Retailers and Restaurants: Future Winners and Losers

Updated from March 9

In the spirit of " The Future of Financial Services" and " Future Financial Winners and Losers," let's look at two important core consumer segments -- retail shopping and eating out -- and see how they might change over the next year or so.

Here are three trends which you should expect to emerge or continue to evolve.

1. Consumers Are Keeping It Simple

For many years there has been a trend of trading up. Consumers were using their spending power to buy more expensive goods and shop or dine at higher end establishments. Companies such as Nordstrom ( JWM), Coach ( COH) and Tiffany ( TIF) saw a rise in sales. These companies extrapolated that trend and began to expand. Not only did they expand but they began to erect palatial and even opulent stores.

For example, have you ever been to a Cheesecake Factory ( CAKE)? Their restaurants are decorated with expensive granite, marble, carved wood and fancy lighting. The wait for a table was long, the menus were reasonably priced and the portions were large. I do not see how Cheesecake Factory can support its huge overhead with its business model in the current economic environment.

So, out with the high end and fancy and in with the low-end and simple.

There has already been a massive shift of spending from the high- and the mid-range retailers and restaurants down to the lower cost names. In retail, we are seeing discounters, such as Wal-Mart ( WMT) ( WMT), Big Lots ( BIG) and Family Dollar Store ( FDO), gain sales and market share as consumers trade down.

The same can be said for the restaurant sector, as the menus at premium steak-focused Ruths' Chris ( RUTH) and Morton's ( MRT) are just too costly for the average consumer and corporate expense account.

Same store sales are now rising in the United States for such chains as Yum! Brands ( YUM) (operator, franchisor of Pizza Hut, KFC and Taco Bell) and McDonald's ( MCD).

And $4-plus cups of coffee are no longer must-have daily beverages. Bad news for Starbucks ( SBUX). Instead, many consumers are now satisfied with the premium coffee offerings at McDonald's or Dunkin Donuts. TV, Jan. 7: Scott Rothbort travels across lower Manhattan to rank his favorite restaurant stocks for 2009.

2. The Need to Shrink Capacity

As the economy expanded more retailers and restaurants emerged and fed consumers' increasing appetite for variety. But now, there are simply too many retailers and restaurants operating in the economy. Get ready for a contraction.

In fact, contraction has already begun. Linens 'n Things and Sharper Image have already closed shops as part of Chapter 7 liquidation. Circuit City is now in the same process.

Normally, companies will first try Charter 11 reorganization but these retailers went right to liquidation. I would note that all of those companies were weak "second fiddles" to more dominant competitors, such as Best Buy ( BBY) and Bed Bath & Beyond ( BBBY). This trend is going to continue.

Ask yourself this: How many office supply companies do we really need? This is a crowded field that's dominated by Staples ( SPLS), with annual sales of about $23.8 billion versus weak "also-rans" like Office Depot ( ODP), with annual sales of about $14.5 billion, and Office Max ( OMX), with annual sales of about $8.3 billion (all sales for the most recent year).

I expect Staples to push at least one of its weaker competitors out of business. Ditto for the drug stores: Walgreen ( WAG) and CVS Caremark ( CVS) might survive, but Rite Aid ( AID) will likely wither and die.

3. One-Stop Shopping

Consumers have less time on their hands and want to spend less gas money traveling from store to store. Why bounce from Kroger's ( KR) to Barnes & Noble ( BKS) to Walgreen to Best Buy, when you can do it all at Wal-Mart or Costco ( COST). (And if you don't mind waiting a few days for shipping, ( AMZN) is the most diverse vendor on the Internet.)

At these super stores and warehouse member clubs (Wal-Mart owns Sam's Club), you can almost get it all. You can even have your eyes checked and grab a decent meal at a reasonable price. Not only will Wal-Mart, Costco, Target ( TGT) and BJ's ( BJ) increase traffic and volume at existing locations, I expect those companies to grab cheap real estate as other retailers go belly up and the REITs, which own those properties, start fire sales on leases.

You have to figure that a REIT like Kimco ( KIM), which operates strip shopping malls, is hurting. I would not be surprised to see a new warehouse competitor formed in the next few years.

The same trend is occurring in the restaurant world. Chains, which have successfully expanded their menus and hours of operation, are going to thrive. McDonald's has been successful at just that, while its competitors Wendy's ( WEN) and Burger King ( BKC) have been late to make all of those changes to their business models.

Restaurants that rely on a single meal, such as breakfast at Denny's ( DENN) or Einstein Noah ( BAGL), are going to have a tough time surviving, especially under the load of long term debt and leases that many of these companies are carrying.

Your Homework

Identify other retailers and restaurants that fit the emerging consumer trends and might have a good chance of surviving the current brutal economic climate. The criteria:

  • Simple and "down to earth" locations
  • Broad-based product and marketing strategies
  • Sales dominance
  • Financially fit (companies with strong balance sheets will conquer competitors with weak ones)
  • At the time of publication, Rothbort was long MCD, YUM and WMT, 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 Term 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 Scott appreciates your feedback; click here to send him an email.

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