26 Sep

The Restaurant Industry: An Overview

WRITTEN BY Rekha Khandelwal, CFA

Eating out is fun, and an increasingly higher number of people believe that. A higher number of Americans are eating out, and they are eating out more often. The restaurant industry’s share of the food dollar has risen from 25% in 1955 to 51% in 2019.

According to the National Restaurant Association, industry sales are projected to reach $863 billion in 2019. That figure is 4% of the US GDP. The industry is projected to employ 15.3 million people in 2019, which is roughly 10% of the working population.

Several factors have contributed to the growth of the restaurant industry, including rising income levels, better hospitality, and a variety of cuisines. Restaurants have become an essential part of people’s lifestyles. The National Restaurant Association noted, “According to data from the Bureau of Labor Statisticshouseholds with annual income of at least $70,000 were responsible for 63 percent of total restaurant spending in 2018.”

About 40% of households had an annual income of more than $70,000. So, 40% of households accounted for 63% of total restaurant spending. Higher-income households have risen steadily over the years, partially contributing to the growth of the restaurant industry’s sales.

Types of restaurants

The types of restaurants offering options for people to eat out are numerous. Let’s take a look.

  • Quick Service Restaurants (or QSR) or fast-food restaurants generally offer limited menus with items that can be prepared quickly. Customers either eat on the restaurant’s premises or opt for takeout. Examples include McDonald’s (MCD) and Kentucky Fried Chicken (or KFC).
  • In contrast, full-service restaurants offer table service and often have more menu choices. The items offered typically require more steps and time to prepare. A wider variety of cuisines is generally available, and the cost of the meal is usually higher than a QSR. Examples include Ruth’s Chris Steak House or Texas Roadhouse (TXRH).
  • Home delivery and takeout services have seen rapid growth in recent years. According to the National Restaurant Association, delivery sales for the majority of restaurant operators across segments have risen compared to just two years ago.

In addition to the above factors, consumers have the option of eating in cafés, grills, and bars, which primarily focus on drinks, as well as street shops, food trucks, and kiosks, which offer limited items, often at low prices.

Operating metrics

While there are many ways to measure a restaurant’s performance, there are certain key metrics that are commonly used to assess its performance. These include:

  • Comparable-store sales: Same-store or comparable-store sales refer to the sales of a restaurant chain’s existing outlets (typically including outlets in operation for more than a year) in a period relative to the sales in the same period in the prior year. Investors usually measure the change in percentage terms.
  • Comparable guest counts: Comparable guest counts refer to the transactions of a restaurant chain’s existing outlets in a period relative to the transactions in the same period in the prior year. Investors usually measure the change in percentage terms.
  • Average check: This is the average amount billed per customer.

Notably, changes in guest counts and check size drive the changes in comparable-store sales.

Top industry trends

Although people have been eating out for many decades, the industry continues to evolve. The players adjust their offerings based on evolving consumer needs and preferences.

  • Home deliveries and takeout services have seen rapid growth in recent years. Delivery sales for the majority of restaurant operators across segments have risen since 2017. As a result, more operators are offering delivery options to capture this growth trend. As an example, McDonald’s (MCD) is expanding the number of outlets that offer food delivery.
  • Technology has changed how customers order, pay, and are served. The use of mobile apps and self-order kiosks offer customers ease of ordering. So, restaurant chains are increasingly adopting these options to drive sales growth.
  • For large players with international operations, the franchise model works best. Typically, the company owns the premises or secures a long-term lease for the location. The franchisee invests in the equipment, furniture, and fixtures. As an example, franchisees operate 93% of McDonald’s restaurants.
  • In response to a shift in consumer preferences, restaurants have increased their focus on healthy food According to a survey by the National Restaurant Association, 61% of consumers say they order more healthful food at restaurants than before. Similarly, a rising interest in vegan or vegetarian food options has resulted in the rise of plant-based packaged food providers such as Beyond Meat (BYND). Beyond Meat uses restaurants as one of the channels to sell its products.

Key risks for restaurant companies

Restaurant companies face several risks. Many of these are also common to other businesses, such as the loss of key personnel or a decreased brand value, resulting in lower customer growth. Let’s take a look at some risks more specific to the restaurant business.

  • While the franchise model offers several benefits, it also exposes companies to certain risks. These risks include the company’s dependence on the ability and willingness of franchisees to implement new initiatives, their ability to maintain food safety, and their ability to grow business.
  • Over the past few decades, restaurant chains have grown in size. As a result, food safety, which has always been vitally important, has gained more prominence. Any incidence relating to food safety may tarnish a brand’s image and seriously impact its business. One such example is Chipotle Mexican Grill (CMG). Multiple E. coli outbreaks in 2015 marred Chipotle’s image. The company and its stock took more than two years to recover.
  • The supply of material used in making the food and drinks served in the restaurants may become disrupted or become more expensive. This may happen because of a disruption in supply due to weather, natural disasters, and transportation issues. Although some of the raw materials are easy to get from other sources, others may not be as easy to obtain. For example, Starbucks (SBUX) uses specific arabica coffee beans. A disruption in the supply of these coffee beans could impact the company’s performance.

S&P 500 restaurant companies

From kiosks to quick-service restaurants to full-service restaurants, there are innumerable options available to the customers. Many of these operate privately, from small shops to popular brands like Subway, Chick-fil-A, or Panera Bread. However, investors have numerous options to make an investment in the sector. Let’s take a look at some of the top players.

The S&P 500 Index includes five restaurant companies—McDonald’s (MCD), Starbucks (SBUX), Yum! Brands (YUM), Chipotle Mexican Grill (CMG), and Darden Restaurants (DRI). McDonald’s and Starbucks are the largest restaurant companies based on market capitalization.

The Restaurant Industry: An Overview

Yum! Brands owns Taco Bell, KFC, Pizza Hut, and WingStreet brands. Darden owns Olive Garden, LongHorn Steakhouse, and Cheddar’s Scratch Kitchen brands. It also owns Yard House, The Capital Grille, Bahama Breeze, Seasons 52, and Eddie V’s. Unlike McDonald’s, Starbucks, and Yum! Brands, Darden Restaurants is a full-service dining company.

Chipotle Mexican Grill identifies itself as fast-casual, which generally means a restaurant with more service and menu options than its fast-food counterparts. However, they offer fewer options and services than a full-service restaurant. For investors looking for restaurant stocks, there are many interesting options. Let’s take a look at some more below.

Other players

Canadian company Restaurant Brands International (QSR) owns popular brands like Burger King, Popeyes, and Tim Hortons. The company was formed in 2014 with the merger of Burger King and Tim Hortons.

Investors looking for mid-cap stocks have options including Dunkin Brands (DNKN), The Wendy’s Company (WEN), Shake Shack (SHAK), Texas Roadhouse (TXRH), and Jack in the Box (JACK). As the above table shows, most of the listed restaurant stocks are small-cap stocks. Brinker International (EAT) owns popular brands like Chili’s Grill & Bar and Maggiano’s Little Italy.

Notably, all the small-cap restaurant stocks in the above table, except Papa John’s International (PZZA) and Denny’s (DENN), generated negative returns in the trailing one-year period. In contrast, all six large-cap stocks generated positive returns over the same period.

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