Restaurant stocks, once seen as solid investments, are beginning to show cracks amidst floundering sales and a customer base more inclined to eat at home.
A weak second-quarter earnings season has caused restaurant share prices to tumble, prompting industry watchers to warn against putting too much weight in restaurant stocks over the short-term.
The restaurant subindex of the Standard & Poor’s 500 index consistently underperformed the S&P 500 over the past six months, with restaurant stocks down 7 percent throughout the period while the S&P 500 was up 6 percent.
Source: The Financial Times
Weak same-store sales are keeping share prices down, affecting many popular brands. Despite launching Mac N’Cheetos, second-quarter same-store sales for Burger King missed analysts’ expectations by 1.6 percent. Similarly, Shake Shack’s unveiling of the Chick’n Shack burger did not stem the sluggish same-store sales numbers, missing expectations by 0.4 percent. Industry benchmarking firm Black Box Intelligence reported that across the industry, same-store sales were down 0.6 percent in August, the third consecutive month of negative same-store sales growth.
Restaurants will continue to perform poorly throughout 2016, putting the sector in a recessionary phase, wrote Stifel analyst Paul Westra in a research note that gained significant media attention this past summer. Westra wrote that an underperforming restaurant sector could be the harbinger of 2017 recession affecting other sectors of the U.S. economy.
Poor restaurant traffic has been blamed on a widening gap between grocery store food prices and restaurant menu prices. With food prices going down, many are choosing to stay home, affecting traffic at restaurants.
“We have a value offering that continues to compete and draw customers into the restaurants, but when you look at what you pay, what you get on some of the core items, it’s gotten a lot more cheaper relatively speaking to go get fresh beef at your local butcher and go home and grill it,” said Wendy’s CEO Todd Penegor on the company’s August earnings call.
Source: Bureau of Labor Statistics
The gap between food away from home vs. food at home inflation is at its widest since 1983, wrote Cowen and Company restaurant analyst Andrew Charles, in a research note last week. Charles recommended that investors should be broadly “cautious” about quick-service restaurant stocks, and he expects the price gap between grocery stores and restaurants will widen over the next six months.
With additional labor costs driven by minimum wage increases in major U.S. metropolitan areas and health care benefit costs, restaurants have limited flexibility to compete with grocery stores. Meanwhile, grocery stores have improved their prepared food offerings. Supermarket ‘grocerants’ are possibly stealing market share from restaurants, impacting share prices.
“There’s no question that supermarkets have upped the game – both in prepared foods as well as the whole ‘grocerant’ aspect,” said food industry analyst Phil Lempert, founder of supermarketguru.com.
Despite these headwinds, some financial advisors argue that it may be premature for investors to dump all their restaurant stocks, particularly those that have growth potential over the longer-term, including Chipotle and Darden. Some restaurant sub-sectors, such as pizza, have actually been doing well. For instance, Papa John’s has outperformed the S&P 500 index since May.
“I don’t think purchasing these stocks for a short holding period is probably a prudent investment, but I do believe there’s room for holding them as part of a well diversified portfolio for the long haul,” said Dan Grote, partner at Denver-based Latitude Financial Group.
Ultimately, investors should only choose a restaurant stock only after carefully reviewing the company’s financial statements and management structure.
“If you focus on three or four key considerations including a solid balance sheet, a nimble, reliable management team and positive cash flow, I think chances are really good that you’re going to do well (over the long term),” said David Steele, CEO of San Francisco-based One Wealth Advisors, and managing partner of Ne Timeas Restaurant Group.