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It’s been 3 weeks (April 19th) since I advocated selling and/or shorting a whole slew of restaurant stocks on the basis that the entire sector had climbed much too far too fast, and there were several names that were ripe for the picking.

Since that recommendation, my average pick is beating the market by 11% vs. shorting the Russell 2000, which is the benchmark I use because these stocks are all small caps.

I wanted to review the stocks that I talked about in that post as well as check in on their performance since that article vs. a few market indexes, as well as their earnings results since most of them have since reported earnings.

These include: Chiptole Mexican Grill (NASDAQ: CMG) (NASDAQ: CMG.B), Buffalo Wild Wings (NASDAQ: BWLD), BJ’s Restaurants (NASDAQ: BJRI), and Panera Bread Company (NASDAQ: PNRA).

Restaurant Stocks: A Lot of Hot Air

Out of these companies, 3 of the names were on my radar screen late last year, with a formal recommendation of Chipotle’s “B” shares at around $45 per share in my Top 5 Stocks for 2009 article.

I still feel strongly that this entire sector, at the very best, is going to trade sideways for awhile, and at average to worse, is going to decline significantly for at least the next few weeks to months.

Let’s get right into each name.

Chipotle Mexican Grill:

Insiders selling shares like there’s no tomorrow

Chipotle LogoChipotle Mexican Grill owns and operates 860 “fast-casual” Mexican restaurants and offers a focused menu of burritos, tacos, burrito bowls (a burrito without the tortilla) and salads made from fresh, high-quality raw ingredients, prepared using classic cooking methods and served in a distinctive atmosphere.

Chipotle adheres to what they call Food With Integrity (FWI), whereby Chipotle seeks better food not only from using fresh ingredients, but ingredients that are sustainably grown and naturally raised with respect for animals, the land, and the farmers who produce the food.

Chipotle’s ultimate goal is to be able to serve only organically raised and grown food in all their restaurants.

Read more about Chipotle.

Why I liked the stock in the past:

  • Stock price was at historically low levels in relative and absolute terms
  • Same-store sales growth still positive
  • Opening restaurants at a break-neck pace, even in recession
  • No debt, strong cash flows, and strong working capital for funding new openings
  • New locations become break even in about 3 years or less
  • Best in breed company, restaurant and management team
  • Continued operational excellence in trying times

Chipotle had some very compelling reasons to purchase shares, at least a small position, way back when I first wrote about the company in my Top 5 Stocks for 2009 article.

Many of those reasons still hold true to this day, including operational excellence, management, etc.

Why I recommended selling/shorting the stock at $80 for “A” shares, and $67 for “B” shares:

  • Stock has doubled in a few month’s time from around $40 to $80 per share, while nothing has fundamentally changed within the company, in fact margins have declined and are expected to do so again as costs increase later this year for marketing
  • Valuation is higher than any other restaurant company within this space (Trailing P/E: 33, Forward (2009) P/E: 30.6 vs. 15.9 for restaurant industry , P/S 1.91 vs. .4 for restaurant industry, etc.)
  • Same-store sales increase was due mainly to increases in prices
  • Stock price is significantly higher (45%) than average price target of $55 per share (way higher than any other restaurant I am covering in this article), meaning expectations are going to be extremely high, and even if analyst’s raise their price targets they are unlikely to raise their stock rating, don’t look for any upgrades even on an earnings beat.
  • Insiders have almost sold more shares in the last couple of weeks than they had in the entire previous time that Chipotle has been a public company!
  • Don’t be greedy.

Bottom Line: The insider selling is alarming, and I think we are in for a formal correction here in Chipotle’s stock rather soon.

Earnings were spectacular, with Chipotle smoking analyst’s estimates, but this was as a result of mostly higher prices on their menu as well as higher margins due to lower advertising expenses.

In fact, traffic levels DECLINED in the quarter!

Hmmm…declining traffic, but increased profits?

If you ask me, this was all smoke and mirrors.

Look for comps to come in considerably lower as we move through the rest of the year and, despite Chipotle’s operational excellence and best in breed status, we are simply in a bad place and time to be an investor in the stock.

It looks like insiders agree!

Performance Since Sell/Short Recommendation:

  • S&P 500:+6.85%
  • Nasdaq:+3.95%
  • Russell 2000:+6.77%
  • CMG-A: -2.39%
  • CMG-B: -.80%
  • Profit/Loss vs. shorting the Russell 2000: +9.16% (CMG-A), +7.57% (CMG-A)

Buffalo Wild Wings:

Typical sell on the news for high flying stock

Buffalo Wild Wings logoBuffalo Wild Wings, Inc., engages in the ownership, operation, and franchising of restaurants in the United States that cater to mainly a sports bar audience serving mainly chicken wings with 14 signature sauces, while providing an atmosphere geared towards watching sports on large screen televisions while enjoying the company of others. The company provides quick casual and casual dining service, as well as serves bottled beers, wines, and liquor.

As of December 28, 2008, the company owned or franchised 560 Buffalo Wild Wings restaurants in 38 states, of which 197 were company-owned and 363 were franchised.

Read more about Buffalo Wild Wings.

Why I liked the stock:

  • Stock price was at historically low levels in relative and absolute terms
  • Same-store sales growth hugely positive even without the influence of higher menu prices
  • Still opening new locations
  • No debt, strong cash flows, and strong working capital for funding new openings
  • Fantastic management team, strong execution, always staying on the cutting edge
  • Continued operational excellence in trying times, in fact thriving because of it

BWLD has performed amazingly in this economic environment because of the perceived value proposition that the company provides.

You get a reasonably priced meal, a festive atmosphere where you can watch the Super Bowl, March Madness and other sporting events, and a good return on your investment of both time and money.

Why I recommended selling/shorting the stock at $37.80:

  • Stock has more than doubled in a few month’s time from around $15-18 to $40 per share
  • Valuation is higher than many other restaurant companies within this space (Trailing P/E: 28, Forward (2009) P/E: 22.52 vs. 15.9 for restaurant industry , P/S 1.57 vs. .4 for restaurant industry, etc.)
  • Cash reserves have been dwindling
  • Simple concept that has no real moat, consumers might trade up as soon as things improve, or the perception of improvement spurs more refined tastes
  • Chicken wing prices are on the rise
  • Has been written about in Investor’s Business Daily, means the good times are near finished
  • Stock price is slightly higher than average price target of $35 per share, meaning expectations are going to be extremely high, and even if analysts raise their price targets they are unlikely to raise their stock rating, don’t look for many upgrades even on an earnings beat.
  • Don’t be greedy.

I will admit that BWLD has rightfully deserved its rapid ascent up the charts.

Management has continued to excel, and the downtrodden economy has seemed to actually help the company’s results.

But buyer beware…expectations are now higher.

Bottom Line: BWLD reported results in-line with expectations, which had been primed to the max as a result of continued execution by the company as well as higher guidance.

The company did announce that costs would be higher in the second quarter of this year however due to higher higher store openings and higher stock based compensation expenses.

Guidance was in-line with what the company traditionally has espoused: 25 percent growth in revenue, and 20 percent to 25 percent growth in net earnings.

The only blemish on the quarter was a marked slowdown in the company’s same-store sales.

Again, BWLD is a great company, and has excellent management, but the valuation and stock price are not justifiable.

That being said, this stock is one of the stronger ones in the group that I am reviewing, so make sure your short position if you have one, is tight, and look to get out on any strength to the upside.

Performance Since Sell/Short Recommendation:

  • S&P 500:+6.85%
  • Nasdaq:+3.95%
  • Russell 2000:+6.77%
  • BWLD: -6.08%
  • Profit/Loss vs. shorting the Russell 2000: +12.85%

BJ’s Restaurants:

Purveyor of famous beer and Pizookie still too pricey

BJs LogoBJ’s Restaurants, Inc. owns and operates casual dining restaurants in the United States.

It operates restaurants under the BJ’s Restaurant & Brewery brand name, which includes a brewery within the restaurant; BJ’s Restaurant & Brewhouse, which receives the beer it sells from its breweries or an approved third party craft brewer of proprietary recipe beers; and BJ’s Pizza & Grill, which is a smaller format, full service restaurant.

BJ’s offers an innovative and broad menu featuring award-winning, signature deep-dish pizza complemented with generously portioned salads, appetizers, sandwiches, soups, pastas, entrees and desserts including their famous Pizookie dessert.

In addition, at most locations, BJ’s features award-winning handcrafted beer to go along with highly detailed, contemporary decor and usually includes a bank of TV’s, including several high definition flat panel televisions for patrons to enjoy while they eat.

BJ’s Restaurants owns and operates 84 casual dining restaurants.

Read more about BJ’s.

Why I liked the stock:

  • Stock price was at historically low levels in relative and absolute terms
  • Same-store sales growth down only moderately, in fact one of the better performing restaurant chains in hard hit California marketplace
  • Still opening new locations, albeit at at much slower pace
  • Very good balance sheet with minimal debt
  • Insider buying at lowest levels late last year
  • Great niche player in crowded sit down restaurant space

BJ’s is very similar to Buffalo Wild Wings, albeit a little more diversified in their menu offerings, and a little less expansive in the “sports bar” arena.

BJ’s is a refined balance between a pseudo-sports bar, with a nice casual sit-down dinner space with unique menu offerings as well as the aforementioned handcrafted beer.

In California, BJ’s largest market, the chain was holding up surprisingly well, even where it had overbuilt restaurant capacity in the hardest hit areas where job losses and the home construction collapse has been the worst.

I was looking to play BJ’s as a forward-thinking rebound play in the California housing market/job market…oops…looks like I was a little too late.

Why I recommended selling/shorting the stock at $15.45:

  • Stock has more than doubled in a few month’s time from around $7-8 to $16 per share
  • Valuation is high (Trailing P/E: 40, Forward (2009) P/E: 30.92 vs. 15.9 for restaurant industry , P/S 1.05 vs. .4 for restaurant industry, etc.)
  • Cash reserves have been dwindling, debt has been increasing
  • Simple concept that has no real moat, consumers might trade up as soon as things improve, or the perception of improvement spurs more refined tastes
  • Not a best in breed player, but a very good restaurant chain. Does not deserve the higher multiples put forth on competitors like Chipotle, Panera, or Buffalo Wild Wings
  • Stock price is 20% higher than average price target of $13.20 per share, meaning expectations are going to be extremely high, and even if analyst’s raise their price targets they are unlikely to raise their stock rating, don’t look for many upgrades even on an earnings beat.
  • Don’t be greedy.

When BJ’s was trading around $8 per share, I was ready to get at least a 1/4 position, but waited to long obviously.

There were some compelling things going for BJ’s including insider buying, and the fact that same-store sales were decreasing but on a much lower level than other similar chains in this space, and it was looking like people just didn’t want to give up their BJ’s Pizookies, and for good reason.

But, as with all the stocks in this sector, greed has gotten the best of this stock as well. It is certainly not worth the premium being bestowed upon it now, and might fall harder than others if it slips at all because it is one notch below other best-in-breed players in the restaurant space.

Bottom Line: BJ’s reported solid earnings that were in-line to slightly higher than analyst’s had expected.

However, just as the smoke and mirrors earnings announcement by Chipotle, BJ’s also had a little trickery involved due to lower costs across the board as well as higher menu prices.

There is a limit to how low you can cut costs and raise prices, before the truth of your operations rears its ugly head.

Zacks had an interesting look at BJ’s Restaurants post earnings.

There are some worrisome trends within the company such as lower margins, low return on invested capital (NASDAQ:ROIC), and return on equity (ROE), as well as management’s assertion that there will be fewer store openings this year as a result of continued consumer weakness.

Out of all the restaurants that I am featuring here, BJ’s is by far the weakest of the bunch and the one that can fall the furthest.

Performance Since Sell/Short Recommendation:

  • S&P 500:+6.85%
  • Nasdaq:+3.95%
  • Russell 2000:+6.77%
  • BJRI: -.2%
  • Profit/Loss vs. shorting the Russell 2000: +6.97%

Panera Bread:

Company can’t keep hiding behind smell of bread, higher menu costs

Panera Bread LogoPanera Bread Company owns and franchises 1,252 bakery-cafes under the Panera Bread and Saint Louis Bread Co. names as of December 30, 2008.

With its identity rooted in handcrafted, fresh-baked, artisan bread, Panera Bread is committed to providing great tasting, quality food that people can trust, highlighted by antibiotic free chicken, whole grain bread, select organic and all-natural ingredients and a menu with zero grams added trans fat.

Panera’s bakery-cafe selection offers flavorful, wholesome offerings, which include a wide variety of year-round favorites, complemented by new items introduced seasonally with the goal of creating new standards in everyday food choices.

Guests enjoy Panera’s warm and welcoming environment featuring comfortable gathering areas, relaxing decor, and free internet access provided through a managed WiFi network.

Read more about Panera Bread.

Why I liked the stock:

  • None: I never liked Panera Bread as a stock. Great company, bad stock. I will say that Panera exhibits some of the characteristics that the other companies highlighted in this article have for advocating purchasing shares at lower levels, such as: no debt, high margins, continued execution in a tough environment, etc.

Unlike the other names on this list, there was never a compelling reason to own shares of Panera Bread in my eyes over the last year or so, and it has been on my “Stocks to short” list for quite some time, although I have yet to pull the trigger because the time hasn’t been right.

I won’t sit here and say Panera is a bad company in any way, but just a very bad stock.

Why I recommended selling/shorting the stock at $60:

  • Stock has been overvalued for about a year now, and even with the recent run up in stocks, and the restaurant sector in particular, Panera has lagged those gains, indicating the stock is getting a little tired.
  • Valuation is high (Trailing P/E: 27, Forward (2009) P/E: 22.81 vs. 15.9 for restaurant industry , P/S 1.40 vs. .4 for restaurant industry, etc.)
  • Same-store sales increases have been as a result of increased prices, and a reshuffling of the menu to highlight higher margin, higher cost items.
  • Company’s profitability has been boosted by several cost-cutting measures, including raw materials hedging for ingredients, this will not last
  • Tons of competition in this space, and again once customers regain their financial footing, they’ll be trading in a nice lunch sandwich for a nice dinner somewhere else
  • Stock price is 14% higher than average price target of $52.50 per share, meaning expectations are going to be extremely high, and even if analyst’s raise their price targets they are unlikely to raise their stock rating, don’t look for many upgrades even on an earnings beat.
  • Has been reported in Investor’s Business Daily and Barron’s, means the good times are near finished
  • 31% of the shares held short, people are betting Panera will fall
  • Don’t be greedy.

Panera is a great company that is a favorite to many.

It’s just not a good stock, and hasn’t been for quite some time, but merely offered a safe haven in the restaurant industry while the rest of the industry was cratering.

The fact that Panera has lagged the market’s gains as well as those of its peers should be a troubling sign to you if you are long, as well as the 31% of the shares that are held short.

Bottom Line: The same story transpired at Panera that happened at the aforementioned restaurant chains. Namely, the company beat or met estimates, but on a little trickery via higher menu prices in the face of slowing traffic.

The trickery, along with Panera’s recent stock price run up, didn’t wow investors, as the stock has sold off dramatically since that earnings announcement took place.

I still think there is way more downside to come in this baby, as it was a high flyer and will be one of the first to fall if it ever revises estimates, or “misses” in any way, shape or form.

If you’ve enjoyed the run up, now’s the time to get out and enjoy your gains.

If you’re thinking about shorting, join the crowd.

Performance Since Sell/Short Recommendation:

  • S&P 500:+6.85%
  • Nasdaq:+3.95%
  • Russell 2000:+6.77%
  • PNRA: -11.8%
  • Profit/Loss vs. shorting the Russell 2000: +18.57%

Still More Restaurant Correction Coming?

In summary, if you would have shorted any of these stocks, or all of them, you would be sitting on some nice gains right now, averaging over 100% annual returns!

I still think that we have more of a correction coming, and that this is just the first leg, especially when you review all the results of the companies in this article, and notice a uniquely disturbing trend among most of them: their results are being propped up by artificial means.

Same-store sales are declining in absolute terms if you exclude menu price increases.

Margins are shrinking for the most part.

Foot traffic is declining.

Costs that were easily shrunk in the first round of “cuts” now become harder to manipulate, and thus margins will contract further, and same-store sales and profits will come under fire.

I would not be long restaurant stocks right now, unless and until, there is a significant improvement in the economy that is NOT already reflected in the stock prices.

As of now, they all seem to be predicting the end of the recession, and more than that, that happy eating out days are here again for all Americans.

I believe that may be true for a few of these names, but definitely not for all of them, and not for the sector overall.

This was an overreaction to the upside just as we had an overreaction to the downside when things were looking grim.

The truth is somewhere in the middle, and we’re not there yet.

Source: Restaurant Stocks: More Downside to Come