How to Invest in Food Stocks: Restaurants

It is only fitting that we end our journey along the food investment chain with a discussion of my favorite link, the restaurant sector (see "A Checklist for Profiting from Retail, Restaurant Stocks" and "Three Ways to Score With Retail, Restaurant Stocks").

To get up to speed on the food investment chain, check out "How to Invest in Food Stocks" and "How to Invest in Food Stocks: The 'Middleman' Plays."

This series of lessons concludes with a look at some restaurant specifics that investors should be cognizant of before making an investment, by highlighting challenges in the current agricultural and economic environment.

The Source

Restaurants will prepare fresh meals from a variety of food sources. Some will cook meals from basic products (like meat, chicken and pasta) which they purchase from suppliers and wholesalers. These companies will make everything from hamburger patties to frozen cod filets to those chicken fingers that kids love to eat.

Many restaurants will just purchase and serve prepared foods or beverages from those same food wholesalers or beverage bottlers covered in "How to Invest in Food Stocks: The 'Middleman' Plays," or from local establishments, such as bakers and dairies.

Several restaurant chains will provide their individual locations with their own prepared products or basic ingredients. As an example, Domino's Pizza DPZ not only owns and franchises their restaurants, but Domino's also distributes the critical cheese and other products to its franchisees.

Finally, restaurants will buy paper goods, cups, glasses and restaurant supplies from a variety of vendors.

Some of the nation's largest food wholesalers that distribute products to restaurants are:

Food Wholesalers and Distributors
Company	Ticker Symbol	Closing Share Price on 3/4/2008	2007 EPS (Earnings Per Share)	2008 Estimated EPS
Dean Foods	DF	21.43	1.20	1.27
Tyson Foods	TSN	14.92	0.74	0.26
Source: Yahoo! Finance

Price Points

As agricultural prices have soared, those costs are being pushed throughout the food chain. How do restaurants handle these inflationary pressures? There are a few ways in which this is accomplished: price hikes, portion reduction and hedging.

Raising prices. This is very simple: As a restaurant owner, just push cost prices onto your customers. Here's the catch, it's not always that easy.

Raising a steak dinner from $19.95 to $22.95 might be easier than increasing the price of a cheeseburger from $1.99 to $2.29. It all depends on the demographic that you serve and the category of restaurant that the company operates in (see below).

Most restaurants manage off of an average ticket price. Thus for the higher ticket restaurants passing the cost can be more direct because it will get lost in the already high average check price, as those diners will be less "price sensitive." For the lower-priced restaurants, the business makes it up in extras or side dishes. For example, instead of pushing up the price of a cheeseburger 20 cents -- which would immediately catch the customers' eye -- the price costs are piled into the price of a beverage or fries or the combination meal where the price increase is less evident and "elastic." You can extend this concept to beer and hard liquor, which are always great places to embed price increases (see "How to Be So Money at the Bars" on TheStreet.com TV).

Cutting down on portion sizes. Instead of putting 10 ounces of chicken strips into a salad, a restaurant will place 9 ounces and leave the menu price unchanged. Perhaps they will use less pasta in a side dish. This is easier achieved at the higher-priced restaurants than the lower-priced ones because the former tend to serve larger and more complex dishes.

Contracting for commodities. More and more, restaurants are risk-managing their commodity costs by locking in to long-term contracts with suppliers or hedging with many of the same commodity futures that investors and speculators will engage in, such as beef, pork bellies, soy beans and sugar (to name a few).

Spectrum of Service and Quality

The restaurant sector is divided into three main categories and offers a wide variety of investment opportunities -- from quick service to premium dining.

Quick Service Restaurants (QSRs). Known to many people as "fast food" restaurants, QSRs have the following characteristics:

Diners order at a counter from a menu on an overhead menu board. Many also have drive-through service.

Diners bus their own food trays from the service counter to unassigned seating.

Menu items are relatively "cheap," with many QSRs providing value or combination meal pricing.

Beverages are limited to nonalcoholic varieties.

The most popular QSRs are:

Quality Service Restaurants (QSRs)
Company	Ticker Symbol	Closing Share Price on 3/4/2008	2007 EPS (Earnings Per Share)	2008 Estimated EPS
McDonald's	MCD	53.63	2.89	3.18
Burger King	BKC	26.35	1.11	1.31
Yum Brands	YUM	35.02	1.68	1.86
Wendy's	WEN	23.91	1.20	1.32
Domino's Pizza	DPZ	13.34	1.03	1.03
Starbucks	SBUX	17.90	0.87	0.97
Chipotle Mexican Grill	CMG	96.52	2.13	2.67
Panera Bread	PNRA	36.85	1.82	2.02
Tim Horton's	THI	34.67	1.34	1.65
Source: Yahoo! Finance