Restaurants have had a rough start to the earnings season, as no company had beaten expectations prior to Thursday. Then, Chipotle (NYSE:CMG) posted a surprising beat, and created new highs. But does this strong performance mean that Chipotle is now worthy of an investment premium, or should you take profits?
What has went wrong?
Three high-profile restaurants in particular had announced earnings this season with disappointing results: Darden Restaurants (NYSE:DRI), Dominos (NYSE:DPZ), and Ruby Tuesday (NYSE:RT).
Darden just slightly missed its revenue target, but still posted revenue growth of 6.1% year over year. In an industry that's barely growing at the rate of GDP, 6.1% growth is quite strong .
However, Darden saw two notable problems in its quarter. First, the company's profit lagged, posting an EPS of $0.53 which was $0.17 shy of estimates . Also, same-store sales for its total brands was poor, a loss of 3.3% year-over-year. Combined, this report just adds reason for why Darden Restaurants is trading with an annual loss of 6% versus strong gains in the S&P 500.
In the case of Dominos, it actually had a fairly good quarter. The company's revenue grew 6.9% and domestic sales store sales increased 5.4% year over year . However, the company did miss EPS targets, as Dominos continues to fight an industry-wide battle of rising food costs. So far, Dominos hasn't unveiled any plans to raise prices, which might keep consumers happy, but investors concerned.
Finally, Ruby Tuesday simply missed badly on all fronts, thus saw double digit stock losses after its quarter earlier this month. In particular, same store sales fell a whopping 11.4%, and the company projected high single-digit same store sale losses in its upcoming quarter . Also, like its peers, costs were an issue, and its EPS of negative $0.37 was $0.32 off from meeting estimates.
What did Chipotle do right?
Dominos is clearly a pizza restaurant, but both Darden and Ruby Tuesday fall under the category of mid-scale and family dining. This particular space saw a 2% overall decline in this most recent quarter. Therefore, both Darden and Ruby Tuesday saw same store sales that were below the rate of industry growth.
In the restaurant space, fast-casual is growing the fastest, increasing 8% during this last quarter according to NPD Research . Chipotle saw revenue growth of 18% in its quarter . However, much like Darden, comparable store sales were not nearly as impressive.
In the third quarter, comparable store sales growth was just 6.2%, which was lower than the 8% industry growth. Moreover, Chipotle had the same exact problems faced by Dominos, Ruby Tuesday, and Darden, which is costs.
For example, operating margin slipped 60 basis points to 26.8%, and the company specifically mentioned on its conference call that it's entertaining the idea of raising prices in 2014 to offset higher costs .
Whether or not this ultimately affects comparable store growth is anyone's guess, but as for this current quarter, EPS of $2.66 missed estimates by $0.12, which is a common trend among restaurants that have reported thus far.
Is it a good buy?
When you stop to consider the rate of growth in the fast-casual space alone, it becomes hard to determine why Chipotle is trading so high. After Friday's gains, Chipotle is trading at 50 times earnings, and 38 times next year's earnings.
With that said, doesn't a company like Darden appear to be a better investment opportunity? When you compare Darden to the rate of growth for its class and then take into account its valuation, Darden looks to be presenting value.
Darden trades at 18 times earnings and 16 times next year's earnings. Moreover, it trades at just 0.78 times sales compared to 4.5 times sales for Chipotle. Lastly, Darden has an annual dividend of 4.4%. Meanwhile, Chipotle pays no dividend.
With all things considered, valuation matters, as does fundamental performance. Chipotle is simply getting too expensive but is facing the same problems that's seen with other companies in the restaurant space. Darden faces these problems as well, but appears to be a safer investment as a cheaper stock in a space that has very few bright spots at the moment.
Brian Nichols has no position in any stocks mentioned. The Motley Fool recommends Chipotle Mexican Grill. The Motley Fool owns shares of Chipotle Mexican Grill and Darden Restaurants. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.