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The Post-Recession Dining Shift

It was late afternoon on Cyber Monday and the line at the Starbucks cafe near Times Square stretched halfway to the door.

Further uptown on the Upper East Side, Chipotle Mexican Grill (CMG) was also catering to a packed house.

It's a sign of the times. Starbucks (SBUX) and Chipotle have kept their profits fat and traffic healthy through the most recent quarter, even as many eateries stumbled amid the challenging consumer spending environment.

Coffee king Starbucks has now racked up double-digit profit and sales growth the past eight quarters.

Fast-casual eatery Chipotle has done so in all but one quarter over that time frame. Another top performer, Buffalo Wild Wings (BWLD), has served up savory profits in all but one of the past four quarters.

All three chains share a recipe for success: a strong value and food quality relative to their peers, and well-differentiated concepts. Their strong performance comes at a time when many consumers, particularly the low- and middle-income crowd, are scrimping on dining — leading to sluggish times for many players.

Across the restaurant industry, same-store sales were "relatively weak through this past summer and fall, with many of the larger mainstream brands facing relatively anemic operating trends," says Wunderlich Securities analyst Bob Derrington.

The days of the mainstream restaurant brands commanding dominant shares of consumer spending appear to be a thing of the recent past, Derrington says.

"The era of restaurant industry specialization appears to be upon us," he said. "Old-school, jack-of-all-trades fast food and casual dining chains — the Olive Gardens and Red Lobsters — are under assault by brands specializing in a differentiated experience, with more craveable and attractively priced menu offerings.

He points to Chipotle with its "food with integrity" theme, and Buffalo Wild Wings' "maniacal 'Wings. Beers. Sports.' focus.

Viva La Difference

"In recent months these specialists have enjoyed typically better-than-industry traffic growth, and continue to encroach on many of the older, more mainstream brands," Derrington said. "In turn, many of those older, incumbent brands have been forced to turn to aggressive deals and price as a 'consumer carrot' at mealtime, ultimately turning dinnertime into 'Let's make a deal'-time for many consumers," he said.

Industry growth is expected to slow from last year, says Darren Tristano, executive vice president at industry consultant Technomic. He forecasts restaurant and bars will see a 3% rise in retail sales this year to $464.3 billion. That compares with about a 5% gain in 2012.

In the aftermath of the recession, consumers have learned how to save money, spend less and look for value, Tristano says.

"In response, the major brands have been pushing value and discounting," he said, making it difficult to raise prices and get consumers to return to spending at higher levels.

He expects fast-casual eateries, the category including Chipotle, Panera Bread (PNRA) and Noodles & Co. (NDLS), to grow sales in the 10% area this year, "driven heavily" by new restaurants opened last year and set to open this year. Fast-casual eateries offer fresh, high-quality food. They are pricier than fast-food chains, but offer better-quality dining experiences.

The industry has seen mixed results in recent months. But overall, the eateries that are doing "relatively well" are those that are a "relative value," with a low average check price, adds Wedbush Securities analyst Nick Setyan.

"The quick-casual category is benefiting from consumers trading down from casual dining restaurants because it provides the same quality of food at more reasonable prices and more efficiently," he said.

And the snack category, which includes chains like Starbucks and Krispy Kreme Doughnuts (KKD), is the "most affordable of the discretionary spend," with an average check of between $3 and $4, he adds.

But the industry's top performers are whetting consumer appetites with more than low prices.

Wing Me, Beer Me, Serve Me

Take Starbucks. The Seattle-based coffee giant posted a 37% rise in Q4 EPS. Thomson Reuters analysts expect a 21% rise in Q1.

"The positive driver for Starbucks continues to be their ability to reach out to customers in innovative ways and to compel them to return to do more and more business," said Setyan.

That includes its loyalty program and marketing. Among efforts on the technology front is a beta test of "Tweet-a-coffee," which is a way to send an $5 Starbucks Card eGift to Twitter friends and followers in the U.S.

Starbucks is branching out on a number of fronts. In October, it opened the Teavana tea bar, which offers tea drinks, salads and items, on Manhattan's Upper East Side. Starbucks bought Teavana last year and is transforming it from a retailer of tea and related items into cafe-style tea bars.

Starbucks in August also began selling its Evolution Fresh juice at Whole Foods Market (WFM).

Chipotle Mexican Grill whet Wall Street's appetite with Q3 sales that beat views and a 17% EPS gain. However, higher food costs kept profits leaner than expected.

Still, sales topped forecasts. The stock spiked 16% Oct. 18, but had advanced only another 2% by Friday. Analysts see Q4 EPS climbing 29%.

One Chipotle strength is an average ticket near $9.50, said Miller Tabak & Co. analyst Stephen Anderson. "They've been gaining market share against some rivals.

He said Chipotle gained share in Chicago as a result of recent closings of 65 locales by competitor Qdoba Mexican Grill, owned by Jack in the Box (JACK).

Chipotle also launched a catering service in Denver in January that has since been rolled out to additional markets. Management said the service represented 1% of revenue in the stores through which it is offered so far.

In an October report, Anderson wrote that Chipotle will be among the early beneficiaries of easing year-over-year commodity prices. By the third quarter of 2014, he expects Chipotle to see "lower year-over-year costs on dairy and stable year-over-year costs on chicken and pork (which we think will more than offset higher year-over year beef costs).

Buffalo Wild Wings racked up a strong 67% EPS gain in Q3, its second double-digit rise since an 11% decline in Q1. Analysts see a 19% rise in Q4 EPS.

In a mid-November report, Derrington wrote that Buffalo Wild Wings should cap the year with strong gains as it benefits from falling chicken-wing prices and other recent initiatives. Spot-market prices for jumbo-cut chicken wings have been in a "free fall" in recent weeks, recently dropping to $1.18 a pound from $1.43 on Oct. 29 and down 36% from $1.88 last year, Derrington wrote in a report released Friday.

Buffalo Wild Wings already served up savory third-quarter results in late October. With current fourth-quarter same store sales off to a "strong start" — up 5.3% vs. a year ago in October — and spot wing prices "drifting unseasonably lower," Derrington raised his fourth-quarter earnings estimate by 5 cents to $1.06 a share and his full-year estimate also by 5 cents to $3.75 a share, both in line with Wall Street.

"To both improve and differentiate its service and grow sales," the company is testing a tablet platform for consumers to place orders, play games and pay their bill, Derrington wrote. The tablets, he adds, will include "Wing Me, Beer Me, and Serve Me" buttons that let customers rapidly order prior selections. The tablets are expected to be in 100 locations by year-end and system-wide by the end of 2014.

He says Buffalo Wild is "poised to continue to outperform" most of its casual-dining industry peers.

Through The Doughnut Hole

Krispy Kreme Doughnuts, which logged a 33% earnings gain in Q3, disappointed investors despite the nice increase. Its shares plunged in the wake of the results posted Dec. 2.

The problem? Comparative store sales at company-owned locations rose only 3.7%, "far below sell-side expectations of 6.3% and even farther below buy-side whisper numbers that were as high as 10%," said Setyan.

In addition, management raised the low end of this year's EPS guidance by 1 cent — again below expectations.

The outlook for the industry is getting brighter.

"We have reasons to be optimistic about a rebound in restaurant spending in the next few quarters," wrote Anderson in a report. He singled out forecasts for moderate job growth in the next six to 12 months, "which in our view has the strongest positive correlation to the health of the restaurant sector.

He also sees "commodity cost comparisons" continuing to get easier. Spot prices on meat and food ingredients have fallen 20%-40% since the end of 2012 and about 30%-50% since the drought-induced peaks of July 2012.

He now sees "overall food cost inflation" for 2013 to be in the 1%-2% range, below the 1.5%-2.5% food cost inflation he had modeled previously.

"In 2014, the backdrop of slightly more hopeful consumer spending, easing restaurant industry same-store sales and a more attractive commodity cost environment is offering some rays of sunshine for industry sales and earnings versus the very difficult trends of 2013," adds Derrington.

Bonnie Riggs, restaurant industry analyst for the NPD Group, expects a 1% increase in traffic and a 3% increase in industry sales in 2014 amid a "little better" economy. That compares with the flat traffic growth and a 2% increase in sales she expects for 2013.