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Despite Positive Signs at Denny’s and IHOP, Midscale Still Drops

SPARTANBURG, S.C. and GLENDALE, Calif. – The two largest players in the midscale restaurant segment reported a positive increase in same store sales, despite the segment's continued contraction.

Denny's Corporation (Nasdaq:DENN) reported on April 28 that same restaurant sales in the United States increased 1.8 percent in its first quarter ending March 26, 2014. Denny's company-owned restaurants increased in same restaurant sales by a grand 3.2 percent compared to a quite respectable 1.5 percent increase in domestic franchised restaurants.

Competitor IHOP (NYSE:DIN) also saw a big upswing in its same-store sales this quarter. "IHOP overwhelmingly outperformed the family dining segment," said holding company DineEquity's chairwoman and CEO Julia Stewart during a conference call to analysts on Thursday.

Denny's & IHOP: Racing neck and neck above the rest

From his vantage point, one chain store analyst and restaurant unit economist thinks the two largest midscale restaurant chains are in a standoff. "It looks like Denny's and IHOP are trading customers back and forth," says John Gordon, principal at Pacific Management Consulting Group. "It looks like both have slightly negative customer volume in their franchises, but the difference between the two was IHOP was able through its new menu configuration to get more average ticket gain." The former Booz Allen Hamilton financial consultant sees the two pretty much in a tied situation.

The rubber hits the road in competitor Jim Wainwright's Denny's restaurants in Colorado, or at least the fork hits the tall pancake stack. His own same-restaurant sales for his three units have gone up by 3.5 percent in this year's first quarter. When asked about IHOP's 3.9 percent gain, Wainwright thinks of the competition like basketball. "I say good for them. Maybe this quarter will be their quarter and the next will be ours," says the Denny's franchisee. He stresses that competition is good for the players and for the brand.

Weak economy, harsh weather and segment shrinkage in 2014's first quarter

Stewart refers to the fact that the family midscale dining segment has been experiencing a shrinkage. That long-term contraction has become a warning beacon for investment analysts of the rocks and risks of family diners.

The gain in restaurant comparable sales for family dining giants Denny's and IHOP, with only a slight decline in traffic, is quite an accomplishment given the declining midscale restaurant segment. It is even more of an achievement given the economic data released from the U.S. Commerce Department last week that shows the country's gross domestic product increased by a meager annual rate of 0.1 percent in the first quarter of 2014 over the same period last year. That softness gives credence to a number of major restaurant chain leaders complaining in their earnings calls with analysts that customers, deterred by harsh winter weather, had stayed away.

NPD on midscale weekend, weekday traffic

That softness is something that Mark Kalinowski of Janney Capital Markets makes a point of in his analysis on this segment to stock investors. "Risks include ongoing challenging fundamentals within the family dining sector," warns the restaurant analyst about the continuing sluggishness of the midscale market.

But number-two Denny's has shown yet again positive same store sales. And IHOP, the largest in the midscale segment in systemwide sales, also has reported a huge 3.9 percent gain in same-store sales this last quarter. IHOP restaurants are 99 percent franchised.

Midscale is not out of the woods

With the first and second largest players in the midscale showing such strong numbers, could things be turning out well for the average restaurant in midscale as a whole?

When asked if traffic at family dining restaurants has finally turned positive, pulled upwards by the two colossal family dining giants Denny's and IHOP, foodservice researcher Bonnie Riggs of The NPD Group replied that things are not out of the woods yet for this segment. "Midscale did have some success during the weekdays, but the gains were offset by weekend weakness," said Riggs. For the year ended February 2014, visits to midscale restaurants were down 3 percent compared to flat traffic for the total restaurant industry. Traffic for the midscale segment, which Denny's and IHOP are part of, was down across all dayparts.

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