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US restaurants shifted from 'survival mode' to limited profits in Q3 – experts

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US restaurants shifted from 'survival mode' to limited profits in Q3 – experts

The U.S. restaurant industry's recovery from the initial shock of the pandemic is slowing as most public restaurant companies are expected to report a drop in profits for their most recent quarter while they brace for continued uncertainty about the future.

Nine out of the 12 largest U.S. restaurant chains due to report earnings in the coming week are expected to report year-over-year declines in operating profit — several of them at a double-digit pace, according to analysts' estimates compiled by S&P Capital IQ. Restaurant chains generally began to recover in the second quarter as local dining restrictions eased and companies shifted toward takeaway and delivery services.

SNL Image

"They've gone from survival mode to actually making some profit," said Peter Saleh, a managing director and restaurants analyst at BTIG.

Chains that have already reported some earnings data for the recently wrapped quarter are presenting a mixed picture. Domino's Pizza Inc. missed profit expectations on heightened pandemic-related costs like additional compensation and enhanced sick pay for its workers despite an overall boost in revenue for the quarter through Sept. 6.

Meanwhile, Darden Restaurants Inc. beat earnings expectations for its quarter through Aug. 30 despite a more than 28% drop in sales due to restaurant closures. The Olive Garden parent cut costs during the quarter, simplified its menus and operating procedures to achieve better-than-expected results, Senior Vice President and CFO Ricardo Cardenas said during a Sept. 24 post-earnings calls.

McDonald's Corp. will report full third-quarter results in November but said Oct. 8 its U.S. comparable sales for the period grew 4.6% year over year. Total comparable sales for the company were down 2.2% from a year ago but was better than analysts' expectations for a 4.3% drop in comparable sales, according to Capital IQ.

Still, investors remain positive on the sector, Dennis Geiger, a UBS analyst, said in an Oct. 12 report. "Recent discussions focus on positioning as earnings approaches, given 2Q earnings reactions consistently went against consensus sentiment," Geiger said.

Early momentum slows

Retail sales for U.S. bars and restaurants plummeted in March as the impacts of the pandemic began to hit the U.S. Sales began to pick up in May and over the summer, but the pace of growth has slowed in recent months. The U.S. Census Bureau will release new advance estimates for September restaurant sales on Oct. 16.

Sales across the industry continue to improve but the pace of recovery has slowed to a crawl, according to an Oct. 2 Black Box Intelligence report. The largest increases in average guest check growth continue to be for limited-service restaurants that offer quick service and fast-casual dining, according to the report.

Many restaurants have learned to do more with less as they cut menu items to save on costs in a slower sales environment, Saleh said. As sales recover, not all restaurants are reverting back to their pre-pandemic menus in a sign that many restaurants are raising the bar for what items make it onto their menus, Saleh said.

READ MORE: Sign up for our weekly coronavirus newsletter here, and read our latest coverage on the crisis here.

Casual dining chains like Darden, Cracker Barrel Old Country Store Inc. and Texas Roadhouse Inc. have been hit hard by the pandemic because their operations were built around dine-in sales that have seen steep declines.

"Casual dining is probably the hardest hit because we do not have drive-thrus," Travis Doster, a Texas Roadhouse spokesperson, said in an interview. Cracker Barrel and Darden did not respond to requests for comment.

Texas Roadhouse restaurant operators have embraced curbside pick up and outdoor dining and establishing safety protocols like employee temperature checks and COVID-19 pay has resonated with people, Doster said. Consumer confidence in going out to eat may be more important for the restaurant industry than a vaccine since it is not clear exactly how many people will actually get the vaccine once one becomes available, Doster said.

"If it's a vaccine or the idea of a vaccine, that can probably help, but there's so many cities, so many states and all have different regulations," Doster said. "It's just hard to tell anything right now."

Lockdowns and restrictions on dining room capacities have played a role in the restaurant industry's sales shortfall and steady recovery. New York City resumed indoor dining with a 25% occupancy limit on Sept. 30, and Chicago allowed restaurants to expand their indoor dining occupancy from 25% to 40%, effective Oct. 1. Lifting capacity restrictions has helped, but a full recovery for the restaurant industry is not likely without a vaccine, Saleh said.

Chains geared more toward delivery and quick-service dining like Wingstop Inc., Papa John's International Inc. and The Wendy's Co. are benefiting from the current climate and are each expected to post year-over-year profit increases.

"Underlying trends in the quick service sector continue to improve as life inches more toward normal," James Rutherford, a Stephens analyst, said in Oct. 13 report.

Wendy's upcoming earnings will face harder comparisons because of last year's successful rollout of Spicy Nuggets. Wendy's, which declined to comment for this story, should have momentum heading into the fourth quarter from new menu items resonating with customers and franchisees reopening dining rooms, Rutherford said.

Papa John's acquisition of new customers is fueling its growth and the elevated sales are expected to carry over into fiscal 2021, Rutherford said.

Even though Wingstop's sales have seen a decline, they remain strong, suggesting the company was able to retain most of the sales gained at the height of the COVID-19 crisis from new customers and increased frequency, Jake Bartlett, a Truist Securities analyst, said in an Oct. 6 report. Papa John's and Wingstop did not respond to requests for comment.

Restaurants in suburban and rural areas that have come out of lockdown have seen better recoveries than restaurants in urban areas still dealing with dining restrictions, Lauren Silberman, a Credit Suisse senior equity research analyst, said in an interview.

SNL ImageChains geared more toward delivery and quick-service dining are benefiting from market conditions brought on by the pandemic.
Source: Domino's Pizza Inc.

"The question I'd ask is, 'What does the future look like?" Silberman said. "How are you best positioning your portfolio to take advantage of today's opportunities, especially when the expectation is that you have smaller independents that are going to close and competitors closing."

Threats remain

While the odds that restaurants could default on their debts has eased since an initial jump in the early days of the pandemic, the industry has seen several bankruptcies this year. Ruby Tuesday and California Pizza Kitchen Inc. filed for bankruptcy in October and July, respectively, as did the Wendy's and Pizza Hut franchisee NPC International Inc. in July. Each company was looking to restructure.

Nearly one in six restaurants has closed permanently or long-term, according to a Sept. 14 National Restaurant Association report, and analysts expect restaurants to continue closing. The association also said 40% of restaurant operators thought it was unlikely their restaurant would still be in business after six months without additional aid from the federal government.

"This survey reminds us that independent owners and small franchisees don't have time on their side," Sean Kennedy, executive vice president of Public Affairs for the National Restaurant Association said in a statement.

The pandemic has raised concerns about whether more closures could be in store for franchisees with significant amounts of debt dealing with muted sales, Silberman said. Restaurant companies can offer assistance to their franchisees, but there is only so much franchisers can do, Silberman said.

"The biggest challenge for these heavily franchised companies is if you have mass closures because that's where you get all your money," Silberman said. "You want to have the healthiest franchise system possible."