This column was originally published on Street Insight on Dec. 26. It's being republished as a bonus for TheStreet.com and RealMoney.com readers. For more information about subscribing to Street Insight, please click here.
So what's on your menu this week? Some leftover latkes from Hanukkah? Perhaps some smoked ham cold cuts from Christmas?
Looking into 2007, there are several themes in the restaurant sector that will continue to create investment and trade opportunities. Here is my restaurant year in review, and a peek at the year ahead.
I believe casual dining will struggle in 2007, as the concepts out there are simply too homogenous, and I see no new offerings on the horizon. Rather, you will have to trade subsector, looking to take a lead from economic signals.
Commodity costs -- namely, energy and food -- should be watched closely. There are some potential turnaround stories as well that could provide opportunities, and one name that comes to mind is
Red Robin Gourmet Burgers
, which is a great concept that has long suffered from managerial mismanagement and misdeeds. Watch Red Robin, but don't rush to act.
This was a really up-and-down year for casual dining. A strong start to the year was thwarted in the spring by a market correction, spiking energy prices and the fear of inflation.
These companies were hit hard as traffic migrated down the food chain to the quick-service restaurants as the "substitution effect" took hold, which states in short that when consumers have less money to spend, they shift from higher-priced to less expensive goods.
Not until energy prices peaked, the market correction ended and the
finally pushed pause in the middle of the summer did the casual dining chains begin to rebound.
OSI Restaurant Partners
( OSI), which operates the Outback Steakhouse chain among others, managed to get a private-equity buyout offer. All of the popular casual-dining chains had similar chart patterns during the year. Here are some of the favorites charted together:
Source: CTS Trend
International expansion will be the dominant topic this coming year -- China, to be exact, for quick-service names. I continue to like
, which are positioned for this theme.
is also a China play, but I am not convinced Howard Schultz can deliver the same tremendous growth exhibited in the past. Headwinds include rising coffee prices and the lingering question: How long can Starbucks continue to push up prices to consumers before they revolt?
With that in mind, this past year the quick-service restaurants were the beneficiary of the substitution effect. The stock that not only weathered the spring squall but managed to be one of the best performers of the year was McDonald's. Not far behind was Yum! Brands.
I continue to like both of these stocks, especially as they both continue to expand overseas, specifically in China. Yum! Brands took a little bit of a hit in December because of an
outbreak at some Taco Bell restaurants, but I believe that to be a short-term issue, and this has presented a good entry point or level at which to add to positions.
I really like the premium steakhouses in 2007, and my favorite name remains
Ruth's Chris Steak House
. Ruth's Chris continues to expand not only from coast to coast, but internationally in major financial center cities and high-end resort destinations.
The spike in beef prices from last summer has subsided, and prices have now abated for several months. The effect of the spike will have worked through by the first quarter of 2007. I believe estimates for the year are still low and that the company will grow by at least 20% in 2007 and over the next few years.
The steakhouses were problematic this year. The reasons for this were the same woes that hurt the casual-dining stocks in the spring and early summer (as I mentioned above). Adding insult to injury, these stocks could not rebound because they were hit with the double whammy of higher beef prices.
I traded out of and then back into Ruth's Chris during the year, managing to sell just at the top and then re-entering back in the fall at dramatically lower levels. I am still holding my new positions today. Here is a combined chart of Ruth's Chris and its closest high-end steakhouse rival
Morton's Restaurant Group
A Stake in Steaks
Source: CTS Trend
We should see a continuation of the activist activity we saw in 2006 -- don't be surprised if you see a private-equity or leveraged buyout deal.
( CKR) is a good trading stock that rises and falls with such speculation.
Looking back, there were several high-profile restaurant IPOs in 2006. First came
Chipotle Mexican Grill
, which soared from the get-go and remained a Wall Street favorite for the balance of the year.
The other restaurant spinoff IPO was
. While THI had some success out of the gate, it has pretty much leveled off and not found a strong following from analysts or investors.
came public to join the quick-service ranks along with
, both of which were the source of the two above-mentioned spinoffs. Burger King stumbled out of the gate, but management appears to be making operational headway and also benefited from the substitution effect.
When it comes to pizza, I think that this is a crowded and competitive market and will continue to be throughout the new year. Look for cheese prices and the economy as a gauge for trading opportunities. If you want the best of both worlds, own Yum! Brands, which has both Pizza Hut and the China growth story all wrapped up in one.
However, the one group I played wrong this year was, in fact, the quick-service pizza sector. I was long
coming into the year and sold too early. On the other hand, I do have pizza exposure through my Yum! holding, so I did not totally blow it.
At the time of publication, Rothbort was long McDonald's, Yum! Brands and Ruth's Chris Steak House, although positions can change at any time. Scott Rothbort has over 20 years of experience in the financial services industry. In 2002, Rothbort founded LakeView Asset Management, LLC, a registered investment advisor based in Millburn, N.J., which offers customized individually managed separate accounts, including proprietary long/short strategies to its high net worth clientele. Immediately prior to that, Rothbort worked at Merrill Lynch for 10 years, where he was instrumental in building the global equity derivative business and managed the global equity swap business from its inception. Rothbort previously held international assignments in Tokyo, Hong Kong and London while working for Morgan Stanley and County NatWest Securities. Rothbort holds an MBA in finance and international business from the Stern School of Business of New York University and a BS in economics and accounting from the Wharton School of Business of the University of Pennsylvania. He is a Professor of Finance and the Chief Market Strategist for the Stillman School of Business of Seton Hall University. For more information about Scott Rothbort and LakeView Asset Management, LLC, visit the company's Web site at www.lakeviewasset.com. Scott appreciates your feedback; click here to send him an email.