The stock market’s recession fears are in the rearview mirror. Year-to-date, the S&P 500 is up 11%, and it’s up nearly 20% from its Christmas Eve 2018 lows, as the big risks in late 2018 (stalling trade talks, a hawkish Federal Reserve and slowing economic growth) have all dramatically improved in early 2019.
Restaurant stocks have been front-and-center of the bounce-back rally in stocks. That’s because as big economic risks have faded, consumers have regained their strength, and the whole restaurant industry has benefited from higher traffic. Indeed, despite adverse weather conditions, comparable sales growth across the entire restaurant industry came in at a two-year high in the December/January period, according to TDn2K.
Consequently, restaurant stocks have been in rally mode. Not all of them will remain so for the rest of 2019, however. Instead, as the year rolls on, industry-wide tailwinds will cool, and there will be a big divergence between winners and losers in this industry.
With that in mind, let’s take a look at seven restaurant stocks to watch in 2019, and try to pick out the winners in this group.
Restaurant Stocks to Watch: McDonald’s (MCD)
Analysis: At the top of the list of restaurant stocks to watch in 2019 is global fast casual giant McDonald’s (NYSE:MCD).
The story here is simple. Over the past several years, McDonald’s has reinvented itself to be more relevant to today’s health-conscious consumers. That included revamping the menu, improving product quality and expanding product assortment. In so doing, McDonald’s has improved relevance and popularity, while sustaining industry-wide low prices and high convenience. The net result has been robust comparable sales growth.
This will continue. McDonald’s is continuing to revamp its menu, including swapping out frozen patties for fresh patties, and as these initiatives continue to roll out, the numbers here will remain good. Meanwhile, the valuation on MCD stock is reasonable and in line with its long-term average. As such, upward and outward is the most likely path forward for MCD stock in 2019.
Analysis: Second on this list is Chipotle (NYSE:CMG), the restaurant chain which has come back from the dead to once again become a Wall Street (and Main Street) favorite.
Right now, everyone on Wall Street is applauding Chipotle’s new growth initiatives, including delivery expansion, menu innovation and new marketing campaigns. These initiatives are good, and they are working. Comparable sales growth has been consistently positive and impressive. Margins are moving higher. Profits are rising. Everything is going right for Chipotle.
But the valuation more than reflects these positives, and importantly ignores competition risks. Namely, Chipotle isn’t what it used to be, nor will it ever be again. The healthy food trend has passed the company up, and now all the craze is about unique sushi, poke bowls, superfood cafes and fresh sandwich shops. Thus, while growth will remain good going forward, it won’t ever become good enough to warrant a nearly 50x forward multiple on CMG stock, meaning the next move in this stock will likely be lower.
Analysis: Next up is global fast casual giant Yum (NYSE:YUM), the parent company of Taco Bell, KFC and Pizza Hut.
The fundamentals here are pretty good. Taco Bell is on fire, and has been for a long time due to favorable millennial appeal. KFC is doing just fine as well. Pizza Hut is finally returning to growth after several bad quarters. Meanwhile, the company is re-franchising essentially all of its locations and turning into an asset-light, hugely profitable, money-making machine. This re-franchising does kill revenues, but the revenue slicing is like getting rid of all the unwanted fat. Profits are consequently moving higher.
All of this will continue for the foreseeable future. You will get steady and healthy comparable sales and bottom line growth. But, the valuation underlying YUM stock seems to already reflect that, with the forward P/E multiple at a multiyear high approaching 25 and the trailing dividend yield at a multiyear low of 1.8%. As such, the valuation seems full, meaning that the strong fundamentals won’t drive that much more upside in YUM stock.
Yum China (YUMC)
Analysis: Any discussion of Yum would be incomplete without talking about its Chinese counterpart, Yum China (NYSE:YUMC).
At its core, Yum China is at the heart of a still very healthy China restaurant growth narrative. For all intents and purposes, China remains a double-digit consumption growth economy thanks to urbanization and digitization tailwinds, while the dining market remains a high single-digit growth sector of that red-hot economy, powered by deeper digital penetration and robust unit growth (restaurants per capita in China remain well below the developed country norm).
Because of this, Yum China will remain a big revenue and profit grower over the next several years. Ultimately, those healthy fundamentals will push YUMC stock higher. But, at current levels (nearly a 25x forward earnings while it sits near 52-week highs), YUMC stock seems more than priced for big growth to persist. As such, valuation will cap upside in the near term.
Restaurant Stocks to Watch: Starbucks (SBUX)
Analysis: Another restaurant stock worth watching in 2019 is global coffee giant Starbucks (NASDAQ:SBUX), mostly because the stock appears to be out over its skis at the current moment.
In the big picture, Starbucks is a stable growth company that has been, still is and will remain the leader of the global retail coffee game. But competitors are chipping away at that leadership position. Namely, indie coffee shops are stealing away trend-oriented consumers, while McDonald’s and other fast casual giants are stealing away price-oriented consumers. Thus, while Starbucks will remain the leader in the breakfast drink category, the company will lose share in this market for the foreseeable future.
The net result will be slower-than-normal revenue and profit growth. The reason that’s a problem for SBUX stock is that it isn’t priced for slower-than-normal growth. Instead, SBUX stock has a bigger-than-normal valuation at around 26 forward earnings. This convergence of slower-than-normal growth and a bigger-than-normal valuation will ultimately result in SBUX stock falling later in 2019.
Domino’s Pizza (DPZ)
Analysis: One restaurant stock that investors should pay close attention to given its secular attachment to the delivery aspect of the food industry is Domino’s Pizza (NYSE:DPZ).
For a long time, Domino’s and other pizza chains were the only game in town when it came to fast food delivery. Thus, the delivery tailwind and the mainstream emergence of the stay-at-home economy was a big positive for this company. But, then food ordering platforms like Postmates and Door Dash democratized delivery services. Now, essentially every fast food chain has delivery capability.
This has leveled the playing field in the delivery game, and neutralized a big advantage Domino’s had over its peers. Nonetheless, management continues to do everything right to keep growth on track, and the company is also benefiting from persistent struggles at Papa John’s (NASDAQ:PZZA). Thus, in the big picture, growth remains good here — it will just slow going forward. Good but slower growth seems appropriately priced in here, at 29x forward earnings (in line with its long term average multiple).
Dave & Buster’s (PLAY)
Analysis: Last but not least on this list of restaurant stocks to watch is multi-entertainment destination Dave & Buster’s (NASDAQ:PLAY).
I’m bullish on PLAY stock for one simple reason: the company is perfectly aligned to win as we increasingly shift towards an experience-oriented consumer economy. Long story short, consumers are increasingly valuing experiences over products, and consumption expenditure growth on experiences has significantly outpaced consumption expenditure growth on products over the past few years. Dave & Buster’s is at the heart of this transition by offering a multi-entertainment experience that includes a restaurant, sports bar and arcade.
Over time, consumers will continue to place greater emphasis on experiences. The net result will be more share of wallet allocated to Dave & Buster’s. That will push revenues, margins and profits higher, which will ultimately drive PLAY stock to new highs over time.
As of this writing, Luke Lango was long MCD and PLAY.