This year hasn’t been a great one for restaurants -- not by a long shot. They have been hit on the revenue line as well as on the profit line. Moreover, despite higher employment, lower oil prices and growing GDP, all of which indicate more disposable income, footfall remains a major issue for most.
So What Could Be Going Wrong?
Health and fitness experts have been going on for years and it’s finally sinking in that we should be extra cautious about what we eat and pay attention to how it’s prepared. So cut out that salt and that sugar please, and make sure it’s grass-fed beef and free-range chicken. Also, how about showing me that it’s all freshly baked, fried or cut? Oh, and did you know that beans are actually so nutritious? Good for vegetarians like me, because finally, vegetarian doesn’t mean under-nourished.
All this is great for the younger generation when they are eager to show difference as a sign of independence. Everyone’s been through those years. But imagine what it means for restaurants that have built their business around convenience, speed, indulgence, etc. It’s practically a war between food-at-home and food-away-from-home. Thank god for those demanding careers that make it more difficult to cook at home!
Jokes apart, this problem is not going away. The goal for restaurants is to look for opportunities within this philosophy, one of which would be snacking. Weight watchers and fitness freaks are often advised to eat small meals all through the day. This is a big positive for restaurants because smaller portion sizes would mean lower input cost that can mean bigger profits.
Second, you get to sell a larger number of meals. Third, it is a fact that controlling cravings lead to binge eating every now and then, which is something you can capitalize on. For example, a recent study found that while millenials wouldn’t recommend fast food restaurants like McDonalds (MCD - Free Report) and wouldn’t talk about their visits to the places, they continue to frequent them.
Declining cost of groceries is a double-edged sword for restaurants because on the one hand, it means lower input cost, but on the other, it makes home cooked meals more affordable. So it isn’t just Gen Y shying away from restaurants, but also anyone else that can cook and has the time to do it.
The other major problem stems from the higher minimum wage and overtime laws that a number of states have adopted. This has increased costs for restaurants at a time when traffic is anyway on a decline, forcing them to raise prices. Higher prices are a big turnoff, especially for lunch customers because the lunch hour is not a very big period and people may need to squeeze in other jobs into the time as well. So they don’t want to spend too much time or money on a meal they’re not planning to wind down with.
An NPD report from earlier this year said that higher prices were having a serious impact on lunch traffic, which makes up a third of total traffic. Other than prices, NPD also found that more people working from home and shopping online were resulting in a smaller number of office goers and shoppers, which were impacting restaurant traffic in the afternoons.
Restaurants Need to Invest in Technology
Like it or not, technology is too much a part of our lives now. Most people that shop online are also attracted by other things they can do online and that includes ordering food. While taste is and has always been an important factor, when you’re ordering online, you may also have a bit of time to research food. This gives restaurants a chance to put across their unique selling points. Partnering with online ordering and delivery companies (or even Google) helps restaurants generate a feedback system wherein customers can vote for the place and write recommendations thus driving sales.
What’s Going for Restaurants Now?
Despite the many problems the segment is facing now, it’s important to remember that certain restaurants have become part of our culture, so they aren’t going away. Also, the older we get, the more we revert to familiar tastes and experiences (with some moderation of course). There are also new restaurants coming up to fill in the gaps created by changing perceptions and choices, which create interesting opportunities for investment.
The five restaurant stocks I’ve picked look good right now because they have a Zacks Rank #2 (Buy) (you can also see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here). My picks also carry a VGM Score A or B (meaning that value, growth or momentum investors wouldn’t be disappointed), a positive surprise history and reasonable valuation. So read on…
Bojangles Inc (BOJA - Free Report)
Bojangles', Inc. is a southern style restaurant chain with a number of company-owned and franchised outlets. Founded in 1977 in Charlotte, NC, Bojangles' focuses on traditional menu items such as delicious, famous chicken, made-from-scratch buttermilk biscuits, flavorful fixin's and Legendary Iced Tea.On September 25, 2016, Bojangles' had 699 system-wide restaurants, of which 301 were company-operated and 398 were franchised, primarily located in the Southeast.
Bojangles has taken action against possible wage inflation as a result of the Obama government’s overtime bill. The company has decided to convert the assistant managers at all the company-owned retail outlets to hourly workers, thus saving on benefits that it would be required to pay out.
Also, similar to most restaurant chains, the company is investing in store improvements based on new designs. In Bojangles’ case, the investment will be on opening some new stores and remodeling some old ones. In addition to making them more inviting, the new design showcases the freshly prepared concept by having a section called “Biscuit Theater" where customers can see biscuits being made fresh every 20 minutes by a Bojangles' Master Biscuit Maker. At one shot, this attracts the millennial crowd that wants to eat healthier and fresher, but also cheaper.
Encouraging investment criteria for Bojangles are-
Zacks Rank #2
VGM Score B
Average 4-quarter surprise 17.23%
PEG 1.36 (industry PEG 1.97)
The shares are trading at 78% of their 52-week high
Cheesecake Factory (CAKE - Free Report)
The Cheesecake Factory operates 200 odd upscale, casual dining restaurants, of which 190 restaurants operate under The Cheesecake Factory brand (this is also a reported operating segment), 10 under the Grand Lux Cafe brand and one RockSugar Pan Asian Kitchen. Grand Lux, RockSugar, bakery and international licensing form the “Other” reported segment. The company offers over 200 menu items including appetizers, pizza, seafood, steaks, chicken, burgers, pasta, salads, sandwiches, omelets and signature desserts including over 40 varieties of cheesecake.
Restaurants in the casual dining segment are full-service, higher end outfits, targeting the kind of customer that is willing to pay more for proper cutlery and decor. The company hasn’t had a whole lot of new store additions this year and profitability has been dependent on its ability to contain costs. Input pricing has supported this while wage inflation has been an offsetting factor. Share buybacks have supported per share earnings.
While 2016 hasn’t been a great year for restaurants, Cheesecake is showing signs that traffic declines may bottom next year. The Grand Lux outlets are doing better than the Cheesecake ones, with comps much stronger and traffic also in positive territory. 2017 will see a number of store additions, including one Grand Lux and one RockSugar Pan Asian Kitchen (for the more adventurous millennial).
Cheesecake tradition calls for large servings, but the company also has low-calorie options and a very wide spread to cater to a diverse crowd. It has also adopted digitization in the form of CakePay and delivery through a partner (already rolled out across 78 stores), conveniences millenials generally prefer.
Encouraging investment criteria for Cheesecake Factory are-
Zacks Rank #2
VGM Score B
Average 4-quarter surprise 10.84%
PEG 1.47 (industry PEG 1.97)
The shares are trading at 93% of their 52-week high
Cracker Barrel (CBRL - Free Report)
Cracker Barrel Old Country Store, Inc. is a popular family dining chain where customers are treated to home-style cooking and care. The company Owns and operates 641 Cracker Barrel stores across 43 states as well as several “Holler & Dash” fast casual restaurants. The restaurant-cum-retail format is unique to Cracker Barrel as are the variety of decorative and functional items it sells. These can include rocking chairs, holiday and seasonal gifts and toys, apparel, cookware and foods, including various old fashioned candies and jellies.
One of the unique things about this chain is its breakfast-all-day feature that attracts people wanting something different. The concept is enhanced by the varying and innovative menu options that allow the company to charge more for the meal.
The company has resorted to cross-training of cashiers and other staff so it can make do with fewer people during slack times. Input costs remain low as with other restaurants and the cost of acquiring approximately 60% of requirements for fiscal 2017 has been fixed (the company expects costs to rise as we move through the year).
Declining traffic remains the number one concern despite continued online and offline marketing efforts.
Encouraging investment criteria for Cracker Barrel are-
Zacks Rank #2
VGM Score B
Average 4-quarter surprise 2.96%
P/E based on 2017 EPS 19.75 (industry P/E 30.2)
The shares are trading at 83% of their 52-week high
Potbelly Corp (PBPB - Free Report)
Potbelly Corporation is a neighborhood sandwich shop concept. While the main focus is on sandwiches, which are sold through its 396 Potbelly Sandwich Works shops across 28 states, the company also sells salads, soups, chili, chips, cookies, ice cream and smoothies. Of these, 372 shops are company operated while 24 are franchisee operated. The company also has 12 internationally franchised shops, of which 11 are in the Middle East and 1 is in the UK.
A typical quick-service-restaurant (QSR) offers a simple menu using standard ingredients that can be served up in high volume and at cheaper prices. But customers are reluctant to sacrifice quality for price at all times, which actually means that they want the best of both worlds. This has led to smaller chains that attempt to fill this gap, such as Potbelly, Culver’s, Chick-fil-A, Freddy’s Frozen Custard & Steakburgers, El Pollo Loco, In-N-Out Burger and Pita Pit.
With eating at home getting much cheaper and healthier, the only reasons to eat out are convenience and desire for most. That’s why QSRs that have traditionally touted price as a lure to increase footfall are taking it on the chin. This environment is more favorable for the emerging category that some have called QSR Plus, i.e. not as expensive as fast casual but offering better quality than QSR.
An additional growth factor for Potbelly is its catering business, which at 14-15% of sales and growing double-digits, can become an important driver of its business. Investments in digitization will drive millenials (digital menu boards to facilitate in-shop messaging and a new and improved app will likely be launched soon).
On the cost front, the company expects to pilot a new system of hourly wages early next year in the hopes of mitigating the impact of rising wages.
Encouraging investment criteria for Potbelly are-
Zacks Rank #2
VGM Score A
Average 4-quarter surprise 19.58%
PEG 1.83 (industry PEG 1.97)
The shares are trading at 76% of their 52-week high
The ONE Group Hospitality
The ONE Group Hospitality, Inc. operates through three segments, the largest of which is the STK segment (a steakhouse concept on leased property in metropolitan areas around the world). The company also develops, manages and operates restaurants, bars, rooftop lounges, pools, banqueting and catering facilities on behalf of hotels and casinos through its F&B hospitality management segment. The Other segment includes owned non-STK leased locations.
Zacks Rank #2
VGM Score B
Average 4-quarter surprise 182.5%
P/E based on 2016 EPS 28.9 (industry P/E 30.2)
The shares are trading at 59% of their 52-week high
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