With Restaurant Traffic in Decline, Add These 3 Stocks to Your Watchlist

The restaurant industry is a mess. In 2018, industry average same-store sales (a combination of foot traffic and average guest ticket size) returned to growth for the first time in two years -- effectively ending the so-called "restaurant recession." That doesn't mean all is well for the sector, though.

That's because average foot traffic on its own continued to decline, further exasperating a problem that has been in place for years. Same-store sales ticked higher as consumers ate out more often and restaurants raised their prices, but dining rooms kept thinning out as the industry overall continues to build more new locations than diners can fill up.

Data source: TDn2K.

While rising sales and better comparable numbers were a much needed reprieve from years of steep losses, declining foot traffic is nonetheless an issue that needs to be solved before the industry overall can return to health. That's because lower traffic at locations drags down average location profitability, crimping margins and putting restaurant chains at even greater risk should American consumers lower their eating-out budgets.

Despite the traffic declines, some chains continue to post healthy advances. Three worth keeping an eye on are McDonald's (MCD 0.37%), Texas Roadhouse (TXRH 0.18%), and Darden Restaurants (DRI 0.14%).

Image source: Getty Images

Fast food is still en vogue

McDonald's recently released full-year 2018 results that demonstrated the world's largest burger chain is still a best-in-class stock. Adjusted earnings for the year were up 19%, driven by the company's expansion overseas and further restructuring of the franchise model. The dividend was also hiked 15%, good for a 2.5% a year yield.

McDonald's and other burger chains have been coping with an influx of "better burger" competition in recent years, one of the main culprits of the declining foot traffic conundrum. The fast-food giant has performed admirably in the face of those difficulties, though, notching 14 consecutive quarters of global same-store sales growth in its latest earnings report. In the U.S., same-store sales easily outpaced the industry average all year.

Data source: McDonald's.

McDonald's trades at a 12-month forward price-to-earnings (P/E) ratio of 22.1, a premium to the S&P 500's 15.8. Nevertheless, if the burger giant can keep its momentum going with its focus on value, the stock is worth keeping an eye on as the rest of the restaurant industry languishes.

Casual dining at its finest

One of the biggest winners in the world of eating out has been Texas Roadhouse. Even as average American stores have suffered, Roadhouse keeps winning with consumers by focusing on underserved suburban areas and offering big portions at a value. 2018 is a case in point. Total sales were up 11% through the first three-quarters of the year, and earnings were up 24% as operations became more profitable along the way -- even though higher wages took a significant bite out of the bottom line.

That's a testament to the casual steakhouse's huge gains in foot traffic and average guest ticket size. The mid-single-digit advance at company-operated and franchised stores has been clobbering the performance of its peers for years.

Data source: Texas Roadhouse.

Like McDonald's, Texas Roadhouse doesn't come cheap. The stock trades at a 12-month forward P/E of 24.0, implying investor optimism that the good times can keep rolling at the Lone Star State-inspired chain. That optimism isn't misplaced as management continues to take a measured approach to expansion of Roadhouse and its new sports-bar concept Bubba's 33. That strategy has paid off, as the restaurant has been able to avoid many of the woes that have negatively affected its more expansion aggressive competitors. That makes this stock worth holding for the long haul.

All-you-can-eat Italian food for the win

Not all is perfect at Darden Restaurants. Though it's still early on in the relationship, the company's purchase of Cheddar's Scratch Kitchen is beginning to look like an ill-advised addition, as the server of American classic fare has been suffering from same-store sales declines. Fortunately for investors, the chain makes up just a small portion of the overall holdings at Darden. The company's flagship brands -- Olive Garden and Longhorn Steakhouse -- have performed well in the last year and have helped overall sales and earnings increase 6% and 39%, respectively, through the first half of the company's 2019 fiscal year.

A focus on value has helped, especially at Olive Garden where never-ending pasta meals continue to be a big hit. Blended same-store sales for the entire multichain company were up 2.1% in the last quarter. Though foot traffic has been flat, menu price increases and better menu item management has meant higher profits for the company's brands.

Fiscal Q2 2019 represents six months ended November 25, 2018. Data source: Darden Restaurants.

Darden is thus faring better than average. In spite of that outperformance, the stock is the best value of the names considered, toting a 12-month forward P/E of 16.7 and an annual dividend yield of 2.8%. If the company can keep besting its competition at casual dining at a value, this stock is worth considering in the year ahead.

Check out the latest McDonald's, Texas Roadhouse, and Darden earnings call transcripts.

The restaurant industry isn't out of the woods. As long as over-expansion persists, the average restaurant will continue to suffer from dwindling foot traffic and bottom-line pressure. That means investors should be picky and opt for stocks posting good traffic numbers bucking the trend. With 2019 under way, McDonald's, Texas Roadhouse, and Darden Restaurants are among the best performers worth keeping an eye on.