On The Money: Commitment Issues

Variables in the first half of the year keep an analyst on the fence.

By David Farkas, Senior Editor -- Chain Leader, 2/1/2007

Nicole Miller Regan, senior research analyst at Piper Jaffray in Minneapolis, can’t say how well or how badly the 14 restaurant stocks she covers will perform this year. After all, consumer spending and commodity prices are anyone’s guess.

What’s the outlook for restaurant stocks in 2007?

As much as we hate it, we’re on the fence. We’d much rather be one way or the other.

Why the reluctance to commit?

We look at five indexes. Same-store sales, which are still negative. Supply and demand, which is becoming more favorable. As for margins, we don’t expect them to expand or contract; we’re looking for sort of flat. Market sentiment is improving. And, finally, the economy remains a question mark as to when consumers will loosen their purse strings.

How long do you expect to fence-sit?

We’ll be on the fence until the end of the first quarter. However, gift-card redemption will be the upside of January. The downside is comparisons in terms of same-store sales. These don’t get easier until the second half of the year.

As far as restaurants are concerned, who has had the upper hand—the bears or bulls?

Bears certainly had the upper hand as we glided into the back end of last year. The biggest question is, with gas prices down, why aren’t sales up? The group wasn’t rebounding as quickly as we expected.

Do investors believe restaurants are valued fairly on fundamentals?

The group is generally fairly valued. There are pockets of stocks that are undervalued where we expect outperformance. Undervalued, that is, because they are higher growth opportunities in comparison. These are relevant concepts with positive same-store sales and that are able to support their growth through cash flow.

Our top picks this year are California Pizza Kitchen, Chipotle and Starbucks.

What could threaten valuations this year?

The wild card is commodities. They have been very favorable the past few years and no worse than flat, in general. Commodity prices, however, tend to go in cycles. As these go on, there’s more risk that commodities can be out of whack. That’s a pressure that’s not anticipated or modeled into projections.

Which commodities in particular?

Cheese, beef and corn. Corn, because there’s more demand for ethanol and an increase in feed prices.

Which managements impressed you in ’06?

Starbucks continues to impress me with the way they evolve their concept. They took a premium coffeehouse experience and brought it to the masses. Now they are embarking on global expansion, which we believe will be critical to their future. Investors really don’t give credit to this management team for what it continues to show in terms of results.

Will those results lead the group?

In terms of earnings, we’re looking for 89 cents per share in 2007. That’s almost 20 percent earnings growth and at the higher end of returns for the group.