Where to Start Looking for Restaurant Stocks

Investors might want to continue to mine the fast-casual niche for their best investment ideas.

Rich Duprey
Rich Duprey
Jul 28, 2014 at 2:16PM
Consumer Goods

Investing in a restaurant is like choosing one for dinner, requiring more than a determination of whether you like its food. Sure, you want an enjoyable meal, but you probably don't want to wait an hour for a table or drive 50 miles to get there. For investors, buying what you know is a good start, but whether a restaurant is growing sales, losing market share, or occupying a favored niche are considerations investors also must take into account.

NPD Group just released its latest quarterly update on restaurant industry growth, showing us where diners prefer to spend their money and where we, as investors, might want to channel our dollars.

In an all-too-common refrain, market researchers say the U.S. restaurant industry remains stagnant, with consumer traffic flatlining this past quarter. Despite seeing tens of millions of guest visits over the past 12 months, NPD sees little hope for consumers turning out en masse again like they did before the recession. The report adds some bulk to the poor results we've seen from the likes of McDonald's (NYSE:MCD) and Darden Restaurants (NYSE:DRI)

Source: NPD Group. 

Traffic in the mid-level dining market that encompasses midscale eateries and casual dining restaurants is still on the wane, with the segments losing 2% to 3% customers from the year-ago period. Those are both one percentage point worse than the numbers realized in the first quarter.

At the investor level we've seen continued sluggishness in Darden's Red Lobster and Olive Garden chains, where second-quarter same-restaurant sales were down 5.6% and 3.5%, respectively, but also at DineEquity's (NYSE:DIN) Applebee's chain, where comps fell 0.5% in the first quarter. Even Brinker International's (NYSE:EAT) Chili's saw barely positive comps of 0.7%. Both DineEquity and Brinker report second-quarter numbers within the next couple of weeks, and investors shouldn't expect anything better from either of them.

While McDonald's poor results would seem to belie the flat results of the quick-serve segment -- the first time in many quarters the niche hasn't produced positive traffic growth -- it's because the sector is again bolstered by the fast-casual component (including Chipotle (NYSE:CMG), which continued to record traffic gains. Fast food, on the other hand, McDonald's home, was down 2% year over year.

Not surprisingly, after Chipotle's recent better-than-expected earnings report, fast casual remains strong, though the Southwest grill continues to dominate the space. It's same-restaurant sales surged over 17% on the strength of increased traffic, which grew an equally robust 12.3% over the year-ago period. Even recently IPO'd Zoe's Kitchen (NYSE:ZOES), a new entrant in the fast-casual category, is trending above the average, with comps up almost 6% on a 4% increase in traffic.

Source: SXC.hu.

The other category seeing growth is upscale restaurants, which recorded 4% traffic gains in the quarter and underscored just how well the well-to-do have made out in this otherwise lame recovery. Ruth's Hospitality Group (NASDAQ:RUTH), which runs the upscale Ruth's Chris Steakhouse, enjoyed comps increases of 2.6% on 1.4% more traffic. While Darden Restaurants' Capital Grille fine dining chain also scored 4% higher comps in its fourth fiscal quarter, its Longhorn Steakhouse also remains classified as one of its growth concepts where overall sales rose 11% as comps climbed 2.4%, perhaps proving that beef remains popular no matter the price point.

In short, investors should continue to mine the fast-casual niche for their best investment ideas instead of looking more broadly at the industry as a whole. Although low valuations may be a tempting morsel for your portfolio, fighting the tide of consumer sentiment can be difficult, and with industry trends favoring continued growth in certain sectors ahead of others, it could just be easier pulling a seat up to the table where everyone else is dining.