by Traders Reserve | November 4, 2013 4:08 pm
America’s addiction to food has propelled some restaurant stocks to record high prices. Valuations are such that even the slightest misstep and you could be looking at a stock that drops 20% to 30%.
While the usual suspects like Chipotle (CMG) and Buffalo Wild Wings (BWLD) soared after solid earnings reports, the rest of the industry may not be so fortunate.
Right now I’m watching three vulnerable restaurant chains that will report earnings this week. All are trading at peak prices and could stumble after earnings reports.
Last Monday, shares of Ruby Tuesday (RT) dropped some 8% after the company confirmed that its chairman had resigned and had sold his stock.
The sector remains strong as consumers continue to flock to casual dining. There’s no letup in sight for Americans’ tight budgets and time constraints, meaning these will remain primary drivers for growth.
The question I would ask is this: how far can these stocks fly?
At some point valuation matters, and for that reason I would be a bit cautious on the space.
Here are big three big restaurant industry names to sell before they report earnings in coming days:
Red Robin Gourmet Burgers
The good old hamburger is alive and well in the U.S. But beef prices are ludicrously high and could be the trigger for a good old crash diet for a name like Red Robin Gourmet Burgers.
Red Robin (RRGB) reports its earnings results on Tuesday before the market opens. The stock is up over 130% in the last year of trading. Analysts expect the company to grow profits by 18% in 2014. That is a very respectable number.
The question is would you be willing to pay 33 times 2013 estimated earnings for that growth? I sure wouldn’t.
Given the risk of an earnings miss, the risks are tremendous. The stock could drop 30% easily if there is a miss.
Noodles & Co.
I’m a big fan of Noodles & Co. (NDLS). I eat there often with my two young daughters.
That said, how much pasta does the world need? I think many investors compare Noodles to Chipotle. They are not the same. In fact, if the country figures out that we need less pasta and not more, Noodles & Co. could be in big trouble. The company reports earnings on Wednesday after the market closes.
Noodles is a newly minted publicly traded company. Its shares got the obligatory pop when first available on the market, but the stock has traded sideways and drifted lower in the last month of trading. Analysts expect the company to grow profits by 37% in 2014.
That is impressive indeed, but the stock trades for 110 times 2013 estimated earnings. When the company last reported, it beat estimates by the proverbial penny per share. That’s not going to cut it with this sort of valuation. Get out before the earnings are reported.
Shares of Wendy’s (WEN) have soared in the last year. The stock has doubled in value in the last 12 months of trading. The third wheel in the fast food hamburger chain battle is certainly doing well for investors.
How long will the trend continue? At its current lofty valuation there is significant risk here. The company is only expected to make 23 cents per share this year. That’s awfully close to break even or worse. It’s also a low base for growth that might be attractive to aggressive investors that then leave at the first sign of trouble. Analysts expect the company to grow profits next year by 17%, but that’s only to 27 cents per share.
There isn’t much wiggle room here if you ask me. With the stock trading for 38 times 2013 estimated earnings, I would be worried about a sharp correction – or crash diet if you will. Get out before the company releases results as the earnings report is often the time when investors decide to bail.
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