From fast food to fine dining, restaurants play a vital societal role. But the side dish is that they’re quite difficult to operate because high inventory and labor costs generally lead to thin margins at the store level. This leaves little room for error if demand dries up, and it seems like the market has some reservations as the industry’s returns were flat over the past six months while the S&P 500 was up 16.4%.
Only some companies are subject to these dynamics, however, and a handful of high-quality businesses can deliver earnings growth in any environment. With that said, here are two restaurant stocks we think can generate sustainable market-beating returns and one we’re passing on.
One Restaurant Stock to Sell:
Darden (DRI)
Market Cap: $23.76 billion
Founded in 1968 as Red Lobster, Darden (NYSE: DRI) is a leading American restaurant company that owns and operates a portfolio of popular restaurant brands.
Why Do We Think Twice About DRI?
- Annual sales growth of 6.5% over the last seven years lagged behind its restaurant peers as its large revenue base made it difficult to generate incremental demand
- Estimated sales growth of 3.6% for the next 12 months implies demand will slow from its seven-year trend
- Lacking pricing power results in an inferior gross margin of 21.8% that must be offset by turning more tables
Darden’s stock price of $208.30 implies a valuation ratio of 18.3x forward P/E. Check out our free in-depth research report to learn more about why DRI doesn’t pass our bar.
Two Restaurant Stocks to Watch:
Chipotle (CMG)
Market Cap: $42.3 billion
Born from a desire to offer quick meals with fresh, flavorful ingredients, Chipotle (NYSE: CMG) is a fast-food chain known for its healthy, Mexican-inspired cuisine and customizable dishes.
Why Do We Watch CMG?
- Rapidly increasing restaurant base reflects a desire to sell in new markets and scale quickly
- Massive revenue base of $12.42 billion makes it a household name that influences purchasing decisions
- Industry-leading 19.8% return on capital demonstrates management’s skill in finding high-return investments, and its returns are climbing as it finds even more attractive growth opportunities
Chipotle is trading at $33.47 per share, or 26.4x forward P/E. Is now the right time to buy? Find out in our full research report, it’s free.
Yum! Brands (YUM)
Market Cap: $37.66 billion
Spun off as an independent company from PepsiCo, Yum! Brands (NYSE: YUM) is a multinational corporation that owns KFC, Pizza Hut, Taco Bell, and The Habit Burger Grill.
Why Should YUM Be on Your Watchlist?
- Aggressive expansion of new stores reflects an offensive push to quickly grow and sell in markets where it has few or no locations
- Disciplined cost controls and effective management resulted in a strong two-year operating margin of 31%
- Robust free cash flow margin of 19.3% gives it many options for capital deployment
At $137.30 per share, Yum! Brands trades at 21.1x forward P/E. Is now a good time to buy? See for yourself in our in-depth research report, it’s free.
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