Wall Street is showing some love for the restaurant industry on Wednesday morning. McDonald's (MCD 1.77%), Darden Restaurants (DRI 3.64%), and Texas Roadhouse (TXRH 4.54%) are all receiving analyst upgrades, a day after most of the fast-food and casual-dining chains rallied with the general market.
The upgrades come at a challenging time for the industry. Most chains are currently limited to take-out and delivery, shutting down dining rooms in an effort to contain the novel coronavirus. The near-term financial hit will be huge, but with many restaurant stocks trading well below their recent peaks, some investors feel that it's finally time to step up and place some orders. It's too soon to know if today's opportunity will pay off.
Wednesday's analyst moves are encouraging on the surface. The market is coming back to the table, but things aren't as rosy as they seem at first glance. The upgrades are certainly welcome.
- James Rutherford at Stephens is upgrading McDonald's from equal weight to overweight.
- Gordon Haskett's Jeff Farmer is lifting his rating on Olive Garden parent Darden from hold to buy.
- Farmer is also upgrading Texas Roadhouse from hold to buy.
The secret ingredient to these bullish turns is that analysts often find themselves lowering their price targets despite the upgrades. Rutherford may no longer be neutral on McDonald's, but he's actually slashing his price goal on the world's leading burger flipper from $210 to $165. With McDonald's stock trading well off last summer's all-time high of $221.93, his new lower price target is actually higher than where the stock was at Tuesday's close.
Darden Restaurants' stock -- even after skyrocketing 31% higher in Tuesday's rally -- would still have to more than double to get back to where it was at the start of this year. Casual steakhouse-chain Texas Roadhouse has held up better than Darden, but the stock is still trading 37% off of last month's high.
Wall Street pros will make some sense of their bullish musings. In upgrading McDonald's, Rutherford argues that McDonald's is a solid recession play. However, even he concedes that this is a valuation call. McDonald's is a cheaper stock now, and despite what will be a lumpy year for the industry, there's no reason to think that diners won't be back when the COVID-19 crisis passes.
The restaurant industry was already benefiting from the growing popularity of third-party delivery apps. Chipotle Mexican Grill (CMG 3.06%) saw its same-store-sales growth surge 13.4% in its latest quarter, and a key driver on that front is that digital sales have soared 78% over the past year to clock in at nearly a fifth of the revenue mix. However, even that bullish scenario isn't perfect. The arrival of Postmates, Uber Eats, DoorDash, and countless others pushes the burden of fulfillment away from the actual chains, but they also charge the restaurants as much as 30% to play along.
There are also some coronavirus concerns for the industry that will linger long after COVID-19 is under control. The current situation is a headwind to most operators.
It's not a surprise to see the country's three largest pizza chains recently announcing plans to hire between 10,000 to 30,000 new drivers, but the sentiment isn't the same for almost everybody else that's laying off staff with dining rooms closing down. With most economists expecting a recession in the coming months, it's not as if folks will be eager to spend money on restaurant food once it's safe to explore the outside world again.
McDonald's, with its focus on value pricing, will hold up better than Darden and Texas Roadhouse. Chipotle has reasonable price points, but if unemployment rates are rising, the weekday lunch crowds won't be spiking the way they have in the past.
It's still a risky time to be investing in restaurant stocks, but if you're willing to be patient until both the coronavirus and recession play out -- to the point where you can truly benefit from a timeless industry where the winners will be stronger given the inevitable shake out -- no one would call you crazy for taking a nibble out of some of the industry leaders.