Best restaurants in town - fast casual food speeds up

Inspired by comments to a previous TradingFloor.com article this post looks into the fastest growing publicly traded restaurant chains. Most people are very familiar with the big brands of McDonald’s (MCD), Starbucks (SBUX), Domino’s Pizza (DPZ) and Yum! (YUM), all of which can be considered fairly mature - having a large and loyal client base. With increased competition in the fast food market and the rise of the premium fast food segment, or as some call it “Fast Casual”, there might be some overlooked rapidly growing stocks in the market that could threaten the livelihood of the existing giants and and in the long-run outperform them in terms of stock returns.

According to research by NPD Group, the “Fast Casual” segment is the only restaurant form that has grown during the last few years (chart 1). Companies like Chipotle and Panera Bread stand out in this segment as those that have grown the most.

The food services market is of course highly dependent on consumption trends and brand values. In recent years people have become more and more aware of the need to safeguard their health and therefore many despise the fast food segment.

Due to this trend several restaurants have extended their product range to include healthier food, thereby capturing this market niche. For a fast food chain like McDonalds its response to the changed consumption pattern was to offer a variety of salads and wraps, which are considered healthier than a traditional burger and fries meal. Other chains have also decided to increasingly focus on healthier types of fast food and it looks like this has paid off. The alternatives are perceived to be healthier and are thought to be amongst the fastest growing in today’s market.

Good revenue and EPS growth
Four stocks stand out when using Saxo Bank’s stock screener which screens for the fastest growing restaurant chains based on a cumulative annual growth rate (CAGR) of revenues and earnings per share during  the past four years, as well as three-year future CAGR for the same variables. They are Chipotle Mexican Grill (CMG), Panera Bread (PNRA), Buffalo Wild Wings (BWLD) and Starbucks Corp (SBUX).

In terms of revenue growth Chipotle Mexican Grill (CMG), Panera Bread (PNRA) and Buffalo Wild Wings (BWLD) have all succsessfully grown their revenues at a higher pace than other large players in the market (chart 2) and are expected to continue to do so in the near future (chart 3).

The only exception is Starbucks’ negative revenue growth in 2009 which reflected a downturn in consumer spending on fast food products, also seen in McDonald’s and Yum!’s revenue streams.  However, for future periods Starbucks is expected to outperform other majors in the market in terms of CAGR EPS growth, as analysts expect a CAGR of 16.9 percent, slightly lower than the other restaurant chains highlighted in table 1. 

Overall the restaurant industry has performed well during the last year and all mentioned stocks have actually outperformed the S&P500 during this period (chart 4).

Is Chipotle Mexican Grill a sizzling hot stock?
Chipotle Mexican Grill is an interesting stock that has seen massive growth in recent years, and has even been referred to as the “Apple of the restaurant industry”. Its stock price has surged 62 percent during the last 12 months, further emphasising just how successful the restaurant chain has been.

Chipotle has benefitted significantly by increased consumer spending on “Fast Casual” foods as consumers switch to healthier types of fast food. Its range of tacos and burritos are particulary perceived as a healthy alternative to the traditional burgers and fries.

On average analysts value the twelve month forward P/E of the stock at around 43.7x, well above the five-year historical average P/E of 15x. In order to reach the industry’s five-year average, Chipotle’s earnings per share would have to increase to roughly 25 USD from 7, reported in 2011, which is more than a 200 percent increase. That is quite a hectic growth plan for a restaurant chain in a competitive market. On average, analysts expect its EPS to grow up to 13.5 by the end of 2014, and a P/E of 29.

The expected 17–20 percent y-o-y revenue growth will definitely play a part in Chipotle continuing its earnings growth, but bear in mind that the stock is currently trading close to its 52-week high and entry barriers are relatively low in this competitive market. In contrast, large dominant players such as McDonalds and Domino’s Pizza are expected to have y-o-y revenue growth in the range of 3-9 percent. A similar story can be told for Buffalo Wild Wings, having a forward looking P/E of 26.1x, well above the industry average, and being traded very close to its 52-week high.

Despite being seen as high growth stocks within the restaurant market it is likely that these stocks are close to being at their peak for now. However, when searching for fast growing stocks within a defensive sector with a beta (relative to the S&P500) close to one then BWLD, SBUX, PNRA and CMG might deliver value for investors should they meet analysts’ future expectations.