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The U.S. restaurant industry was under strain in the latter half of 2013 and the beginning of 2014. This was heightened by Fed’s “taper talk,” the temporary government shutdown in October and concerns regarding consumer spending trends. Rising food costs also added fuel to the fire.  

In this scenario, a little caution can do investors a lot of good. Economic events or numbers may fail to restrict the downtrend, but investors may jump to precautionary action to secure the portfolio. We will pick some stocks that are likely to see further downside and it might be an ideal time to trim them from your portfolio.

Before we discuss further about the stocks, let us look at what has been plaguing the sector in the recent times.

Weaknesses Hurting the Sector

Food Cost Inflation: The U.S. restaurant industry has been severely affected in recent times by a rise in food prices. The consumer price index (CPI) for U.S. beef and veal is up almost 10% so far in 2014 — the fastest increase in retail beef prices since 2003-end. With the drought conditions in Texas and Oklahoma worsening to some extent in April, the situation deteriorated further for the beef production industry.

According to the U.S. Department of Agriculture (USDA), overall U.S. food price inflation for 2014, including food bought at restaurants, would gain 2.5% to 3.5%. Food costs account for about one-third of restaurant sales, thus making the industry vulnerable to food cost inflation.

Limited Pricing Power: U.S. consumers are facing the brunt of government budget cuts, higher gasoline prices, payroll tax increases and delayed tax refund checks. These factors have dented their discretionary spending. The USDA forecasts that food-at-home inflation as well as food-away-from-home inflation index in the U.S. is expected to grow in the range of 2.5–3.5% in 2014. This would likely leave less room for consumer companies to exercise pricing action putting restaurant sales under pressure.

Affordable Care Act to Hurt Margins: Since the sector plays a key role in the nation's employment picture, the recent Affordable Care Act by President Obama, commonly known as Obamacare, is expected to have an adverse impact on the margins for the rest 2014. The law entails companies to provide coverage for workers or face penalties, though it is not applicable for employees clocking less than 30 hours per week on an average. To avoid these austerities, most companies are trying out different labor models such as recruiting more part-timers and cutting work hours, in turn affecting margins.

Stocks to Remove from Your Basket

Here we list 3 stocks that may witness further downside. These stocks – each with either a Zacks Rank #4 (Sell) or a Zacks Rank #5 (Strong Sell) – have witnessed downward estimate revisions over the past few weeks. Moreover, each of these stocks has slid around 5% in the last four weeks.

Jamba, Inc. (JMBA - Snapshot Report): The California-based restaurateur provides beverage and food offerings. The company also retails consumer packaged goods through various retail channels, such as grocery, mass, club and convenience stores as well as online.

The company reported first-quarter loss of a cent, which compared unfavorably with the Zacks Consensus Estimate of earnings of a cent, mainly due to lower sales, which stemmed from the reduction in the number of company-owned outlets, due to the company’s refranchising strategy.

Estimate Revision – Jamba has seen a sole negative revision in the last 30 days for both the current quarter and current year estimates. Quarterly earnings consensus slumped from 41 cents a share to 39 cents. Yearly earnings consensus dropped from 43 cents a share to 39 cents.

Share Price – This Zacks Rank #4 (Sell) stock has lost around 5.0% over the last four weeks.

Additionally, Jamba trades at a P/E Ratio of 27.46x, compared to a negative industry average, which signifies the stock is expensive compared to its peers

Chuy's Holdings, Inc. (CHUY - Snapshot Report): The Texas-based restaurateur operates Mexican and Tex-Mex restaurants in Texas and 13 states in the southeastern and midwestern United States.

The company reported first-quarter earnings of 16 cents per share, which missed the Zacks Consensus Estimate by 5.9%, mainly due to higher operating costs.

Estimate Revision – Chuy’s has seen mostly all its revisions being revised downwards in the last 30 days for both the current quarter and current year. Quarterly earnings consensus slumped from 25 cents a share to 23 cents. Yearly earnings consensus dropped from $1.00 per share to 98 cents.

Share Price – This Zacks Rank #5 (Strong Sell) stock has lost around 8.0% over the last four weeks.

Additionally, Chuy’s trades at a P/E Ratio of 40.48x, compared with a negative industry average, which signifies that the stock is expensive compared to its peers.

Diversified Restaurant Holdings, Inc. (BAGR - Snapshot Report): The Michigan-based restaurateur owns and operates Bagger Dave's Burger Tavern – a full-service restaurant and full bar – and Buffalo Wild Wings grill and bar franchised restaurants.

The company reported first-quarter earnings of a penny which were in line with the Zacks Consensus Estimate, primarily because higher revenues were offset by even higher costs.

Estimate Revision – Diversified Restaurants has all its estimates revised downwards in the last 30 days for both the current quarter and current year estimates. Quarterly earnings consensus slumped from break-even earnings to a loss of a penny per share. Yearly earnings consensus increased from a loss of 4 cents per share to a loss of 5 cents per share.

Share Price – This Zacks Rank #4 (Sell) stock has lost around 6.0% over the last four weeks.

Bottom Line

With consumer spending trends at an all-time low due to a sluggishly recovering economy, we believe it will be a prudent move to get rid of these stocks now.

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