What Restaurant Investors Should Know For Earnings Season

• In a report issued Monday, Jefferies analysts share a preview of the third quarter for the restaurant industry.
• They assure that the correction the market recently experienced took a toll on most restaurant stocks as sentiment moved from a “glass half full” view to a “glass half empty” perspective.
• After five years of considerable “post-recession outperformance for restaurant stocks, the recent pull-back shouldn’t be a surprise,” the report adds. Thus, the firm remains selective on the industry, and assures its analysts will focus on wage inflation commentary in the third quarter earnings calls.

Jefferies analysts led by Andy Barish and Alexander Slagle believe third quarter results to be mixed, with some results slightly below the Street’s consensus expectations. Most of their conservatism derives from their expectations for same store sales and restaurant-level margins.

While same store sales figures remained mostly positive over the quarter, traffic continues to be negative. In fact, the experts believe “many have been left wondering what happened to the broad pick-up that really never took place.”

In addition, many of the quick service restaurant companies, which may have benefited from the additional consumer spending seen in the second half of 2014 (mostly related to the drop in gas prices) “are now rolling over more difficult SSS,” the note explains.

The focus this quarter will most likely be put on labor costs, as minimum wage increases at state and local levels, coupled with increasing growth in employment and increased competition, “has led to wage inflation that is pushing north of 3%, not to mention the higher costs of recruiting, turnover and training that may be with the industry for some time to come.” On top of these labor pressures, Jefferies sees a few commodity tailwinds starting to fade heading into the third quarter. This should also impact on margins.

The Word Out There

According to the report, a few themes developing over the quarter include:

1) The McDonald's Corporation MCD “hope trade, with potential to start seeing a US SSS turnaround at MCD, which we are not expecting, but could have negative ramifications around other QSR players and those with higher breakfast exposure given the early October roll-out of all-day breakfast here in the U.S.”

2) Harder same store sales compares from the second half of 2014, “which seems to be generating more scrutiny than usual, and particularly on the traffic component and the need to see positive traffic to maintain valuations.”

3) Fourth quarter calendar shifts, as Halloween will fall on a Saturday this year, and Christmas and New Year’s, on a Friday. In addition, the experts envision potentially tougher weather in the southern states and up the East Coast, as the El Niño weather pattern strongly takes shape in the Pacific.

Below is a table of Jefferies’ new earnings estimates and price targets for the industry.

Source: Jefferies

Disclosure: Javier Hasse holds no positions in any of the securities mentioned above.