The restaurant business is experiencing a tectonic shift. Initially, changing consumer tastes and pressure from labor costs hurt restaurant stocks. Now, however, restaurants are suffering from the slowdown in China, which has been a primary growth driver.
Suddenly, exposure to China is a bad thing. Suddenly, eating fresh and organic food is more important than price. Suddenly, even emerging market consumers want fresher, healthier food choices. And as it turns out, these things are big challenges for major restaurant stocks.
Some might argue that such turmoil warrants sitting it out on the sidelines. Some suggest that you’d be better off not having any exposure to restaurant stocks.
But if you listen to those critics, you might miss out on the restaurant stocks that do have value. Of course, investors need to be especially selective in deciding which restaurant stocks are worth digging into and which ones you should dump.
Given the choppy waters in this sector, it’s going to be sink or swim. Luckily, InvestorPlace has you covered with three calls on major restaurant stocks. Read on to find whether you should dump them or dig in.
Restaurant Stocks: Chipotle — Dig In
Earlier in October, Chipotle (CMG) reported earnings of $4.59, below analysts’ estimates, and CMG sold off to the tune of 8% overnight. Many argue that Chipotle’s rapid growth, which drove CMG stock higher for 10 years, is now over; the Mexican restaurant chain simply has no more space to grow.
But a quick look under Chipotle’s hood suggests that CMG stock still has plenty of upside. And that, of course, means you can use the recent pullback to dig in to Chipotle stock.
ROE for shareholders is among the highest in the business with a 12-month ROE of 25%. Those kinds of numbers come from healthy profit margins and almost no debt. Thus, Chipotle could decide to take on debt to accelerate its expansion without any significant risk.
CMG Stock has a strong earnings record. Over the past 10 years, net income increased on average by 33% per year. One quarter’s earnings miss doesn’t mean the picture has changed. CMG Stock still enjoys strong profitability and higher growth than most of its peers.
Restaurant Stocks: McDonald’s — Dig In
McDonald’s (MCD) is, no pun intended, on a roll. MCD stock earnings smashed analysts’ expectations with an EPS of $1.40 vs expected $1.27. MCD also saw a turnaround in U.S. same-store sales of 0.9% after two years of contraction. Globally, same-store sales jumped 4%.
This is all part of a grand turnaround plan orchestrated by the newly appointed CEO Steve Easterbrook. Easterbrook gained his good reputation on the turnaround of McDonald’s U.K. business.
At the heart of Easterbrook’s turnaround scheme are two pillars:
- Reshuffling MCD management. MCD is reducing the number of executives to enable more efficient cost reductions. Additionally, markets will no longer be segmented geographically but rather on their growth outlook.
- Placing a strong emphasis on consumer tastes and preferences. MCD is serving breakfast items all day long, which helped boost sales. The menu was also tweaked extensively. New additions include buttermilk crispy-chicken sandwiches and customizable hamburgers. Finally, Easterbrook made a pledge to eliminate non-vital antibiotics from its chickens.
The turnaround for McDonald’s is expected to be significant and shift its business outlook. Essentially, MCD isn’t running on cruise control anymore.
MCD stock is trading at a price-to-earnings ratio of 25, which is fair; it also sports a decent dividend yield of 3%. Despite the recent stock surge, it doesn’t seem the turnaround has been priced in. That means MCD stock still has further to climb.
Restaurant Stocks: Yum Brands — Dump It
Currently, the darkest cloud looming Yum stock is its China business, which continues to deteriorate. Despite the weakness in Yum Brands’ China segment, investors have been patient.
Throughout the weak results, management stressed that China was an important pillar of growth for the company. They also continued to express their belief that a turnaround was close.
Now, there’s news that Yum brands is planning to spin off Yum Brands China into a separately traded stock. This not only erodes management’s credibility but comes with incredibly bad timing. Yum stock has been hit hard by China’s weakness, all the way down. So, when a turnaround does eventually come … who benefits? You guessed it! The upside from a turnaround is primarily going to benefit a different stock.
As if that weren’t scary enough, YUM stock carries a high multiple of 35, combined with a high debt ratio 1.5 times its equity. It’s time to jump off the Yum stock train before it completely derails.
As of this writing, Lior Alkalay did not hold a position in any of the aforementioned securities.
