Grains Oilseeds

[johnlw]

Note to buyers: Go for the steak, not the sizzle

Hollie Shaw, Financial Post Published: Saturday, February 16, 2008

Do rising food prices and the prospect of lean times ahead make investors want to sink their teeth into a juicy steak?

First the bad news. Indications are that family dining outlets and mid-tier restaurant chains, like KFC and Pizza Hut, are vulnerable in these times of higher food prices. As well, with signs that the economy in parts of the country is weakening, publicly owned companies like Priszm Income Fund, which operates KFC and Pizza outlets in Canada, are finding they have to take steps to survive in the ultra-competitive casual dining sector of the restaurant market.

Priszm, with more than 400 restaurants under banners that also include Long John Silver's and Taco Bell, announced that it would close 25 restaurants and sell up to 120 other locations over the next 24 months. Among the factors it mentioned was the higher prices for chicken that are gobbling up profits.

Here's how BMO Capital Markets analyst Chris Bolton describes the situation at Priszm: "Same-store sales have been negative for three consecutive quarters, food and labour costs have increased recently, and the Ontario economy appears to be slowing." He rates the fund as a "market perform" with a $6 target, a long drop from a 52-week high of $11.99

Restaurant operators report that the price of cheese, for example, has jumped by a third over the past 18 months. The Canadian restaurant industry operates on razor-thin margins and food-input prices typically account for more than a third of a restaurant's operating revenue, while labour sucks up another third. So when prices rise, operators have to take a hit on profits.

Still, investors who want to take a bite into restaurant stocks have some bright spots. For example, while average industry growth in the "casual dining" segment is usually in the 2%-to-3% range, The Keg steakhouse posted robust 7.3% sales growth in 2007. A report from RBC Capital Markets gave an "outperform" rating on The Keg Royalties Income Fund (KEG.un/TSX), with a $13.50 target.

It also noted the company had a high level of gift card sales in November and December, which the restaurant chain's officials predict will result in redemptions during the first two quarters of the year. "When questioned about its exposure to an economic downturn, [Keg] management insisted that it was less sensitive [than] higher-end steak house chains, and that customers trade down to a lower check casual dining restaurant (the average check per person is $35)," the RBC report says. The Keg, which operates 44 corporate stores and 52 franchises, plans to open 12 more outlets in 2008.

The climate also seems to be sound for Vancouver-based Boston Pizza Royalties Income Fund, owner of the Boston Pizza casual dining chain, where total sales rose by 16.9% in 2007 to $755.5-million, and same-store sales growth was 5.7%.