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3 Top Restaurant Stocks to Watch in December

By Demitri Kalogeropoulos, Leo Sun, and Jamal Carnette, CFA – Updated Dec 13, 2018 at 3:57PM

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Why investors should keep an eye on Yum! Brands, Texas Roadhouse, and Starbucks this month.

December is a big month for consumer shopping, and the extra holiday traffic typically lifts restaurant sales, too. But growing during short-term industry spikes isn't enough to make a company a solid long-term investment.

With that idea in mind, these three contributors take a look at a few stocks that seem to have what it takes to beat back rivals not just this month but over the years to come. Read on to see why Yum! Brands (YUM 0.16%), Texas Roadhouse (TXRH 1.59%), and Starbucks (SBUX 0.06%) made this list.

A man takes a bite out of a sandwich.

Image source: Getty Images.

A "pure play" on Chinese fast food

Leo Sun (Yum! China): Yum! Brands spun off its Chinese business as Yum! China in late 2016 due to decelerating sales growth and a series of food safety issues. Yum! China's stock rallied about 40% after the split, but it shed about 10% of its value this year, as escalating trade tensions caused investors to shun companies exposed to China.

Yum! China's revenue rose 6% annually on a constant currency basis last quarter, but its comps fell 1% -- as KFC's comps rose 1% but Pizza Hut's comps fell 5%. Its restaurant margin fell 40 basis points annually to 17.6%, but its operating profit grew 4% on a constant currency basis as its net income grew 17% on the same basis.

That improving profitability can be attributed to an aggressive expansion strategy that relies heavily on franchisees to eventually boost its store count from about 8,300 to 20,000. That strategy boosts Yum! China's free cash flow, which it's spending on buybacks and dividends.

The company bought back $93.7 million in shares last quarter and boosted its buyback plan from $550 million to an aggregate total of $1.4 billion -- or 10% of its current market cap. It also currently pays a forward dividend yield of 1.4%, and its low payout ratio of 30% gives it plenty of room for future hikes.

Analysts expect its revenue and earnings to rise 16% and 6%, respectively, this year -- which are sound growth rates for a stock that trades at 22 times forward earnings. If trade tensions between the U.S. and China wane this month, shares of Yum! China could quickly rebound.

Labor pressures are temporary, but growth will continue for decades

Jamal Carnette, CFA (Texas Roadhouse): If you're looking for growth from a restaurant, look no further: In the recently reported third quarter, Texas Roadhouse reported revenue growth of 10%. Even better, the bulk of this growth is from existing restaurants -- and not from aggressive store-count expansion -- as comparable restaurant sales increased 5.5%. Texas Roadhouse continues to post strong top-line growth, averaging 12% per year over the last five fiscal years.

Still, in the last three months, shares of the company are down approximately 14%. The reason for the recent sell-off is further down the income statement. Total operating expenses increased 13%. Labor costs, the largest expense item on Texas Roadhouse's income statement, were the main culprit, growing 17%  from a combination of inflation and increased hours worked. As a result, EPS fell 6.7% over the prior-year's quarter to $0.40 and missed analyst estimates of $0.54 by an even wider margin.

In the short run, the company expects labor costs to continue to grow at a single-digit clip throughout 2018, but wage growth will eventually abate to the U.S.' nominal growth rate, which is currently 3%. Long-term investors should look past short-term wage inflation pressures and focus on Texas Roadhouse's history of strong top- and bottom-line growth.

'Tis the season for hot coffee drinks

Demitri Kalogeropoulos (Starbucks): The holiday season is always an important time for Starbucks, but this year, investors have a few extra reasons to follow the coffee chain's performance. For one, growth trends are on shaky ground right now, with customer traffic declining in its most recent earnings report.

Two cups of coffee with hearts drawn in the foam.

Image source: Getty Images.

That result took some of the shine from a generally strong financial outing that showed Starbucks finally meeting growth targets after stumbling in several of the last few quarterly announcements. Investors haven't forgotten last year's holiday slip-up, either, so the stakes are high for the chain to show that it made the appropriate marketing and retailing changes this time around.

Finally, Starbucks is facing stepped-up competition this month from Dunkin', which is rolling out espresso machines to its entire franchise base in a bid to push its offering beyond the drip coffee it's already known for. The shift is a key part of Dunkin's growth strategy aimed at widening its menu options as it matures into a national rather than regional restaurant player. It also adds another competitive threat that Starbucks will have to manage as it seeks to build on its modest growth momentum heading into fiscal 2019.

Demitrios Kalogeropoulos owns shares of Starbucks. Jamal Carnette, CFA has no position in any of the stocks mentioned. Leo Sun has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Starbucks and Texas Roadhouse. The Motley Fool recommends Dunkin' Brands Group. The Motley Fool has a disclosure policy.

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