Fitch views the quick service restaurant (QSR) segment as better positioned to withstand the current economic stress and market turndown because of its value perception, lower priced menu items, and continued consumer trade-down from full-service dining establishments. The Issuer Default Rating (IDR) for Burger King Corporation was upgraded by Fitch to 'BB' from 'BB-' and the Outlook was revised to Positive, because the company's credit measures were strong for the previous rating and operating performance continues to be good. McDonald's Corporation (McDonald's), which has an IDR of 'A/F1', and YUM! Brands, Inc. (YUM), which is rated 'BBB-', currently have Stable Outlooks. These companies have significant liquidity and do not have material near-term maturities.

Fitch's outlook for the casual dining segment remains negative. Credit ratings for casual dining restaurants that have engaged in large debt-financed acquisitions or share repurchases, such as Darden Restaurants, Inc. (Darden) which is rated 'BBB', and Brinker International, Inc. (Brinker) which is rated 'BBB-' have declined. Further increases in leverage could result in additional downgrades.

Given the lack of substantial catalysts, a sustainable turnaround in the casual dining segment is not anticipated in 2009. On average, the segment is expected to experience low- to mid-single-digit same-store sales (SSS) declines and continued margin pressure. However, some companies will perform worse than others; for example, Ruby Tuesday, Inc. (Ruby Tuesday), is experiencing double-digit declines in SSS. Companies with multiple large-core concepts, such as Darden which operates Red Lobster, Olive Garden and LongHorn Steakhouse, are expected to report blended SSS growth that outperforms their single-concept peers.

CREDIT RISK RISES AS INDUSTRY CASH FLOW COMES UNDER PRESSURE

Fitch expects credit risk, specifically for the full-service segment of the restaurant industry, to rise in 2009. Significant debt reduction is not anticipated to occur, unless required by lenders, due to continued pressure on cash flow and a desire to reinvest in the business. The absence of significant maturities and higher investor risk premiums will also limit debt issuances in 2009. Managing credit ratings, maintaining strong banking relationships, and preserving liquidity will be a focus of most management teams.

Restaurants which amend their credit facilities are paying higher fees and could, as in the case of Ruby Tuesday's, be required to provide collateral. Access to capital and financial flexibility is especially limited for restaurants which engaged in whole-company securitizations to make large debt-financed acquisitions or pay special one-time dividends, such as DineEquity, Inc. (DineEquity), Sonic Corporation (Sonic), and Domino's Pizza Inc. (Domino's). Higher-cost sale-leaseback financing for those with real estate assets could increase.

Market capitalizations of most major restaurant operators have declined drastically over the past 12 months. However, because lack of access to low cost capital and free cash flow pressure, Fitch does not anticipate heightened share repurchases or restaurant acquisitions in 2009. The stock price of Ruby Tuesday (NYSE: RT), DineEquity (NYSE: DIN), Wendy's/Arby's Group, Inc. (NYSE: WEN), Brinker (NYSE: EAT), Domino's (NYSE: DPZ) and Sonic (NASDAQ: SONC) were down over 50% for the 12-month period ending Oct. 31, 2008.

Given declining stock prices and cash flow generation, a reduction in dividends could help improve the liquidity of some restaurant companies. As of Oct. 31, 2008, the dividend yield of the S&P 500 Index was 3% but the yield of Wendy's/Arby's Group, DineEquity and Brinker were well above this at approximately 8.8%, 5.5% and 4.7%, respectively. Ruby Tuesday was forced to eliminate its fiscal 2008 dividend until it is able to meet leverage thresholds for two consecutive fiscal quarters. The company's dividend yield approached 5.0% following the end of its June 2008 fiscal year.

CAPEX REDUCTIONS AND REFRANCHISING HELP SUPPLEMENT CASH FLOW

The availability of attractive real estate sites and the growing need to reinvest in the business by providing franchisees financial assistance to support remodeling programs and new product offerings has increased the demand for capital. There could also be an uptick in unit purchases from struggling franchisees in 2009, given the difficult operating conditions. Fitch expects the current environment to dictate short-term changes in the financial strategies of most restaurants.

A number of casual dining companies continue to reduce capital expenditures, primarily by slowing the development of new company-operated units, in order to preserve liquidity and in some cases remain free cash flow positive. Noticeable reductions include those by Brinker and Ruby Tuesday. Brinker cut capital spending dramatically in 2008, plans additional cutbacks in 2009, and stated that it will eliminate virtually all company-owned restaurant development in the fiscal year ending June 2010. The company's capital expenditures have fallen from $431 million in 2007 to $270 million in 2008 and to an estimated $135 million-$145 million in 2009. Ruby Tuesday, whose credit agreement limits capital spending, expects to spend $25 million in 2009 versus over $115 million in 2008.

In order to supplement cash flow generation, refranchising efforts are continuing across the industry. Most restaurants met their 2008 refranchising goals but the pace of refranchising is likely to slow in 2009. Transaction sizes are smaller and deals are taking longer to consummate due to increased lender due diligence and higher capital requirements from buyers. Recent decisions by GE Capital's franchise financing unit and Bank of America, two of the largest national lenders to restaurant franchisees, to pull back on new franchisee lending will certainly reduce activity within the industry. Refranchising is a longer-term strategy for YUM and Brinker, but companies such as DineEquity are depending on these programs as an additional source of cash flow.

Merger and acquisition activity will also remain slow. Brinker's pending divestiture of Romano Macaroni Grill took longer than originally projected and as a result of financing difficulties resulted in the company maintaining a minority stake in the concept. Triarc's acquisition of Wendy's was an all-stock transaction instead of the debt-financed acquisition originally anticipated. The management buyout of Landry's Restaurants Inc. - operator of Rainforest Cafe, Chart House and Saltgrass Steak House - remains delayed due to difficult credit conditions and the company's declining stock price. As previously mentioned, Fitch does not expect acquisition activity to heat up in the industry during 2009 despite attractive market valuations.

BANKRUPTCY FILINGS ADVANCE INDUSTRY RATIONALIZATION

Due to the high rate of leverage buyout and recapitalization activity that occurred over the past several years, bankruptcy risk is likely to increase in 2009. Highly leveraged restaurants that are experiencing persistent declines in SSS, generate negative free cash flow, and require multiple amendments to credit facilities are most vulnerable. Publicly traded restaurants that have lost significant equity value could also be at risk.

In 2008, most of these filings were full-service restaurants in the family dining or bar and grill categories. Concepts which were involved in bankruptcy filings included Baker's Square, Village Inn, Old Country Buffet, Ryan's Steakhouse, Bennigan's, Ponderosa, and Bonanza. Fitch believes a high level of bankruptcy risk continues in these subsectors, given the general oversupply of units and the high number of restaurants with weak brand equities.

An increase in the number of bankruptcy-related restaurant closures combined with less unit growth will advance the reduction in industry capacity. Buffet's and VICORP, which filed for Chapter 11 bankruptcy protection in January and April of this year, are closing restaurants. Metromedia Restaurant Group, which operates Bennigan's and Steak & Ale restaurants, filed for Chapter 7 bankruptcy protection in July and closed more than 300 company-operated units. Metromedia Steakhouse Co., L.P., a related subsidiary, which operates Ponderosa and Bonanza Steakhouses filed for Chapter 11 bankruptcy protection in October is also likely to close units.

Fitch expects the high level of rationalization occurring in the restaurant industry to prove to be especially positive when consumer spending recovers. Concepts that are leaders within their categories, such as Olive Garden and Red Lobster, and those that have a strong consumer followings or brand equities, such as Chili's and Applebee's, are likely to benefit.

SAME-STORE SALES WEAKNESS PROLIFERATES THROUGHOUT THE INDUSTRY

Unfortunately, conditions which would normally be positive for the industry, such as declining gas prices and additional consumer-related government stimulus packages, are being muted by fears of rising unemployment and continued downward pressure on both the housing and the stock markets. Without a meaningful recovery in consumer sentiment, traffic growth will decline for the entire restaurant industry in 2009. Modest increases in prices, as indicated by the USDA forecast of a 4.0%-5.0% increase in food-away-from-home prices (up from a 3.5%-4.5% increase in 2008), are likely to be offset by negative mix shift toward value-priced menu offerings among QSR and increased promotional activity by casual dining restaurants.

The casual dining segment will enter its third year of negative SSS performance, but heightened promotional activity and discounting along with an uptick in restaurant closures should help minimize the level of consumer trade- down. SSS growth for the QSR is generally expected to remain positive. The QSR segment will continue to benefit from the attraction provided by their everyday value menus and the rollout of premium products such as Pizza Hut's Tuscani Pasta, Long John Silver's Freshside Grille and Burger King's Steakhouse Burgers.

The considerable international presence of QSRs such as McDonald's and YUM, will continue to benefit these companies in 2009, despite rising global economic pressures. SSS performance could weaken meaningfully in emerging geographies with low per-capita disposable incomes; however, Fitch anticipates that revenue growth will continue to be supported by international unit development.

MARGIN PRESSURE COULD ACCELERATE DUE TO DISCOUNTING AND FOOD COSTS

Restaurant margins, particularly within the casual dining segment, deteriorated significantly in 2008 due to higher food and labor costs. Fitch expects margin compression to remain an issue in 2009. Although agricultural commodity prices have declined from peak levels, the USDA is projecting a material increase in chicken prices due to reduced industry production, while beef costs are forecast to remain high due to a continued low level of cattle supply.

Furthermore, Fitch believes structural changes in the meat industry could transfer more commodity price risk to the foodservice industry. Supplier consolidation and less favorable contract terms could limit the future bargaining power of the industry. The relationships most restaurants have with their suppliers could change.

Fitch projects that higher food costs combined with an increase in lower margin limited-time offers, such as Applebee's Neighbor Deals which include an appetizer and two entrees for $20, and $4.99 Angus Burger and Fries lunch, will pressure restaurant margins for casual dining restaurants in 2009. Restaurant margins for QSR companies and their franchisees could also be negatively impacted by an uptick in purchases from less profitable value menu items and a slowdown in sales from higher margin international operations.

Labor costs, however, are not anticipated to be a major issue in 2009 despite implementation of the third and final phase of the federal minimum wage increase to $7.25 per hour. Merger activity along with the increase in restaurant closures has resulted in a larger pool of available staff and could put downward pressure on compensation levels. Reductions in restaurant expenses and corporate overhead during the current downturn have helped make restaurants generally more efficient, but for some operators, this will not be enough to offset the impact of higher food cost and increased sales of lower margin products.

The following is a list of Fitch-rated issuers and their current Issuer Default Ratings (IDR):

--McDonald's Corporation ('A'; Outlook Stable);

--YUM! Brands Inc., ('BBB-'; Outlook Stable);

--Burger King Corporation ('BB'; Outlook Positive);

--Darden Restaurants Inc. ('BBB'; Outlook Negative);

--Brinker International, Inc. ('BBB-'; Outlook Negative);

Fitch's rating definitions and the terms of use of such ratings are available on the agency's public site, www.fitchratings.com. Published ratings, criteria and methodologies are available from this site, at all times. Fitch's code of conduct, confidentiality, conflicts of interest, affiliate firewall, compliance and other relevant policies and procedures are also available from the 'Code of Conduct' section of this site.