dipping sauce. Another dish boasts a favorite of Millennials, quinoa. Items such as these not only excite the customer, but they are often unique to a restaurant. Further, smaller plates generally mean fatter profits because a group will order more plates for the table so that everyone can get full and within approachable price points. We are also entering a golden age for the bars at Chili's and Applebee's. The drinks are better prepared, and there is an emphasis on premium spirit combinations. If you have watched Spike TV's "Bar Rescue," you will be aware that the trend toward cocktail mixology could be quite lucrative to bar owners. Mixology is now moving outside of hipster mom and pop joints in urban areas and into publicly traded restaurants that call suburbia home. To get some context: alcohol sales are about 14.5% of DineEquity total sales.
New, bold menu items that just make sense: The restaurant industry has long been synonymous with poorly thought-out new menu additions. Remember TGI Friday's Tex-Mex Tower? Or how about Burger King's enormous fried fish sandwich, the Whaler? Those days of silly new items are in the rearview mirror, in large part because big data and good old-fashioned research are helping to understand consumer preferences at a minute level. Yum! Brands' (YUM) Pizza Hut now sells skinny pizza at 250 calories per slice. I received an email from a contact that Dunkin' Brands (DNKN) just introduced a limited-time spicy omelet breakfast sandwich. This seems like a win to me, targeting preferences by many for indulgent breakfast sandwiches with a little kick (see Yum!'s Taco Bell Crunchwrap AM Supreme). Starbucks (SBUX) last week quietly released a host of new pre-made drinks to be sold in grocery stores, some featuring a favorite of workout lunatics like me: protein. The product risks are being minimized and, by extension, so are the risks of holding restaurant stocks.
Finally, old-school restaurants finally have the capital to reinvest in newer, flashier restaurant remodels. In doing so, they are positioning themselves to compete with upstart fast-casual chains that include Blaze Pizza, PizzaRev (part owned by Chipotle (CMG)), or NYC's Dig Inn that have inviting interior ambience and external signage that grabs in the eye.
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