Casual dining stocks have performed well in the past 12 months, as evidenced by the 69% gains registered by both Cracker Barrel Old Country Store (NASDAQ:CBRL) and Bloomin' Brands (NASDAQ:BLMN). However, surging stock prices are best met with caution, not optimism. Stocks become less attractive as their prices rise.
The attractiveness of these two casual-dining companies has been greatly diminished after their share price surges. After recent runs, both Cracker Barrel and Bloomin' Brands sport price/earnings ratios of over 20. While a P/E ratio of over 20 isn't always necessarily a red flag, such a ratio can only be justified by huge potential for profit growth.
Cracker Barrel's bottom line expansion appears unsustainable
When Cracker Barrel reported its first quarter 2014 results, its net income was up 17%. If growth like that could be sustained, the company's high P/E ratio might be justified. However, the company's revenue growth has been meager for the past four years. The company's most optimistic projections predict revenue growth of only 4% in 2014.
Cracker Barrel spends significantly more on labor than its peers, meaning the bottom line still has room to expand even as top line growth remains unimpressive. That being said, Cracker Barrel cannot sustainably generate the profit necessary to justify its high P/E ratio without significant revenue growth. Such revenue growth has eluded Cracker Barrel in recent years. If the company has provided reliable guidance, significant revenue growth will not occur soon.
Why Bloomin' Brands is unattractive
A large debt load does not plague Cracker Barrel, although the same cannot be said for Bloomin' Brands. The operator of Outback Steakhouse has $1.45 billion in long term debt, a number equal to nearly half the company's market capitalization. Interest charges on that heaping pile of debt have sucked up more than 25% of the company's operating cash flow in each of the past two years.
Thanks to that debt load the company's tangible book value is negative, and its ability to pay shareholders a dividend is nonexistent. Over the past few years revenue growth has been modest, albeit consistent, and the company has grown operating cash flow at an impressive clip. Still, that does not change the fact that this is a debt-laden company that is very expensive relative to the profit it produces.
This poor performer is no bargain either
So two of the best performing companies in the casual dining industry both make for poor investments. Perhaps there is opportunity among laggards in the casual dining space? In the case of Darden Restaurants (NYSE:DRI), a company whose stock has risen a mere 1% over the past 12 months, the answer is no.
Sure, Darden has its positive attributes. For instance, the company isn't facing a huge pile of debt and pays a very respectable 4.1% dividend. However, Darden suffers from the same basic problem as the two aforementioned companies--it costs too much relative to its proven earning power and the potential for massive profit growth just doesn't seem to be there. The company's management also projects 2014 same store sales will range from flat to 2%, and that EPS will decline.
Foolish bottom line
The superb stock price performances of Cracker Barrel Country Store and Bloomin' Brands have pushed both companies far out of the realm of attractive investments. Both are expensive relative to their proven earning power, and without a big drop in share prices that will likely remain the situation. This is because neither company's management predicts massive profit growth.
Despite the fact that its share price hasn't run up, Darden is still pricey relative to its profit, and the company's own guidance predicts lackluster growth. Great American enterprises exist that are much cheaper relative to their proven earning power, IBM and Chevron for example. Given that situation, buying any of these casual dining companies seems like pure folly.
Ryan Palmer has no position in any stocks mentioned. The Motley Fool recommends Chevron. The Motley Fool owns shares of Darden Restaurants and International Business Machines. Try any of our Foolish newsletter services free for 30 days. 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.