A number of restaurant stocks were downgraded last week with analyst sentiment toward the industry turning negative. It suggests the good times have come to an end. Some experts have gone as far as predicting a “restaurant recession” where only the best operators will survive the impending downturn.
In the past two years, restaurant stocks, whose proxy is the Dow Jones U.S. Restaurants and Bars Index, delivered a total annual return of 10.2%, 270 basis points higher than the S&P 500. From a market perspective, the restaurant industry’s been on a roll.
But that’s going to change, say analysts.
“It’s a time to be very picky and cautious about restaurant stocks,” Jefferies analyst Andy Barish noted recently. Even more pessimistic, analysts at Stifel last week downgraded 11 restaurant stocks due to slowing comps. Paul Westra, an analyst at Stifel, believes what will start as a problem for the restaurant industry could turn into a bigger economic meltdown in early 2017.
Is it time to abandon restaurant stocks altogether? That’s definitely one way to go. Another is to follow the advice of Jefferies analyst Andy Barish and focus exclusively on the strongest restaurant stocks currently available.
Which ones are those?
I believe this trio of stocks will do the best job avoiding the impending restaurant recession.
Stocks to Avoid the Restaurant Recession — Domino’s Pizza, Inc. (DPZ)
Everybody loves pizza — in good times and bad.
No restaurant stock has performed as consistently as Domino’s Pizza, Inc. (DPZ) since the last major recession in 2008. Since then, it has delivered seven consecutive years of positive returns — up 62.4% on an annualized basis — with an eighth on the way. Over the past five years, DPZ stock has beaten the S&P 500 by 28 percentage points annually.
If you had invested $10,000 in DPZ stock on November 21, 2008 (it’s low for that year), today you’d have $565,211. That buys a lot of pizza.
But that’s the past. It’s the future we’re concerned about.
Domino’s announced Q2 2016 results on July 21 and they were a thing of beauty. Domestic same-store sales grew 9.4% year over year; international same-store sales were up 7.1% — the 90th quarter of positive comps; and earnings per share increased 21% in the quarter to $0.98. It’s easy to see why CEO J. Patrick Doyle was pleased with DPZ’s Q2 performance.
In March, I suggested Domino’s was the best pizza stock available. Today, I say it’s one of the three best restaurant stocks available — of any category.
Stocks to Avoid the Restaurant Recession — McDonald’s Corporation (MCD)
Its breakfast business has been the talk of the industry, but McDonald’s Corporation (MCD) is not about to rest on its laurels. It’s seen business come and business go. Customers’ tastes change, as do their loyalties, keeping even the biggest of restaurant operators continually on their toes.
CEO Steve Easterbrook isn’t taking anything for granted. “We know there’s still more work to do, and that’s why we remain committed to executing our turnaround plans for at least two more quarters,” he noted in MCD’s Q1 conference call in April.
Fast forward to Q2 and its business hit a speed bump with global same-store sales up 3.1% in the quarter, 50 basis points less than expectations. As a result, MCD stock took it on the chin last week. Not unexpected.
But, that doesn’t mean it isn’t the right bet for a difficult market.
“I’m encouraged that we continue to win relative to our QSR competitors in key markets around the world,” said Easterbrook in McDonald’s Q2 2016 conference call. “In the U.S., our comparable sales gap versus the QSR sandwich segment was consistently positive and averaged 130 basis points for the quarter, despite softer industry growth.”
While the top line might be slowing, its margins at both franchises and company-owned locations are on the rise. In the midst of flattening the organization to be more responsive to the field, any turn for the positive in terms of future comps will fall to the bottom line as G&A expenses are tightened.
McDonald’s will weather this storm.
Stocks to Avoid the Restaurant Recession — Starbucks Corporation (SBUX)
The competition in the coffee business has become cutthroat. No company can afford to let up, not even Starbucks Corporation (SBUX).
Howard Schultz knows this more than most. He took his foot off the gas, stepping down as its CEO in April 2000 after 13 years in the role. Orin Smith, COO at the time, did a good job as SBUX’s chief executive, but retired in March 2005. His replacement, Jim Donald, failed to maintain momentum and by January 2008, Schultz was forced back into the CEO’s chair to revive its fortunes.
We know what’s happened since then. Starbucks stock is up 527% on a cumulative basis, versus 54% for the SPDR S&P 500 ETF Trust (SPY). If anyone can figure out how to position SBUX for future growth, Schultz can.
He understands that to remain static is the kiss of death. So, Schultz announced SBUX’s long-term strategic plan on July 25 to company employees. Included in the plan were several personnel changes to ensure the future over the next eight years is as bright — or brighter — than the past eight.
Schultz is doubling down when it comes to coffee. To meet this challenge, SBUX has created a new division called Siren Retail to be headed by Cliff Burrows, Starbucks’ Americas chief over the past eight years. Burrows will be responsible for increasing brand awareness and developing new concepts that take coffee production to the next level.
Some might think the coffee business is oversaturated, but these moves by Starbucks suggest it has only just begun.
Good CEOs make bold moves and utilize great talent to execute at a higher level. In this regard, I don’t see how the likes of Dunkin Brands Group Inc (DNKN) can keep up.
If you can only own one restaurant stock over the next five years, SBUX is the one.
As of this writing, Will Ashworth did not hold a position in any of the aforementioned securities.