For quite some time now, there has been a lot of buzz about the restaurant industry hitting recession. While MarketWatch announced the arrival of recession for the restaurant industry, Google searches for the phrase “restaurant recession” peaked in early November. As foot traffic slowed down, many downgraded restaurant stocks.

The speculations surrounding restaurant recession, nonetheless, hold no ground as the industry has been seeing a lot many deals that will generate revenue growth and counter traffic fall. Sustained strength in the labor market on the back of steady rise in wages will also encourage consumers to dine out more.

Lest we forget, that the Wall Street is still in favor of the restaurant industry with some of the solid performances coming from major restaurant companies. Hence, investing in some sound restaurant companies to whet your appetite won’t be a bad proposition.

What’s Spooking the Restaurant Industry?

Restaurants have been seeing solid sales growth ever since the Great Recession and 2016 wasn’t any exception. This year was off to a similar start, with total sales rising 2.4% compared with the first couple of months last year. Then what’s bothering the industry? Even though total sales are up, foot traffic at individual restaurants are declining at a rapid pace. Same-store sales that account for traffic dropped 1.1% and 2.4% in the third and fourth quarter of 2016, respectively, according to the TDn2K’s monthly restaurant report. Also, same-store sales were flat and down 3.7% in January and February, respectively.

Lower prices at grocery stores and increased rent and healthcare expenses deterred customers from dining out. But, the drop in same-store sales is basically because of the increased number of new restaurants amid limited growth in eating-out budgets. Supply glut and limited demand are impacting traffic as well as stock prices for restaurants. This has led to bankruptcy for many public and private restaurants. Darden Restaurants Inc. (DRI Quick QuoteDRI - Free Report) CEO Gene Lee said that each new Darden restaurant is failing to generate new sales and is rather snapping up share from other restaurants. 

Restaurant Deal Frenzy

Consolidation in the restaurant business, however, is going on. This will boost revenues and provide operation leverage, where restaurants are grappling with weak traffic.  Darden Restaurants, which is buying Cheddar’s, a chain with 165 locations across 28 states, is up more than 13% this year. Burger King parent company – Restaurant Brands International Inc (QSR Quick QuoteQSR - Free Report) – agreed to buy Popeyes Louisiana Kitchen Inc. and its share price rallied 17%.

In fact, Panera Bread Co’s $7.5 billion takeover by JAB Holdings is expected to trigger a wave of deals in the restaurant sector. Panera was exploring a possible sale option after it saw significant takeover interest from a number of companies. Shares of Panera surged over 50%.

JAB Holdings, in the meanwhile, has investments in various top consumer products brands and owns leading makers of high-end brewing products. Thus, the food conglomerate’s portfolio of brands positions it well to benefit from Panera (read more: Panera Bread to be Bought by JAB Holdings for $7.5 Billion).

Continued Strength in the Labor Market

There might be light at the end of tunnel as rising wages and continued improvement in employment are also expected to put a check on declining traffic. As households get a boost, one of the items in the family budget that has grown many folds is eating out. Hourly earnings for an average American worker inched up 0.2% to $26.14 an hour last month, while drop in the unemployment rate fell to a nearly 10-year low of 4.5%. Disposable personal income, which is a suitable measure of economic well-being, is rose 0.3% in February after the 0.4% hike in January.

U.S. consumer confidence, in the meantime, jumped in March to the highest level since Dec 2000 amid growing labor market optimism. Such a record consumer confidence number is a significant reading since it has been, historically, good at predicting future consumer spending for the next three to six months. More the confidence household generates, more will they spend, which should bode well for the restaurant sector (read more: 5 Stocks to Buy as Consumer Confidence Hits 16-Year High).

Restaurant Stocks Start the Year on a Strong Note

Many believe that the U.S. is on the brink of a “restaurant recession”, citing negative same-store sales. But, thanks to the aforementioned developments, such concerns should ebb. And why not? A recession is defined as two consecutive quarters of negative growth. However, publicly traded restaurants are already up more than 7% this year, beating the 5.2% increase for the S&P 500, as per NRN Restaurant Index. Bigger restaurant companies including McDonald's Corporation (MCD Quick QuoteMCD - Free Report) , Chipotle Mexican Grill, Inc. (CMG Quick QuoteCMG - Free Report) and Domino's Pizza, Inc. (DPZ Quick QuoteDPZ - Free Report) are all up at least 6% this year.

The Dow Jones U.S. Restaurants and Bar Index, after being rejected at the 1,207 level as many as six times over the past eight months, broke the level on Mar 14 and then rallied from that point. Currently, the index is trading at 1302.99. Technicians call it a successful break out, suggesting a good amount of upside remaining.

5 Stocks to Suit Your Taste

The restaurant industry is positioned to get its mojo back. We have, thus, selected five solid restaurant stocks that can bolster your portfolio. These stocks flaunt a Zacks Rank #1 (Strong Buy) or 2 (Buy) and a VGM score of ‘A’ or ‘B’. Here V stands for Value, G for Growth and M for Momentum and the score is a weighted combination of these three metrics. Such a score allows you to eliminate the negative aspects of stocks and select winners.

Darden Restaurants is a full-service restaurant company. The company has a Zacks Rank #2 and a VGM score of ‘A’. The Zacks Consensus Estimate for its current year earnings increased 1.8% over the last 60 days.

The company is likely to return 12.9% this year, better than the Retail - Restaurants industry’s gain of 6.3%. The company has outperformed the broader industry on a year-to-date basis (+14% vs +1.7%).

Bob Evans Farms Inc produces and distributes pork sausage products and a range of home-style refrigerated side dishes. The company has a Zacks Rank #2 and a VGM score of ‘B’. The Zacks Consensus Estimate for its current year earnings advanced 1.3% over the last 60 days.

The company is likely to return 12.4% this year, more than the Retail - Restaurants industry’s gain of 6.3%. The company outperformed the broader industry on a year-to-date basis (+19.3% vs +1.7%).

Papa John’s Int’l, Inc. (PZZA Quick QuotePZZA - Free Report) operates and franchises pizza delivery and carryout restaurants. The company has a Zacks Rank #2 and a VGM score of ‘B’. The Zacks Consensus Estimate for its current year earnings improved 1.4% in the last 90 days.

The company is likely to return 10.2% this year, higher than the Retail - Restaurants industry’s increase of 6.3%. The company has outperformed the broader industry in the last one-year period (+43.1% vs -2.6%). You can see the complete list of today’s Zacks #1 Rank stocks here.

Bravo Brio Restaurant Group, Inc. is the owner and operator of around two Italian restaurant brands, including BRAVO! Cucina Italiana and BRIO Tuscan Grille. The company has a Zacks Rank #1 and a VGM score of ‘A’. The Zacks Consensus Estimate for its current year earnings soared 44.4% over the last 60 days.

The company is likely to return 51% this year, way higher than the Retail - Restaurants industry’s addition of 6.3%. The company has outperformed the broader industry on a year-to-date basis (+27.6% vs +1.7%).

Diversified Restaurant Holdings, Inc is a restaurant company. The company is a franchisee of Buffalo Wild Wings. Diversified Restaurant has a Zacks Rank #1 and a VGM score of ‘A’. The Zacks Consensus Estimate for its current year earnings climbed 100% over the last 60 days.

While the company is poised to return more than 100% in the coming quarter, it has outperformed the broader Retail - Restaurants industry by a huge margin on a year-to-date basis (+64.3% vs +1.7%).

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