U.S. same-restaurant sales dipped into negative territory in February for the first time in nine months. A potentially softening U.S. restaurant environment suggests investors need to be even more selective when it comes to choosing restaurant stocks. Morgan Stanley analyst John Glass recently said investors should focus their attention on fast food stocks in 2019.
Here’s a look at his top three favorite restaurant stocks to buy.
The past decade hasn’t all been smooth sailing for McDonald’s (NYSE: MCD) or its investors. However, Glass says the Golden Arches are still the gold standard of restaurant stocks:
“U.S. sales will outpace peers in ‘19 and should accelerate as the year progresses as benefits from a comprehensive re-imaging plan become more visible.”
McDonald’s has made an aggressive push toward its Experience of the Future initiative in recent years. This initiative emphasizes mobile ordering, delivery and pickup options, store remodels and in-store kiosks.
Glass says heavy investments likely clouded McDonald’s numbers in 2018. The market doesn’t seem to appreciate how much these under-the-radar improvements could improve business efficiency in coming years.
In the near term, focus on value offerings and local advertising in 2019 should support same-store sales numbers. Glass predicts return on invested capital will soon hit new highs as McDonald’s reaps the rewards of its investments. In addition, he says earnings will get a boost from declining capital expenditures starting in 2020.
Finally, in an increasingly unpredictable market environment, MCD stock offers investors value, stability and an attractive 2.5% dividend yield. Morgan Stanley has an “overweight” rating and $210 price target for MCD stock.
Restaurant Brands International (QSR)
Restaurant Brands International (NYSE: QSR) is the parent company of Burger King, Popeyes and Tim Hortons. Glass says there is a huge disconnect between QSR stock valuation and the company’s impressive growth numbers.
Fundamentals at Tim Horton’s seem to be improving, including same-restaurant sales growth of 2.4% in the most recent quarter. Burger King’s SRS growth dropped from 10.1% in 2017 to just 8.9% in 2018, but it still outpaced most of its peer group. Popeyes stole the show for QSR stock investors last year. SRS growth jumped from 5.1% in 2017 to 8.9% in 2018.
Glass said that after a big year in 2018, investors can expect more big numbers for this restaurant stock in 2019.
“Catalysts include improving margins at Tim’s, better visibility on international expansion and economics, and increased investor outreach to help broaden the shareholder base.”
From a valuation perspective, QSR stock is trading at a free cash flow yield of roughly 7% based on Morgan Stanley’s 2020 cash flow estimates. Glass points out that makes QSR a rare value among restaurant stocks.
Morgan Stanley has an “outperform” rating and $70 price target for QSR stock.
Chipotle Mexican Grill (CMG)
Chipotle Mexican Grill (NYSE: CMG) has been a battleground stock for several years now. The company’s growth story was derailed back in 2015 following a series of food safety scares. However, CMG stock has nearly doubled in the past year on optimism that new CEO Brian Niccol can replicate his past success as head of Taco Bell.
Glass says Chipotle is a perfect early-stage turnaround opportunity for investors. Niccol and the management team are pushing hard on several initiatives, focusing on throughput, advertising, menu improvements, digital ordering and customer loyalty. Early returns on the initiatives have been positive, but 2019 will certainly be a show-me year for Chipotle.
Because Chipotle’s restaurants are company owned and not franchised, the company may face unique margin pressures compared to its franchised peers. Rising wages will certainly take a bite out of Chipotle’s bottom line. However, Glass said investors should be watching traffic as a key indicator that Chipotle’s outlook is improving. In the fourth quarter, Chipotle reported 6.1%t SRS growth, double-digit revenue growth and a 2% increase in total transactions.
As long as the recovery keeps trending in the right direction, Glass said long-term margins could eventually improve from around 18.7% to 21%. Morgan Stanley has an “overweight” rating and $617 price target for this restaurant stock.
As of this writing, Wayne Duggan did not hold a position in any of the aforementioned securities.