Morningstar published its latest Consumer Observer, “Lessons from the Next Generation of Moats in the Fast-Casual Restaurant Industry.” The Observer explores what it takes to become one of the up-and-coming, fast-casual restaurants that don’t just offer healthy ingredients but provide a holistic experience for consumers from ordering via mobile app to fostering brand loyalty once the transaction is complete. Morningstar equity analysts went beyond their public company coverage and evaluated several quickly growing, private, fast-casual restaurants including Sweetgreen, Blaze Pizza, and Mendocino Farms to better understand what drives restaurant traffic in today’s consumer environment.

Key highlights of the Consumer Observer, which evaluates public and private companies, include:

Morningstar analysts developed a four-pillar blueprint for restaurant chains looking to drive traffic in today’s environment. The framework takes into account attributes such as convenience, flexibility, employee training, establishing authenticity, maintaining a scalable supply chain, and finding ways to connect with consumers beyond the brick-and-mortar store.

One question pertinent to this market is whether the restaurant industry is about to endure a “restaurant recession.” Morningstar analysts found it may be difficult for restaurants to raise prices in the back half of 2016 and likely into 2017, making companies more dependent on transaction growth to drive same-store sales and margin expansion over the coming quarters. This will not be an easy task, especially as consumer expectations about continue to evolve. However, those chains that have adapted to changing expectations about convenience, healthy eating, food supply transparency, and mobile technology are well-positioned to outperform industry traffic trends over the near future, and it could be a mistake for investors to write off these players.

One company, Sweetgreen, exemplifies the next generation of moat companies, or those with competitive advantages, bringing the idea of a scalable “farm-to-table” concept to the market. The restaurant is also a leader in mobile engagement, featuring mobile ordering, Uber pick-up, and a loyalty program.

The market may be underestimating the changes that several players under Morningstar’s restaurant coverage have made to adapt to these trends, including Starbucks and Panera, each of which trade at a significant discount to analysts’ longer-term discounted cash flow-driven fair value estimates of $63 and $250, respectively.

At a time when most restaurants and retailers are struggling to stimulate traffic growth, Starbucks' remains a key consumer destination through greater peak-hour capacity, expanded food offerings, menu timing adjustments, mobile payments and delivery, and My Starbucks Rewards marketing opportunities.

Fast Casual, News