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The Best Fast Casual Stocks of 2016

By Daniel B. Kline – Nov 26, 2016 at 9:09AM

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These chains should be on your menu to buy and hold.

The fast casual segment has hit some bumps in the road in 2016 partly due to over-saturation and partly because Chipotle (CMG -0.34%) has had trouble winning back customers after its well-publicized food safety problems.

But, while it might not be on an unimpeded rocket ride to the top, fast casual sales have been growing faster than any other restaurant category. In fact while the consumer foodservice industry had 5.3% growth in 2015, fast casual basically doubled that growing by 10.4%, according to data from Euromonitor.

Those numbers may not be quite as bright in 2016, given that the entire restaurant industry has had its share of problems, but the long-term prognosis for the segment is very strong. Fast casual should continue to grow because people are changing their expectations when it comes to eating out.

"Consumers are shifting their dining preferences, especially in developed markets," Elizabeth Friend, consumer foodservice strategy analyst at Euromonitor International, told QSR Magazine. "Coffee shops, for example, saw a high increase in sales last year, which shows that the dining-out culture is continuing to evolve toward more modern, premium, casual, and social experiences."

Of these three stock picks, two have been innovators while the third may be down, but it's clearly not out. Starbucks (SBUX -1.41%) and Panera Bread (PNRA) have both found different ways to be leader and innovators while at some point customers will remember why they like Chipotle.

Starbucks is currently pushing its holiday beverages. Image source: Starbucks.

Why Starbucks is a buy

Starbucks has been a monster and it shows no signs of slowing down even in the face of broader concerns about the restaurant industry around the world. The company just finished its fiscal year and it saw global comparable store sales increase 5%, (6% increase in the Americas segment) while consolidated net revenues grew 11% to $21.3 billion.

There are few reasons to think that will slow down as the chain has done a good job maximizing same-store sales by improving efficiency and its overall revenue should be helped by its quick expansion in China.

Starbucks has done a great job getting consumers to use its app for payment and even to order ahead. That lessens lines, allowing for less personnel behind the counter working on taking orders and more working on making them. As that adoption continues to grow, same-store capacity should go up, lines should get shorter, and same-store sales should steadily grow.

That, of course, helps on the revenue front, but so does adding new locations. The chain expects to increase its store count in China alone to 5,000, up from about 2,500 now. In addition it expects to roll out its upscale Roastery & Tasting Room in New York, Shanghai, and Tokyo by 2018, along with a European location in a yet-to-be-picked city. These upscale stores/production facilities raise revenues with their own sales and also by roasting high-end beans for sale at stores throughout their region.

Why Panera Bread is a good pick

Panera has not been the same obvious slam dunk that Starbucks has. The company was slow to the technology party and it has not finished updating all of its stores with its "Panera 2.0" model.

What Panera has done is act quickly to follow Starbucks' lead. The fast casual restaurant has adopted mobile ordering and in some ways has improved upon what its rival has by offering a pickup location (a modified bookcase) in its stores where customers can pick up an order placed through the app without any sort of staff interaction.

That process, much as it does for Starbucks, shortens lines, improving the experience for new and existing customers. In addition to improving its technology and efficiency Panera has also staked out a clear position as a place that sells more natural foods. The company has made many changes to its menu because of that and has a well-publicized "no-no list" of items, additives, and ingredients it won't sell.

Those efforts have been paying off as in its third quarter earnings release the chain reported a 3.4% sales increase in company-owned comparable net bakery-cafe sales. It has also raised its full-year earnings per share (EPS) guidance to between $6.67 to $6.72.

Panera also had a 22% digital utilization rate in its company-owned stores which suggests that customers are embracing the technology. These aren't Starbucks numbers, but the chain has built a solid foundation for future growth.

Chipotle will rise again

Since its E. coli scandal began in July 2015, the company has struggled to win customers back. In Q3, the chain saw revenue fall 14.8%, comparable restaurant transactions drop 15.2%, and comparable sales fall 21.9% year over year. Those are awful numbers but they represent a slight improvement over the previous quarter when revenue dropped by 16.6%, comparable transactions were down 19.3%, and comparable sales fell by 23.6%.

It's hard to call those improvements a victory, but it's slow progress in a war the company will eventually win because even if it takes time, scandals do eventually fade from public memory. Nobody frets about taking Tylenol anymore, even though at one time that product was rocked by a scandal which resulted in people dying, not just unpleasant stomach issues.

It's also worth noting that Chipotle's next 12 months will include post-scandal comps, which should make its numbers look better. This is a comeback that has taken longer than expected, but at its core the chain has a well-liked, quality product which consumers should come back to. It's hard to know how long that will take, but ultimately it will happen.

Daniel Kline has no position in any stocks mentioned. He is eager to try Chipotle's chorizo. The Motley Fool owns shares of and recommends Chipotle Mexican Grill, Panera Bread, and Starbucks. 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.

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