Why Restaurant Stocks Look Ripe For A Rebound

Posted: Oct 06, 2018

Big fast-food chains are overdue for some gains, says Keybanc Capital Markets.

Where we were: Many restaurants have lagged the market this year, in stark contrast to the revival in retail.

Where we’re headed: Bigger brands could finally do some catching up, says Keybanc.

For much of 2017, retail sank like a stone, as investors worried that e-commerce would kill traditional retailers. Yet when mall traffic sank, there was another casualty—restaurants (after all, shopping works up an appetite). A number of restaurants also sold off during the retail rout for this reason, even as analysts predicted better days, thanks to catalysts like corporate tax cuts.

However, last year’s holiday season helped reverse sentiment on retail, and the sector has been booming in 2018, with brick-and-mortar stores fighting back and consumer confidence at an 18-year high. Yet many restaurant stocks haven’t enjoyed the same rally, with major chains like McDonald’s (MCD) and Starbucks (SBUX) stuck in the red year to date.

That seems likely to change, argues Keybanc Capital Markets’ Eric Gonzalez. He initiated coverage on eight fast-food companies Thursday, writing that the group has largely underperformed the broader market and retail in 2018, “somewhat uncharacteristic of a group that has outperformed in each of the previous three years and are arguably better businesses today than they have been in years.”

Over the past five to seven years, there’s been a “dramatic reduction” in restaurant ownership levels at big fast-food firm, and without the distractions of managing store-level performance, companies have more human capital at hand to improve execution of the basics. It couldn’t come at a better time, he argues, as valuations are increasingly tied to sales growth, which means chains have to stay creative with their menu and foster strong relationships with owner/operators.

Gonzalez’s favorites are those companies that boast a mix of rising free cash flow generation, “credible” same-store sales catalysts and “superior” system-wide sales growth. He has Overweight ratings on Restaurant Brands International (QSR), McDonald’s, with respective price targets of $68 and $185. “Restaurant Brands’ high-single digit top-line growth and long-term mid-teens total return is unmatched, while McDonald’s high-single digit EPS growth should drive accelerating free-cash-flow generation, post-remodel cycle,” he writes. He’s also Overweight rated on Starbucks, with a $65 price target, as he thinks near-term expectations are low and its sales initiatives will pay off, and Chipotle Mexican Grill (CMG), with a $500 price target, thanks to latent pricing power and greater efficiencies.

Additionally, he thinks that “benign” food price inflation and ongoing competitive discounting create an environment that favor bigger players.

He has Sector Weight ratings on Yum Brands (YUM), Bojangles (BOJA), Dunkin’ Brands Group (DNKN), and Wendy’s (WEN).

Gonzalez isn’t the only one bullish on Chipotle however: Jefferies’ Andy Barish reiterated a Buy rating on the stock Thursday as well, writing that the recent pullback is an attractive buying opportunity, even if third-quarter same-store sales will be slightly weaker than last year, due to the 2017 introduction of the popular queso product. “We continue to find the company and its new management team in a good position to execute and drive industry-leading same-store sales and margin gains in 2019 and 2020.” He has a $550 price target on the stock and Street-high earnings estimates.

Credit Suisse ’s Bhumika Gashti is more cautious on the restaurant sector in general, writing that expectations look fairly high, as do valuations, but she, too, is bullish on Restaurant Brands International.

McDonald’s is a favorite at Bernstein as well.

Starbucks’ days of white hot growth may be over, and its valuation should reflect that.

By Teresa Rivas
October 4, 2018

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