4 Restaurants with Improving Fundamentals and Good Technicals

TK All-Star posted on 05/08/12 at 04:32 PM

Alan Brochstein Screens Casual Dining Restaurants 

The Great Recession hit the casual dining restaurants hard, but, four years later, there are signs that consumers are dining out again. Many of the stocks in the sector have managed through the challenges well, and recent M&A activity, including the purchase of PF Chang’s (PFCB) earlier this month and several other smaller acquisitions, points to an improved outlook.

In addition to a retrenching consumer, who ate out less and spent less when doing so, rising costs for food have crimped profit growth over the past few years. With the weak industry conditions, many of the companies responded by slowing or eliminating new openings. In all, this led to slowing sales and EPS for the casual dining restaurants.

The outlook for restaurants is getting brighter, with an improvement in near-term trends lately. Looking ahead, declining unemployment, stable food prices and potentially more favorable gasoline prices all support improving fundamentals. With restaurants focusing again on opening new locations, the longer-term growth outlook could accelerate as well.

Given the improved sentiment for the sector, I thought it might make sense to look for potential buy ideas. The screen I set up using Baseline was designed to find stocks with improving fundamentals and good technicals. Here are the parameters I used:

·       Market Cap: > $500mm
·       2012 EPS Growth >10%
·       2013 EPS Growth > 13%
·       Earnings Revisions (3 Months) > 0
·       YTD Price Return vs. S&P 500 > 0%
·       1-year Price Return vs. S&P 500 > 0%

The goal, then was to identify stocks that are growing earnings a bit faster than the S&P 500, with analysts not cutting estimates over the past three months and positive price momentum over the past year as well as so far in 2012.

Here are the four restaurants that met the criteria, sorted by ticker symbol:

Please keep in mind that these are not recommendations, but rather suggestions for further research. You should always fully investigate the risks and opportunities before making any investment.

At the top of the list is Cheescake Factory (CAKE), which is actually at the top of my list to investigate further. Not only does it have a very strong balance sheet (net cash per share of almost $1, which is in contrast to net debt at most restaurants), but the stock is trading near its five-year average PE. It’s also up only slightly more than the market so far in 2012 and over the past year, but, impressively, it has increased in price over the past five years compared to a 10% decline in the S&P 500. The company operates 171 restaurants, seven more than a year ago. The company has been repurchasing stock and has suggested that it will use the $100mm in free cash flow it expects to generate this year to buy more stock.

Brinker International (EAT) is best-known for Chili’s but also operates Maggiano’s. Recent performance at Chili’s has improved significantly from a year ago, with same-restaurant sales improving 4.5% in the most recent quarter compared to a year ago. The company has 864 company-owned restaurants and 710 franchises. It expects to open 37-39 franchised restaurants in FY12, almost all of which are outside the U.S. While EAT has a bit more debt than I like to see, I am impressed that its stock is near an all-time high (35.74 in early 2007) and its earnings are at a record. My perception is that this is a company that historically hasn’t been well managed, but it looks like management is doing a much better job these days.

Red Robin Gourmet (RRGB) has not been operating as well as peers in the industry as reflected by low margins compared to its historical margins, but they are improving. The company hosted an analyst day in April and took a critical view of itself, which I find encouraging. They pointed to a strategy of having a broader offering, improved quality, better service and a better guest experience.  Increasing alcohol sales and a new smaller format aimed at non-traditional locations like college campuses and sports venues are parts of their growth strategy as well. The company currently has 464 locations, most of which are company-owned, and is planning to add about 15-20 units per year in the future.

I added Texas Roadhouse (TXRH) to my watchlist earlier this year when its founder took on the role of CEO again. This is a very well run company in my view, though their higher-price steak offering suffered as the economy was weak. One of the reasons the company does well is that they spend less on advertising and use the savings to invest in their waiters. They end up with low turnover and an improved customer experience in my view. Like CAKE, the company has a very strong balance sheet, and it also pays a 2% dividend. The company is opening restaurants at a rapid pace and expects to add 25 this year after adding 8 in Q1 (374 units currently). I think that the stock may be a bit ahead of itself, but my target a year out is 21 based on achieving 18 PE.

While these stocks aren’t as cheap as they have been in recent years, the improving fundamentals could sustain longer-term earnings growth. The four stocks discussed offer a nice combination of improving fundamentals and positive price momentum. Hopefully I have given you a few ideas to ponder. I certainly intend to look more closely at CAKE.  Remember, screening is only a first step. Before investing, you should do your own investigation to identify risks and potential opportunities.

Alan Brochstein
Founder, Invest By Model and AB Analytical Services
TradeKing All-Star Commentator

Disclosure:  No Position in any stock mentioned.

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Posted by TK All-Star on 05/08/12 at 04:32 PM


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