A recession isn't a dead end. It's simply a detour.
Perhaps that's the reasoning behind a pair of intriguing upgrades this morning: BMO Capital's move to raise its rating on yoga apparel retailer lululemon athletica (Nasdaq: LULU ) , and Bear Stearns' decision to up the ante on casual-dining behemoth Darden (NYSE: DRI ) . The two decisions have a lot in common.
No, you won't see your local Olive Garden or Red Lobster overrun with Zen-minded upscale soccer moms anytime soon. However, two separate moves to upgrade companies that are clearly in the line of fire when it comes to diminishing disposable income -- that's refreshing.
We're not going to stop spending money if the economic funk deepens. We're just going to be smarter about how we spend it.
Thus, the market is reevaluating the steep markdowns that have taken place in the sector. Lululemon's price isn't that much lower than it was when BMO downgraded the shares two months ago, but the stock has shed more than half of its value since peaking after last year's hot IPO.
Lululemon's prospects aren't any dimmer than they were during last year's run. In fact, the outlook may be even brighter today. Analysts see the company earning $0.73 a share this new fiscal year, higher than the $0.65 a share they expected three months ago.
Paying 37 times forward earnings for a trendy retailer may seem outlandish, but then you warm up to the company's growth trajectory. Net revenue soared by 75% through the first three quarters of fiscal 2007, with expanding margins propping profits even higher. As many retail concepts stagnate or retreat, lululemon comps are clocking in higher by double-digit percentage chunks.
Eat up at these prices
Darden can't point to the same kind of market dominance, but this morning's upgrade indicates that at least one pro feels that the restaurateur is cheap at just 11 times this year's earnings. Will Darden be challenged if consumers stay home, weary of higher gas prices taking even bigger bites out of their diminishing billfolds? Of course. However, most chains that have made it this far know a thing or two about adapting to weaker economies.
Have you checked the new Sonic (Nasdaq: SONC ) ads? The drive-in fast-food joint is promoting Happy Hour these days. Don't bother asking for a wine list or wondering what's on tap. Sonic's version of Happy Hour features half-priced drinks and slushes during the typically moribund hours between 2 p.m. and 4 p.m. daily.
Burger chains like McDonald's (NYSE: MCD ) have been nurturing their dollar-menu choices for years now, preparing themselves for stingier pockets. Pizza chains like Yum Brands' (Nasdaq: YUM ) Pizza Hut and Domino's (NYSE: DPZ ) have hit the market with deals for $5 medium pizzas.
Will margins get dinged along the way? Perhaps. Buck-a-burger masters like McDonald's and Burger King (NYSE: BKC ) have gone for the barbell approach, hoping that customers ordering off the dollar menu will either pair up their orders with a higher-margin drink and fries, or will go for pricier fare like chicken breast sandwiches and salads. Pizza chains will naturally be susceptible to spikes in dairy prices, but as long as the product is profitable, $5 deals will help the companies make it up in volume.
In short, I understand the market's apprehension about buying into retail stores and restaurants. I just don't share it. Even if few companies are growing as quickly as lululemon, plenty offer fetching market valuations similar to Darden's.
As long as you're comfortable with the near-term bumps and hiccups, it's time to start nibbling. Don't take my word for it -- the better-seasoned minds at BMO Capital and Bear Stearns seem to agree.
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