Restaurant stocks are about to be taken off the menu.
Stocks like Darden Restaurants (DRI), Ruth’s Hospitality (RUTH) and Buffalo Wild Wings (BWLD) have drawn impressive double-digit gains over the past year, serving up great returns for investors.
But now the market is turning, which means all the easy gains are gone.
The restaurant sector is facing weaker traffic lately with stagnant growth in employment and wages, although restaurant sales have been edging up. Restaurant same-store-sales in the third quarter were up 1.5% from the year prior as same-store traffic declined 1.2%, according to the latest data from Black Box Intelligence, a company that analyzes data and benchmarks in the restaurant industry.
Compounding the more dire outlook for some restaurant stocks, the restaurant industry is expected to suffer overall a tougher weather season this year, which should further weigh on traffic, versus last year’s mild winter.
As a result, restaurant stocks are now deflating toward more reasonable valuations.
Honing in on softness in the restaurant industry, Raymond James downgraded DRI, RUTH and BWLD from “outperform” to “market perform” on Monday, citing concerns over rising employment costs.
In the context of this wavering restaurant market, let’s take a closer look at three restaurant stocks to stay away from.
Restaurant Stocks to Sell: Darden Restaurants (DRI)
Darden Restaurants’ (DRI) strong rally seems to have simply run out of steam.
With brands such as Olive Garden, Longhorn Steakhouse, Bahama Breeze and The Capital Grille, Darden runs a total of about 1,500 restaurants in the U.S., Canada and Puerto Rico.
While Darden relies most heavily on its Olive Garden Italian Restaurant chain for revenue, drawing more than 50% of its revenue there, its most promising restaurant for future demand is Yard House, which taps into the booming craft beer industry.
The majority of Darden’s planned 18 to 22 restaurant openings this year are Yard House restaurants, a chain it acquired for $585 million in 2012.
DRI stock has an inflated price-to-earnings ratio of 28, fairly high for this industry, considering peers like Bravo Brio Restaurant Group (BBRG) and Del Frisco’s Restaurant Group (DFRG) trade for P/E ratios of 20 or less.
DRI stock is down 5% in the past five days, following many other restaurant stocks, and there doesn’t seem to be much upside in the near future.
Restaurant Stocks to Sell: Ruth’s Hospitality (RUTH)
Ruth’s Hospitality Group (RUTH), a higher-end restaurant company has made a strong run in the past year, pushing RUTH stock into expensive territory.
Ruth’s, which owns 65 of its own Ruth’s Chris Steakhouse locations and licenses the franchise rights to another 77, has seen shares rise steadily since early 2009 after a recession-related plunge.
The company owns four other brands focusing on high-quality steak and seafood: Mitchell’s Fish Market, Mitchell’s Steakhouse, Columbus Fish Market and Cameron’s Steakhouse.
RUTH stock has a price-to-earnings ratio of 29, right up there with DRI’s high multiple, meaning the stock is priced for relative perfection going forward.
And, yes, RUTH did report 9.7% increase in revenue compared to a year prior, thanks in part to a 4.2% increase in same-store sales. It reported earnings of 22 cents per share, which, like revenue, beat the Street view, sending shares into a month-long tear.
But, like many other restaurant stocks, the question is whether RUTH can continue to exceed expectations in a weaker market.
Restaurant Stocks to Sell: Buffalo Wild Wings (BWLD)
Buffalo Wild Wings (BWLD) has a price-to-earnings ratio of 39.7, which is high even among restaurant stocks, and is trading toward the top of its 52-week range. But BWLD stock is already losing momentum — despite being up 55.8% over the past year, shares are down 4% the past month.
The company, which operates the Buffalo Wild Wings chain along with PizzaRev and Rusty Taco brands, is expanding abroad, having opened its first restaurant in Dubai in September. It’s already operating in Canada, Mexico and the Philippines. Earlier this year, Buffalo Wild Wings snapped up 41 of its franchises in Texas, New Mexico and Hawaii for $160 million.
Buffalo Wild Wings reported second-quarter results in July that missed analysts projections, and the company blamed the miss on rising food and labor costs. However its revenue does continue to draw impressive gains — quarterly sales were up 16.5% year-over-year.
As of this writing, Rebecca McClay did not hold a position in any of the aforementioned securities.
