The globe is crippled with uncertainty, so I consider this homework regarding restaurant stocks preparing for opportunities.
The situation is fluid for at least the next few weeks. The macroeconomic assumptions are changing rapidly, as the coronavirus from China is taking a financial toll on all businesses. If you went shopping this weekend, then you know what I’m talking about. The grocery store shelves are empty and the staff is limited. This will have a massive financial impact on global GDP. We simply don’t know where the bottom for stocks lies!
The 2008 financial crisis was a surprise, but this we scheduled ourselves. Once governments decided to shut everything down, they essentially triggered a financial wave of ruins. I don’t want to be an alarmist, but I’m realist and people are acting crazy — so I expect crazy things. I will welcome the rally with open arms when it comes, and that’s why we’re doing homework.
With regards to the correction, the technicals suggest we are near a bottoming process. But I suspect that there could be a few more waves of volatility like Monday morning. The level of panic I saw at the retail level in stores like Costco (NASDAQ:COST) and Walmart (NYSE:WMT) is frightening, so it’s hard to guesstimate how this will impact retail.
Here, though, let’s discuss how this impacts restaurant stocks. These won’t see a surge in sales like grocery stores, so the pain has already started for them. They rely on foot traffic and the primary global strategy to combat the virus is to stay indoors. So, stocks like Starbucks (NASDAQ:SBUX), Chipotle (NYSE:CMG) and Lukin Coffee (NASDAQ:LK) are already suffering. Nevertheless, all three stocks have fallen from extreme highs so a lot of the technical damage has happened — and there will soon be opportunities to scoop up a few shares.
So, let’s dive in.
Restaurant Stocks to Buy on the Dip: Chipotle (CMG)
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Chipotle stock is a fast mover in either direction; this morning’s crash is prime example. On the way up, experts loved it up until its 2015 food problem which caused a 67% selloff. It took its time bottoming, but it finally rallied to a new astonishing $940 level.
Then, last month and exactly two years after the bottom, it fell 40% from that record. On the way up, experts were in a race to outdo each others’ price targets just like they did with Tesla (NASDAQ:TSLA). It’s only a matter of time before they reverse the process now. Maybe they wait until CMG management revises its current estimates. But until then, the risk will loom and keep buyers away.
This is a stock that has never been cheap, so value is not going to save it. It is a growth stock and its ace is its impressive comparable sales performance. But now, this again is in jeopardy from how the virus will affect its foot traffic. Buying shares of a really expensive restaurant stocks during these times is dangerous. This will take time to heal, so there is no need to rush into it all at once. It is becoming attractive to longer-term investors who have been looking for entry points since 2019.
Moreover, it is important to acknowledge that this stock will never be cheap because they are positioned to spend a lot in order to deliver the top-line expansion at the expense of profitability. This makes it hard to trade because they rarely give investors obvious points of entry. For CMG stock, the decision is always relative to its own charts. Last week, it fell into a support zone. But when the CBOE Volatility Index (VIX) is this high, I look for zones — not thin lines.
There should be buyers around $600 through $510 per CMG share. This is a wide range, but keep in mind that the whole market is moving 4% to 7% per day. The overnight future session indicates more of the same to start this Monday.
Starbucks (SBUX)
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Starbucks is a global brand, and is definitely suffering from the virus impact. It is the established giant coffee retailer, so it will survive it but this is a formidable test. China is an important market for the company, and there it has serious competition from Luckin Coffee. The recovery in that market, though, will give us clues as to what Starbucks operations will face worldwide.
Furthermore, SBUX stock has stumbled a few times before, so this is not new. But this time, the problems are not intrinsic. Prior reasons were with long lines at the checkout registers or social flubs from staff. But overall, management has proven it can eventually rise to the occasion and right the wrongs. After this wave passes, it will still be a healthy business that is the envy of many.
Value could also play into initiating a position in SBUX stock. It sells at a 26 times forward price-earnings ratio, which is less than half of CMG’s 50. Furthermore, last week’s low was 37% below the all-time high and 31% below the February highs. Clearly, investors shed the froth quickly, leaving more meat on the proverbial bone. The zone between $64 and $56 is pivotal, as investors spent months fighting over it between 2015 and 2018. This builds support when prices fall back into it, so the bulls have that security underneath last week’s lows. The candle was a doji, which indicates indecision and what they do this week will be important.
If it were not for the shock of the virus headlines, this dip would invite plenty of SBUX stock buyers. But there is no need for anyone to be a hero yet. Nevertheless, investor timeframe dictates the decision to buy or not. Active traders are busy buying intraday dips and selling rips. The longer term investors may also be nibbling, but it’s the swing traders that are stuck worried as they should be.
Those who stayed long all this way and haven’t sold it yet, it might be too late to do so now. Last week’s low was the levels that served as the base for the 60% October rally.
Luckin Coffee (LK)
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Luckin coffee operates entirely in China, yet the stock did not collapse out of speculation. Yes, the correction has been big, but it it still above January’s low. Therefore, giving back some of the bounce is normal but they need to hold. Losing last week’s low could invite more sellers and risk another $5 per share. This is nothing against the company itself, but rather a chart comment.
This stock has a strong fan club on Wall Street, so when this madness abates it will recover. This makes it a better long than short on big dips. Management is committed to growing fast and it’s executing well on plans. It is now a formidable competitor to Starbucks in China in a very short period of time. However, it is still a speculative stock because they are being very aggressive. That’s okay for now, as long as it continues the exponential growth to justify the expenditures. Management so far is showing it can be bold enough to blaze new trails. Last year. they announced creative ways of adding sales self-serve access points.
China was first to suffer the consequences of the coronavirus, so it is first coming out of it. The upswing may have started there, so maybe LK is a better bet then the other two; Luckin may have calmer seas ahead than its U.S. counterpart.
I usually trust support levels, but these days nothing is foolproof. The situation is extremely volatile and on a global basis so the technicals are not absolute. Nobody has the right answers without further information. We need time to pass and the death counts stay low as the infection counts rise. This would improve the kill rate and maybe bring it closer to that of the regular flu — and only then may sentiment recover. With that, it will bring a rally into the markets assuming no further complications or surprises.
This is all to say that there are great bargains in the stock market. But caution is most definitely warranted from both bulls and bears, as nobody has all the answers.
Nicolas Chahine is the managing director of SellSpreads.com. As of this writing, he did not hold a position in any of the aforementioned securities. Join his live chat room for free here.
