Finding Quality in Casual Dining

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Casual dining is dying. This has everything to do with the slow yet methodical disappearance of the middle class. Not many people remain in the middle, where blue-collar workers see wage growth. This is unfortunate for our society as well as for casual-dining companies such as Brinker International , Darden Restaurants , and DineEquity . However, a silver lining might exist for one or two of these companies. 

(Source: Wikicommons, author: anthony92931)

Recent results lead to a specific strategy
When you read the words "Brinker International," think of Chili's, and to a lesser extent, Maggiano's. Regardless of what you think of, you're not likely to think much of the company's top-line performance over the past five years:

EAT Revenue (TTM) Chart

Brinker revenue (trailing-12 months) data by YCharts

However, revenue is actually up 0.1% over the past year. That's not going to lead to much excitement, but it's better than the alternative (negative growth). In the first quarter, the top line improved 0.1% year over year -- another minuscule number. This improvement was primarily due to increased capacity (1.5%) and, to a lesser extent, price increases (0.9%) and a favorable mix shift (1.1%). On the other hand, comps slipped 1.3%, and traffic slid 3.3%. These two readings indicate declining demand. That's why Brinker International is making moves to increase demand and drive its bottom line.

Bottom-line focused
Brinker International aims to drive positive sales growth and to improve the customer experience by investing in new kitchen equipment, operations software, and remodels.

In Brinker International's most recent 10-Q filing, it's obvious that the company is primarily focused on new kitchen equipment. Based on numerous tests, it has been proven that this new equipment will lead to higher-quality food cooked at faster speeds, which is expected to improve the customer experience and profitability.

It's also expected to lead to new menu items, which should then increase traffic and sales. At least that's the plan. One new menu item, as an example, is the Bacon Avocado Chicken Sandwich, which is already the best-selling sandwich on the menu. 

Chili's has also added an integrated point-of-sales back-office system, which should enhance efficiency and reporting capabilities.

Based on the aforementioned initiatives, Brinker International has seen bottom-line improvements over the past year:

EAT EPS Diluted (TTM) Chart

Brinker EPS diluted (trailing-12 months) data by YCharts

Remodels have been taking place at a rapid rate at Chili's restaurants, and Brinker International plans to open nine-to-14 new restaurants in high-potential markets this year.

Brinker International aims to grow through acquisitions, franchisee relationships, joint-ventures, and equity investments. It will focus on demographics and eating trends with its new restaurant openings. This is all great in theory, but it will be difficult for Brinker International to grow through acquisitions without making its leveraged position even more concerning. Brinker International sports a debt-to-equity ratio of 7.0. Perhaps a safer investment option exists.

The Big 3
Remember the revenue chart above? Darden Restaurants was the best performer over the past five years. However, this has been primarily due to new restaurant openings, including the acquisition of 40 YardHouse restaurants. For more on this, you can read: "Why You Shouldn't Underestimate Red Lobster's Parent."

Speaking of Red Lobster, it's one of the company's "Big 3," pertaining to Red Lobster, Olive Garden, and LongHorn Steakhouse. The problem is that the "Big 3" looked small as a cohesive unit in the company's most recent quarter (first quarter), with comps declining 3.3% year-over-year. Overall, diluted earnings per share slid 37.6% to $0.53 due to higher restaurant expenses and restaurant labor costs.

Looking ahead, Darden expects FY 2014 sales to increase 6%-8%, with the YardHouse acquisitions playing a big role. While various expenses are expected to increase, Darden Restaurants is relying on workforce reductions and program- spending cuts to offset those increases.

For the year, expenses should be reduced by approximately $10 million (net). This will help the bottom line grow by about 3%-5% for FY 2014. Beginning in FY 2015, Darden Restaurants expects to save $50 million per year in expenses.

Darden Restaurants is facing some steep challenges at the moment, but bottom-line improvements are likely, and the YardHouse brand should help drive the top line. Darden Restaurants also sports a healthier debt-to-equity ratio of 1.3 when compared to Brinker International. Additionally, Darden Restaurants yields 4.1%, whereas Brinker International yields 2%. Now let's take a look at DineEquity.

Should you hop to IHOP?
I hadn't been a big fan of DineEquity, but an interesting trend is being established and the company is realizing and acting on that trend. Applebee's is losing steam, and IHOP (International House of Pancakes) is performing well. This is likely due to the decline in casual dining and IHOP being unique in what it offers in family dining.

Over the first nine months of the year, Applebee's saw comps decline 0.1%. During the same time frame, IHOP's comps improved 1.7%. In the third quarter, domestic systemwide sales for Applebee's declined 0.4%, primarily due to reduced traffic. At the same time, systemwide sales for IHOP jumped 3.6%, thanks to a higher average check and favorable product mix. However, traffic softened. 

DineEquity now expects to see 25-30 new Applebee's restaurants in FY 2013 versus earlier expectations of 40-50 additional locations. This seems to be a logical move. Why increase investments in what's not working?

Look for DineEquity to slowly shift investments away from Applebee's and more toward IHOP, going more inline with industry trends. This should lead to long-term improvements, but the company still has a long way to go to be considered a top-notch investment option. It's also highly leveraged, sporting a debt-to-equity ratio of approximately 4.5. DineEquity currently yields 3.6%.

The bottom line
None of these companies are in-trend at the moment. Invest with caution.

Brinker International should see continued bottom-line improvements, but increasing demand for the Chili's brand will still be a challenge. DineEquity should shift investments more toward IHOP, and that should prove to be effective, but the company is likely to have difficulty growing its top line. Darden Restaurants should offer the most long-term potential given its broad brand diversification, recent investment in high-demand YardHouse restaurants, and superior debt management and yield. 

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The article Finding Quality in Casual Dining originally appeared on

Dan Moskowitz has no position in any stocks mentioned. The Motley Fool owns shares of Darden Restaurants. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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