Are QSRs the New Tech?

The hot industry gets the big-time valuations, and usually that industry lies in or around technology. It makes sense, given that many of the companies are set for lightning-fast growth and offer products and services that make investors swoon. But lately, there's an unsuspecting industry rivaling tech's historic P/E dominance: quick-service restaurants. With multiple QSRs trading at 30 times earnings or more, some investors are scratching their heads. Why are we paying so much for fast food?

Fast and furious
Upon its IPO several business days ago, Noodles & Company (NASDAQ: NDLS  ) stock rocketed up as if it were NASA reincarnated. The company, around since 1995, is 343 restaurants strong, with more on the way. Unsurprisingly, Noodles & Company sells mainly noodle-based dishes, but from different corners of the earth -- customers can opt for Chinese, Italian, Thai, Indonesian, and more. (Of course, all dishes are centered toward more Americanized versions of the ethnic foods.)

An interesting concept? Sure. For 208 times trailing earnings ... wait, what? It's true. Noodles & Company trades at 208 times 2012's earnings. On an EV/EBITDA basis, the company trades at roughly 30 times.

Now, obviously this is the market predicting Chipotle Mexican Grill (NYSE: CMG  ) , version 2.0. But as Barron's recently pointed out, Noodles isn't quite Chipotle. Last year's same-store sales were up 5.4% and in the last quarter up 2.2%. In the year before Chipotle's IPO, same-store sales jumped 10.2%, and the company was earning much more per restaurant.

Even if Noodles is the next Chipotle, there is still considerable risk. Chipotle is an incredibly expensive company to own. While it's tough to argue with the more than 800% rise in stock price since its 2006 IPO, Chipotle was a risky bet that paid off. At Chipotle's 31 times forward earnings, the market expects it to continue its amazing growth -- even while domestic opportunities are slowing and some international prospects (such as the company's London operations) have not played out as expected.

Price-conscious investors understand that they pass up certain opportunities in the name of a good night's sleep. Paying $200 for $1 of yesterday's earnings, for a fast-food noodle restaurant, does not let one sleep well.

Not alone
Chipotle and Noodles are just two examples of the QSR craze. Panera Bread (NASDAQ: PNRA  ) trades at 23 times forward earnings. While not as unreasonably priced as the other two, it's still got a hefty price tag for a company that has already gone through its biggest growth phase.

To put it in perspective, a growing tech firm like Blucora trades at under 20 times forward expected earnings. Blucora operates TaxAct, a leading Web-based tax preparer service that is expected to continue its market-share gains. The company also owns InfoSpace, a search and online monetization business. Sure, it has Google to compete with, but Blucora has still managed to grow at a CAGR of 18% since 2009.

Ten years ago, it would be hard to imagine an Internet company trading at a strong relative discount to a burrito shop.

Bottom line
Chipotle and Panera are proven companies with strong management. I have no doubt they will continue to be successful in the coming years. But paying the premiums the market demands today is a stacked bet. The same goes with Noodles, though we know less of management's shareholder-friendliness.

I'm not predicting widespread multiple correction for these companies, because the market can remain irrational for an infinite amount of time, but an investor concerned with the value received for the price paid shouldn't be too eager to jump on these trains. Perhaps even more interesting is that tech may be a new darling for value-oriented investors. Let that marinate for a while.

Food for thought
The retail space is in the midst of the biggest paradigm shift since mail order took off at the turn of last century. Only the most forward-looking and capable companies will survive, and they'll handsomely reward investors who understand the landscape. You can read about the 3 Companies Ready to Rule Retail in The Motley Fool's special report. Uncovering these top picks is free today; just click here to read more.


Read/Post Comments (0) | Recommend This Article (0)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

Be the first one to comment on this article.

DocumentId: 2529308, ~/Articles/ArticleHandler.aspx, 7/24/2014 7:02:44 PM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...


Advertisement