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The Pain for These Beat-Up Restaurant Stocks May Not Be Over

By Nicholas Rossolillo - Oct 5, 2017 at 10:44AM

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Consumer trends and competition in a struggling restaurant industry are putting pressure on these three chains.

It's been a tough year for Shake Shack (SHAK -1.66%), Jack in the Box (JACK -3.15%), and Buffalo Wild Wings (BWLD). Shares of all three chains have been in decline as the restaurant industry struggles against its own overexpansion and ever-greater competition. While some may see a buying opportunity at these depressed prices, investors should be aware of the risks before digging in.

JACK Chart

Data by YCharts.

The better burger is a crowded concept

Shake Shack has been a favorite on its home turf in the northeast part of the U.S. The "roadside-style" chain has been moving quickly in the last year, growing its number of locations by 40% to 134. That strategy had been enjoying an extra boost from increasing same-store (or "same-Shack") sales, but that changed this year.

Period

 Same-Shack Sales Increase/Decrease (YOY)

Q2 2016

4.3%

Q3 2016

2.9%

Q4 2016

1.6%

Q1 2017

(2.5%)

Q2 2017

(1.8%)

Chart by author. Data source: Shake Shack quarterly earnings.

As Shake Shack moves further west, the company is running into fierce competition from regional peers that are well established in their respective markets. The Habit, for example, has its own fan base in California, a market where Shake Shack is trying to make inroads. That is just one rival in a sea of them, including private companies like Five Guys and Fatburger.

Shake Shack has thus far been able to carve out a following with the help of its cachet in Northeast markets. But as better burger restaurants become more and more common, investors must question whether an expanding store base alone can justify the 54 times forward P/E ratio.

A fast-food chain with a foot in both camps

Even though share prices are down this year for Jack in the Box, things appear to be going well. Revenue through the first three quarters of the fiscal year are up 1.2% to over $1.2 billion, and earnings per share are up 26% to $3.37, thanks to a restructuring plan through which the company has been taking over underperforming, franchised stores.

A close-up shot of a plate full of French fries.

Image source: Getty Images.

So what's the problem? Traffic has been trending lower at the fast-food chain much as it has been across the industry. Jack in the Box comps for the year are at 0.9%, but management expects that figure to drop to down 2% to flat for the last quarter of the year. Comps at its fast-casual Mexican grill, Qdoba -- which makes up over a third of total revenue -- are down 1.2% for the year and are expected to be in the same negative range as Jack in the Box to finish the fiscal year.

The company has enlisted the help of Morgan Stanley to explore options for the Qdoba brand, which could help simplify the business and get things trending upwards again. However, there is no time frame or guarantee anything will come of these efforts. 

Casual dining is feeling the heat

Bar-and-grill dining has been the hardest hit segment of the restaurant industry, according to research group TDn2K. Buffalo Wild Wings felt that pain with second-quarter comparable sales dropping 1.2% and 2.1% at company-owned and franchised locations, respectively. The overall industry average was a decline of 1% in the second quarter.

The company also concluded an ugly battle with an activist investor earlier this summer, with the activists winning. Longtime CEO Sally Smith announced her retirement by the end of this year, and the reshuffled board of directors has announced plans to try to sell 83 locations to franchisees, even though franchised locations have historically underperformed company-operated ones.

Period

Company-Owned Comparable Sales Increase/Decrease

Franchised Comparable Sales Increase/Decrease

2014

6.5%

5.6%

2015

4.2%

2.5%

2016

(2.4%)

(2.7%)

Q1 2017

0.5%

0.6%

Q2 2017

(1.2%)

(2.7%)

Chart by author. Data source: Buffalo Wild Wings earnings reports.

There is a lot up in the air at B-Dubs right now. Such uncertainty has caused the stock to tank, but if changes pushed by the activist investor prove successful, prices could rebound. Investors should expect a bumpy ride, though.

I may be wrong ...

All of the pain restaurants have experienced will eventually ease once the industry right-sizes itself once again. However, any investors who decide to jump aboard shouldn't expect a quick and easy path to recovery -- from major expansion to brand spin-offs and refranchising, the challenges these three companies face are significant.

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Stocks Mentioned

Jack in the Box Inc. Stock Quote
Jack in the Box Inc.
JACK
$57.53 (-3.15%) $-1.87
Buffalo Wild Wings, Inc. Stock Quote
Buffalo Wild Wings, Inc.
BWLD
Shake Shack Inc. Stock Quote
Shake Shack Inc.
SHAK
$40.33 (-1.66%) $0.68

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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