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Fast-casual chains have room to grow

With fresh ingredients, no tipping and sleek design, these restaurants appeal to millennials. In Canada, though, the sector is lagging behind the United States

By: TERRY CAIN

Date: October 6, 2017

It’s a Friday in downtown Toronto, and Freshii’s Eaton Centre location is doing a brisk lunchtime business, despite not having any nearby seating for its customers.

Stephanie Toller and Jonathan Vincent sneak into a competitor’s dining area to eat their meal. They are friends who both work in the mall, and they are fans of Freshii’s nutritious and healthy concept.

“It’s the only place around here you can get a decent salad,” says Ms. Toller. “I like the bowls,” says Mr. Vincent. “I’m trying to cut out bread. It’s a little expensive, but it’s not like we eat here every day.”

Meanwhile, at the other end of the mall, the sprawling food court is just as busy, with more than 20 outlets competing for customers. They range from McDonald’s and KFC to world cuisine and newer concepts such as Urban Herbivore’s vegan meals.

Everyone seems to have a lineup, including Mucho Burrito. Michael Ambrosi is about to dig into his lunch. “I like burritos, what can I say,” he laughs. “I like choosing what they put in it, and it’s filling. … I don’t go to burger places as much, they always make me feel gross and greasy.”

The choices being made at this urban mall offer a glimpse at powerful trends in the Canadian restaurant industry. The sector has always been competitive and volatile. Some companies are taking advantage of current trends, though, presenting a real opportunity for investors.

Restaurants can be broadly categorized as quick service or full service, with fast-casual outlets having some characteristics of the two. Quick-service restaurants are the classic fast-food model typified by traditional players such as McDonald’s and Subway. Fast-casual offers food that is higher quality (and somewhat higher priced), with fresher ingredients but in a casual atmosphere without table service or tipping. Examples include Freshii Inc. and Chipotle Mexican Grill Inc.

The fast-casual segment has experienced strong growth in the North American restaurant industry over the past decade or so, with Panera Bread Co. and Boston Market enjoying success. But there have been recent signs of a slowdown in the fast-casual sector, with several of the publicly traded companies reporting disappointing results. Their stock prices have been punished accordingly.

Only some of the fast-casual names have made their way to Canada, and that is reflective of an overall lag compared with the United States.

“Canadians are a little behind in terms of going out for dinner,” says Brian Pow, an equity analyst and vice-president of research at Acumen Capital in Calgary. The dollar amounts that families spend in restaurants are historically lower here than in the United States, but he notes that supporting data indicates this is changing – and he sees that favouring the fast-casual segment of the market.

Mr. Pow highlights two publicly traded Canadian companies that he feels are well-positioned to benefit from this trend.

The first is MTY Food Group Inc. The Montreal-based company has more than 55 quick-service and fast-casual brands including Manchu Wok, Cold Stone Creamery and Mucho Burrito. Its 5,600 franchised and corporately owned locations generated $1.5-billion in revenue in 2016.

Mr. Pow notes that MTY has steadily increasing revenue, a successful acquisition strategy, a diverse portfolio of brands, a strong return on equity and a conservative dividend payout. Other analysts seem to be taking more of a wait-and-see approach, however.

The second company favoured by Mr. Pow is Imvescor Restaurant Group Inc. The Halifax-based company is one of the largest franchisors of full-service restaurants in Canada. It operates 260 restaurants under five brands primarily in Quebec and Atlantic Canada. The brands include Pizza Delight, Scores and Baton Rouge. Mr. Pow notes that each of the brands targets a different segment of the restaurant market, positioning the company across a range of demographic, economic and geographic sectors.

Imvescor announced a strategic plan in April, 2015, to stabilize declining overall sales. The plan has four pillars: quality of food, quality of service, value and ambiance. Mr. Pow notes the company’s comparative sales have been positive for eight consecutive quarters since that plan was launched. He also likes the company’s conservative dividend payout rate, low debt and strong cash flow.

Other Canadian restaurant stocks may also benefit from the rise of fast-casual. Freshii is the clearest example. Most analysts are positive on the company, but its stock has been essentially flat since the firm went public at the start of 2017. The fast-casual sector is being squeezed by the fast-food giants who are offering better-quality food for less money. For example, the burger chain A&W is working to capitalize on trends toward healthier food by updating its restaurants and stressing its hormone-free beef and antiobiotic-free chicken.

The Canadian food court will no doubt continue to be a battleground, as chains try to stay on top of fickle consumer trends and turn chicken and quinoa into cash.

Publicly traded Canadian restaurant companies

Restaurant Brands International Inc.

Tim Hortons and Burger King

Cara Operations Ltd.

Harvey’s and Swiss Chalet

MTY Food Group

Manchu Wok, Cold Stone Creamery and Mucho Burrito

Imvescor Restaurant Group Inc.

Pizza Delight, Scores and Baton Rouge

A&W Revenue Royalties Income Fund

Pizza Pizza Royalty Corp.

Keg Royalties Income Fund

Boston Pizza Royalties Income Fund

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