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3 Restaurant Stocks That Are Headed to Zero

restaurant - 3 Restaurant Stocks That Are Headed to Zero

Source: John Pluta

Restaurant stocks have had a rough couple of years. With bankruptcies and declining same store sales figures, it doesn’t appear that this hurt will end any time soon. Investors have many options when looking at restaurant stocks to buy, but should be cautious trying to catch falling knives in this industry. Sometimes early warning signs are overlooked and can cause long-term pain for shareholders.

3 Restaurant Stocks That Are Headed to Zero

The first quarter of 2017 saw restaurant same store sales decline 1.6%, marking the fifth consecutive negative quarter. This is a similar downtrend last seen in 2009 and 2010 that hit the industry hard.

The first-quarter miss follows a fourth quarter that saw restaurant same store sales decline 2.6%. Same store sales also fell in the most recent reported month of May with a decline of 1.1%. The last positive month for the overall restaurant industry was February 2016.

Investors have seen restaurant stocks come and go, as several publicly traded companies have declared bankruptcy. While some restaurants that declare bankruptcy survive in the long run, investors often come out on the losing side of things. In September, when Cosi Inc (OTCMKTS:COSIQ) filed bankruptcy, it marked the eighth restaurant bankruptcy in the last 10 months.

Warning signs like store closures, declining margins, and weak same-store sales can help tell investors which restaurant stocks to sell ahead of time. Here are three restaurant stocks under $5 that could soon head to zero if they can’t turn things around.

Restaurant Stocks Headed to Zero: Noodles & Co (NDLS)

Noodles & Co (NASDAQ:NDLS) saw its 2013 IPO price at $18 per share. Since then, shares have lost 90% of their value and now trade at less than $4 apiece. The company is closing restaurants and has seen sales decline significantly at comparable stores. NDLS is one of the restaurant industry’s stocks to sell right now.

Restaurant Stocks Headed to Zero: Noodles & Co (NDLS)First-quarter revenue increased 2.4% for NDLS and same-store sales increased 1.1% at franchised locations. That’s where the positives end for this company. Same-store sales declined 2% overall, as company-owned comparable stores saw sales decline 2.5%. Restaurant margins also took a significant dip, a bad sign for future earnings.

Noodles has put a plan in place to close 55 restaurants to improve overall results. The company closed 39 of these stores in the first quarter and 16 additional since then, which will hit second-quarter results. Management believes the closings will help improve profitability and performance.

The average unit volume for an NDLS store was $1.07 million at the end of the first quarter, which was a decline of $34,000. Excluding the closed restaurants, that figure comes in closer to $1.12 million.

Higher cost of sales (+1.1%) and labor (+1.1%) hit the company margins in the first quarter. Restaurant margin was 11%, a significant fall from the prior year’s 13.3%. The company says in its full-year outlook that it believes margins will hit between 13.5% and 14.5% for the full year. I find that figure a little too optimistic after the first quarter, and labor hitting the industry across the board. That figure is also trimmed back from a prior guidance range of 14%-15%.

The declining same store sales is the biggest item investors should look to when concerning NDLS. In fiscal 2016, all four quarters came in negative and got worse as the year progressed. Franchised stores actually saw positive comparables in the third and fourth quarters, but couldn’t offset the poor performance at company-owned locations.

Keep in mind that NDLS is now calling for same-store sales to decline in the low-single digits, after previously guiding flat to slightly negative same-store sales at the end of the last fiscal year.

Restaurant Stocks Headed to Zero: Famous Dave’s of America, Inc. (DAVE)

You may have heard of popular BBQ chain Famous Dave’s of America, Inc. (NASDAQ: DAVE), which opened its first location in 1995. If you’ve been in an investor in the chain, you have watched shares decline 51% since their IPO. Some investors may have seen bigger declines, as shares were over $30 in 2015 and are down 82% in the last two years.

Restaurant Stocks Headed to Zero: Famous Dave's of America, Inc. (DAVE)

Shares of DAVE trade for less than $4, but don’t appear to be set to rebound any time soon. A new franchising plan may excite some investors, but this is just another restaurant stock to sell.

First-quarter results were once again poor for DAVE. Same-store sales declined 4.8% at franchised locations and 3.3% at company-owned locations. The overall same-store sales decline of 4.5% came against a weak negative 6.3% comparable from the prior year. Last year, Famous Dave’s saw company-owned stores post negative same-store sales of 5% and franchised locations post negative 4.7%.

The big plan from DAVE is to become a franchising company collecting royalty checks. The company had 173 restaurants open at the end of the first quarter, with only 35 of those locations company-owned. Since that time, management has closed two of the company-owned locations and announced plans to refranchise the other 33 stores in the next 12-24 months.

Famous Dave’s squeaked out a 1-cent profit per share last fiscal year on an adjusted basis. That was a decline from the prior year’s 4 cents per share. The first quarter saw earnings per share decline to a loss of 5 cents from a profit of 2 cents in the prior year. Despite a small $25 million market capitalization and a plan to be a holding company, I see no reason to buy, or even hold, shares of DAVE.

Restaurant Stocks Headed to Zero: Papa Murphy’s Holdings Inc (FRSH)

With more than 1,500 stores across the U.S., Papa Murphy’s Holdings Inc (NASDAQ:FRSH) is a well-known name in the restaurant industry. The company was founded in 1981 and thrived on the take ‘n bake concept of preparing pizzas with fresh ingredients in-house and having customers cook them at home. This allowed for the company to have small store spaces and low operating costs.

Restaurant Stocks Headed to Zero: Papa Murphy's Holdings Inc (FRSH)

FRSH priced its 2014 IPO at the low end of its initial range with an offering price of $11 per share. The company saw its shares climb over $20 in 2015 and remain in double digits for part of 2016. However, FRSH shares now trade for less than $5 and the company sports a small $74 million market capitalization.

In the first quarter, FRSH saw same-store sales decline a whopping 5%. That came with a staggering 9.9% decline at company-owned locations and a decline of 4.5% at franchised locations. In the last fiscal year, same-store sales declined 2.8% overall. For the current fiscal year, FRSH expects to see same-store sales in a range of -2% to flat, which is lowered guidance from a previous range of flat to positive 2%.

In a January investor presentation, Papa Murphy’s pointed out that its recent same-store sales woes are a new thing for the company, which had seen 19 positive quarters and five negative quarters prior to the first-quarter earnings report. In fact, only two years have seen negative same-store sale declines for the full year.

While that’s a positive, it’s also worth pointing out that since 2008, only two years have had same-store sales growth above 3%. The company has posted minimal gains or declines in each of the last several years. It looks like the take ‘n bake craze may be over.

Like many other restaurant stocks, Papa Murphy’s believes increasing the rate of franchised locations is the right move to long-term success. Of the company’s 1,566 stores at the end of the first quarter, 1,357 were franchised, 168 were company-owned and 41 were internationally licensed locations.

Of these three restaurant stocks, this could be the one least likely to go to zero, at least for now. Despite more than 1,500 stores across three countries, FRSH has minimal locations in the New England and East Coast regions of the U.S. In fact, FRSH believes the opportunity in the U.S. calls for 4,500 locations.

This restaurant stock could see a boost if it can continue to expand its store count, despite the falling comparable same-store sales.

As of this writing, Chris Katje did not hold a position in any of the aforementioned securities.

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