The emergence of the Fast Casual restaurants, which include Chipotle (CMG), Panera Bread Co. (PNRA), and Jack In the Box's (JACK) Qdoba Mexican Grill, have eaten into the sales of both casual dining and quick service restaurants (QSRs), as casual dining restaurants-- like Ruby Tuesday (RT), DineEquity (DIN) (owners of Applebee's and IHOP), and Darden Restaurants (DRI) (owners of Olive Garden, Red Lobster, and LongHorn Steakhouse)-- experienced declines in sales. Even McDonald's (MCD), after nearly a decade of positive numbers, saw its domestic same-restaurant sales decline last October, though has since rebounded slightly with a 0.7 increase in July.
Fast Casual restaurants are still a small segment of the restaurant industry, accounting for only 14% of the $223-billion limited-service restaurant segment (where patrons order and pay before eating), however this segment is increasing rapidly as sales rose 13% in 2012 up from 5% 10 years earlier. Mexican Fast Casual increased sales over the previous year 17% to $5.7 billion, while bakery cafes rose 10% to $6.2 billion; the sandwich category climbed 17% to $4.4 billion and Asian food rose 16%. According to Technomic, the leading fact-based consulting and research firm serving the food industry, Fast Casual (now a $31 billion segment) will continue to outperform both QSRs and full-service restaurant chains.
So what accounts for the rise in the Fast Casual dining segment? The great recession had a lot to do with it. Fast Casual gave diners who were watching their budget the option to step down from casual dining without sacrificing quality and taste. Fast Casual also offered diners a step up from QSRs by catering to the needs of a changing consumer: a younger and more hip consumer who is looking for something more substantial than what QSRs offer. These new groups of consumers are demanding quality food along with healthier options, including more fresh fruit and vegetable choices and organic products served in a more environmentally conscious establishment.
Though many of the hottest Fast Casual restaurant companies today are privately held, such as Five Guys or Smashburger, there are a number of Fast Casual companies that are publicly traded and have experienced double-digit stock gains. These stocks, though no longer a bargain, still show potential for one's growth stock portfolio.
CHIPOTLE - A HIGH PRICED STOCK WITH ROOM TO GROW
Chipotle Mexican Grill, which has seen sales growth above 20% per year over the last five years, continues its excellent stock run, closing Friday August 8th at $405.74, up over 36% year-to-date. The company operates 1,502 restaurants, including 5 in Canada, 6 in London, 1 in Paris, and expects to open between 150 and 185 new locations in the U.S. in 2013. Only about 10 of the restaurants are franchised as the company owns roughly 99% of its stores.
For the second quarter 2013, Chipotle announced revenues of $816.8 million, up 18.2% from the same quarter 2012; the rise is due mostly to new locations the company opened. Net income rose 7.6% to $87.9 million. The company has $281 million in cash, down from $322 million on December 31, 2012. And Chipotle has not encumbered itself with extensive debt, according to its latest 10-Q filing; company assets total $1.81 billion while liabilities are only $442 million.
Due to its tremendous growth (Chipotle has a market cap of $12.53 billion), the company has seen its stock rise 450% in the last 5 years, and sits at a very high P/E ratio of 42.9, which has some investors looking for a pullback in the stock. On August 8th Zacks placed a "neutral" rating on the stock with a price target of $425.00 per share, citing a solid 2nd quarter. Earlier, on July 15th Stifel Nicolaus initiated coverage, setting a "hold" on the stock. On July 3rd Argus upgraded the stock from a "hold" to a "buy" with a $430.00 price target. However, on July 1st analysts at Deutsche Bank, expecting a pullback, placed a $360.00 price target, which the company easily blew past.
But for Chipotle stock to continue its streak, the company and its restaurants must continue to grow. And while there is still plenty of room for expansion of the Chipotle brand, both domestically and abroad, the company is experimenting with a new concept named ShopHouse Southeast Asian Kitchen, serving curries, chicken satay, Laab, Tofu, and other Southeast Asian inspired dishes. Currently ShopHouse is being tested in 2 locations, Los Angeles and Washington D.C. If Chipotle can do for Asian foods what it did for burritos and tacos, look for ShopHouse to be another Fast Casual destination… and for Chipotle stock to continue to rise. However, even if ShopHouse proves not to be successful, the company hasn't over-invested in the concept, so it should not hurt the brand or the stock. Chipotle appears to have room to grow and could continue to be a long term winner in one's portfolio
PANERA - FRESH BREAD AND ANTIBIOTIC FREE CHICKENS
Panera Bread Company is a bakery-cafe concept with 1,708 locations in 42 states, and Ontario, Canada, operating under Panera Bread, Saint Louis Bread Co., and Paradise Bakery & Cafe. Panera Bread is the epitome of the Fast Casual sector as each store freshly bakes high quality breads from scratch, using quality ingredients and, in total, bakes more bread each day than any bakery-cafe concept in the country. Panera, like Chipotle, emphasizes fresh high quality ingredients in its dishes at a moderate price. The company, which is known for using only antibiotic-free chicken, also has a line of organic dishes with all-natural ingredients. During the second quarter fiscal 2013, the company opened 37 new bakery-cafes with 19 being franchises.
Panera, which has a market cap of $4.94 billion, has seen its stock rise over 12% year-over-year, closing on Friday August 9th at $175.81 per share. The company reported lower than expected second quarter earnings, as sales at company-owned net bakery-cafes open more than one year were up just 3.8%. Panera had second quarter revenue of $589.00 million for the quarter, compared to the consensus estimate of $596.01 million, but was still up 11.0% on a year-over-year basis. Panera reported net income of $51 million or $1.74 per share for the quarter, missing the analysts' consensus estimate of $1.77 by $0.03, but up from second quarter 2012 net income of $44 million, or $1.50 per diluted share, representing a 16% year-over-year increase in diluted earnings per share.
On August 8th Wunderlich upped its rating on the stock from a "hold" to a "buy" raising its price target from $200.00 a $212.00 indicating a potential upside of 20.75% from the company's current price. Earlier on July 25th, analysts at Susquehanna cut their price target from $183.00 to $180.00 and placed a "neutral" rating on the stock. On August 7th Zacks reiterated a "neutral" rating and has an $180.00 price target, citing the company's new menu, increased media exposure, its focus on an off-premise catering program, and faster resurgence of high-end consumers as all positive moves for the stock. Given the market environment for the Fast Casual segment, I think Panera has a lot of room in its breadbasket to run, and I think this is a good growth stock for one's portfolio.
QDOBA MEXICAN GRILL - JACK THE CLOWN GOES FAST CASUAL
While Jack in the Box restaurants itself is not considered Fast Casual, its subsidiary Qdoba Mexican Grill, which Jack acquired in 2003 in an effort to enter the expanding fresh Mexican food market, does fit the definition. And though the company announced the closing of 67 underperforming restaurants by the end of fiscal 2013 (Sept. 29, 2013), it still has high hopes for the future of the Qdoba brand. Chairman and CEO, Linda Lang, who announced she will step down on January 1, 2014, commented: "We believe in the tremendous potential of the Qdoba brand, and we plan to continue expanding in North America with 70 to 75 new locations expected to open system-wide in fiscal 2013, including approximately 40 company locations." Ms. Lang sees the closing of the underperforming restaurants having a positive impact on financial performance, which will result in higher future earnings. According to Ms. Lang, the company will continue opening new locations and expects to open 60 to 70 new Qdoba locations in 2014, half of which will be company owned.
Jack in the Box, which operates 2,255 Jack in the Box restaurants (1,729 that are franchised) and 592 Qdoba restaurants (308 that are franchised), has a market cap of $1.8 billion. The company has experienced an excellent run year-over-year with its stock up 53%, closing on Friday August 9th at $40.48 per share. On August 7th the company reported earnings of $17.3 million, or $0.38 per diluted share, for the third quarter that ended July 7, 2013, compared with earnings of $12.6 million, or $0.28 per diluted share, for the third quarter of fiscal 2012. Same-store sales increased 1.2% for the quarter exceeding that of the QSR sandwich segment by 1.0% for the comparable period; Qdoba same-store sales in the third quarter increased 0.5% for company restaurants and 1.3% system-wide.
The company has repurchased approximately 1,366,000 shares of its common stock in the third quarter at an average price of $37.20 per share for an aggregate cost of $50.8 million. Year-to-date the company has repurchased approximately 2,773,000 shares at an average price of $33.24 per share for an aggregate cost of $92.2 million. In August, the board of directors authorized an additional $100 million stock-buyback program that expires in November 2015.
While I like Jack in the Box (as the stock has potential to continue to grow), until the Qdoba brand can gain traction the company will still have to rely on its earnings with its QSRs, which means it's competing with McDonald's, Five Guys, and the upstarts like Smashburger. And even if Qdoba becomes a successful brand I doubt it will in any way match the success of a Chipotle; it will at best be a Wendy's if Chipotle is McDonald's. However, there still is plenty of room in the sector for a Qdoba to flourish, which will help the stock grow.
While I believe the Fast Casual segment will continue to expand and take market shares from casual dining and QSRs, there are challenges; both casual dining and QSRs are not taking their losses to the Fast Casual restaurants sitting down. Quick service restaurants are developing their own lines of upscale offerings like Taco Bell's (YUM) Cantina Bell menu, or KFC's new Fast Casual concept, KFC 11, which offers a broad menu of grilled and fried chicken dishes with a more international flavor, along with sides such as garlic smashed potatoes. Red Lobster is countering with its "pay-at-the-counter" where lunches are priced from $6.99 to $8.99. Even supermarkets have gotten into the Fast Casual business, offering quick high-end prepared foods. Plus if the economy worsens it could put a damper on growth of Fast Casual, where the average price of a meal is between $8.00 and $15.00, compared to QSR's average price between $5.00 and $7.00. For me, Chipotle does it right: A limited high-quality menu that tastes the same no matter which restaurant you visit. That's what made McDonald's (other than the high quality) - and now it's what made Chipotle. Panera and Jack in the Box are also solid contenders and I think they will also continue see strong gains over the next few years.