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Restaurant Industry Outlook: Near-Term Prospects Look Grim

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The Zacks Retail – Restaurantsindustry consists of several owners and operators of casual dining restaurants, full-service restaurants, quick-service restaurants and fast-casual restaurants. The industry also includes roaster, marketer and retailers of specialty coffee.

Let’s take a look at the industry’s three major themes:

  • The restaurant industry is facing declining traffic for quite some time now. According to tdn2k, same-store traffic declined 3.5% in the month of April. The general tendency of consumers to avoid dining out is concerning. Despite lower traffic, average guest check growth has been accelerating which shows that restaurant operators are solely deriving sales from higher guest spend and are thus not focusing on traffic-driving initiatives. The erosion in traffic is probably because of restaurateurs’ rapid menu price increase.
  • The industry has shown steady signs of recovery through 2018. Although comps declined 0.4% in April, it is not indicative of a reversal trend for the restaurant industry. The month of April was largely affected by bad weather conditions. However, steady rise in wages, lower unemployment and restaurant operators’ focus on digital innovation are keeping the industry going. With the growing clout of Internet, digital innovation has become the need of the hour. Restaurant operators are continuously partnering with delivery channels and digital platforms to drive incremental sales. According to an article by Restaurant Business, the fast-casual restaurant space is likely to record sales growth of 8.3% in 2019 compared with 8% in 2018. Casual dining sales are expected to rise 3.4% in the current year, up from the last year’s 3.2%. Fine-dining restaurants will also see rise growth of 5.2% compared with 5% rise in 2018.
  • Meanwhile, restaurant operators are plagued by high cost of operations. Further, sales-building efforts such as promotional activities and prudent pricing plans are eroding margins. Apart from this, competition, high wage and food cost inflation remain concerns. Moreover, most restaurateurs are facing rising employee vacancies and are perpetually understaffed, which is affecting overall performance.

Zacks Industry Rank Indicates Dismal Prospects

The Zacks Retail – Restaurants industry is grouped within the broader Retail-Wholesale sector.

The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates gloomy near-term prospects. The Zacks Retail - Restaurant industry currently carries a Zacks Industry Rank #169, which places it at the bottom 34% of 256 Zacks industries. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.

The industry’s position in the bottom 50% of the Zacks-ranked industries is a result of negative earnings outlook for the constituent companies in aggregate. Looking at the aggregate earnings estimate revisions, it appears that analysts are gradually losing confidence in this group’s earnings growth potential.

Despite the drab near-term prospects, we will present a few stocks that one can consider buying. Also, it’s worth taking a look at the industry’s shareholder return and current valuation before that.

Industry Outperforms S&P 500 & Sector

The Zacks Retail – Restaurants industry has outperformed its own sector and the Zacks S&P 500 composite over the past year.

Over this period, the industry has gained 21.6%, compared with the sector and the Zacks S&P 500 composite’s increase of 0.4% and 4.4%, respectively.

                               One Year Price Performance

Restaurant Industry’s Valuation

On the basis of the forward 12-month P/E ratio, which is a commonly used multiple for valuing restaurant stocks, the industry is currently trading at 23.93X compared with the S&P 500’s 16.48X. It is also above the sector’s forward 12-month P/E ratio of 22.76X.

                               Forward 12- Month P/E Ratio Compared With S&P

Over the last five years, the industry has traded as high as 25.25X, as low as 19.60X and at the median of 22.56X.

                              Forward 12- Month P/E Ratio Compared With Sector

Bottom Line

Restaurants are currently facing the flak of wavering consumer interest on discretionary spending. However, the industry’s top-line momentum is likely to be supported by strong growth in to-go and other forms of off-premise sales.

Here are four stocks with positive earnings estimate revisions and a favorable Zacks Rank.

Noodles & Company (NDLS - Free Report) develops and operates fast-casual restaurants in the United States. It offers noodles and pasta, soups, salads, and appetizers. The company carries a Zacks Rank #1 (Strong Buy). The Zacks Consensus Estimate for current-year earnings per share (EPS) has risen 33.3% over the past two months to 16 cents. EPS in 2019 is expected to increase 716.7% year over year. You can see the complete list of today’s Zacks #1 Rank stocks here.

                              Price and Consensus: NDLS

Chipotle Mexican Grill, Inc. (CMG - Free Report) is currently one of the best performing restaurant stocks. The Mexican food restaurant chain’s increased focus on food safety and sales-building initiatives bode well. The company carries a Zacks Rank #2 (Buy). The Zacks Consensus Estimate for current-year EPS has increased 5.2% over the past two months to $13. This indicates that earnings are expected to increase 43.5% year over year in 2019.

                               Price and Consensus: CMG

The largest restaurant company in China, Yum China Holdings, Inc. (YUMC - Free Report) is the owner and operator of KFC and Pizza Hut. The company’s focus on menu innovation, digital enhancement and strong brand recognition are expected to effectively drive sales. The Zacks Consensus Estimate for current-year EPS has increased 2.4% over the past two months to $1.68, suggesting a 9.7% increase from 2018. The company carries a Zacks Rank #2.

                               Price and Consensus: YUMC

Denny's Corporation (DENN - Free Report) owns and operates full-service restaurant chains under the Denny's brand. The company holds a Zacks Rank #2. The Zacks Consensus Estimate for current-year EPS has increased 5.2% over the past two months to 61 cents.

                              Price and Consensus: DENN

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