So 2011 is off to a bullish start… The year began with positive manufacturing and construction data, giving the bulls an opportunity to celebrate.
But in Monday’s “risk-on” session, one industry was curiously quiet. Restaurant stocks were relatively soft, despite what should have been positive news for broad consumer spending.
Whenever the broad market moves almost unanimously in one direction, with a hand-full of stocks bucking the trend, it usually pays to dig a bit deeper and determine why these securities aren’t participating with the broad trend.
So what’s the deal with restaurant stocks?
According to a report from the National Restaurant Association:
For the first time in three months, restaurant operators reported a net decline in same-store sales. … Restaurant operators also reported a net decline in customer traffic levels in November. ~hat tip: Calculated Risk
So despite general assumptions that the US consumer is slowly recovering, the restaurant data indicates cautious spending. Will this trend continue? It’s hard to say… But a number of key restaurant stocks are taking on water and setting up excellent short opportunities.
As the divide between the “haves” and the “have-nots” continues to widen, consumers on the short end of this chasm are finding it more difficult to stretch their budgets.
Companies that cater to low-end consumers are finding the environment challenging – and this includes operators in the Quick Service Restaurant (QSR) sub sector.
Last week, we covered our three favorite QSR short ideas – expecting weakness in Chipotle Mexican Grill (CMG) as well as Panera Bread (PNRA) and Yum! Brands (YUM). Since that time, the Mercenary portfolios have taken a short position in YUM which has broken below a key consolidation area (click to enlarge).
The other notable development for QSR stocks is a significant breakdown in the 800 pound gorilla – McDonald’s Corp. (MCD).
MCD of course has a global footprint and is more likely to see growth from emerging markets than from domestic spending and traffic patterns. But as a huge purchaser of ag commodities (beef, grain, poultry etc), the company will certainly be vulnerable to rising commodity prices in the coming year.
Today’s break puts the stock squarely below key support areas, and for the technical analysis junkies we have a mini “death cross” with the 20 EMA crossing below the 50 EMA. These aren’t magic signals by any means, but the EMA movement just helps to quantify the fact that near-term momentum is decidedly negative. Considering the fundamental challenges, today’s weakness should lead to further price erosion (click to enlarge).
Moving up a notch in quality (and price point), the casual dining sub-sector doesn’t look much better. Consumers with looser purse strings are likely to continue to spend, but higher food costs will still be a challenge.
More importantly, investors are largely bullish on the mid-tier casual restaurants – with optimistic growth expectations, and premium stock prices in place. In this scenario, it doesn’t take much weakness to undermine assumptions, and stocks in this area are beginning to show signs of fatigue as well.
P.F. Chang’s China Bistro (PFCB) should report 5% growth in EPS this year, with analysts expecting acceleration to 12% growth in 2011. But with the stock priced at 22 times expectations for next year, there is plenty of room for disappointment.
In late November, PFCB broke above $50 (a round number that looked like significant resistance at the time), only to fall back below in late December. From a technical perspective, a break below the 50 EMA is concerning. Considering the high valuation relative to the industry – and relative to the company’s growth – PFCB looks like an accident waiting to happen (click to enlarge).
The Cheesecake Factory Inc. (CAKE) has yet to fully break down, but I’m watching the inflection point very closely. CAKE’s multiple is a bit more reasonable than PFCB – (only 18.5 times expectations), but analysts are expecting the earnings growth rate to decelerate from 33% in 2010 to 17% this year.
CAKE logged a 50% run in just over a 3-month period as investors went “all-in” on the rebounding consumer theme. But the company is only registering low single digit revenue growth quarter after quarter – a trend that will leave the company especially vulnerable if commodity prices continue to pressure industry profit margins.
A break below $30.50 would be significant as this represents a short-term support area and is also right at the 50 EMA. momentum traders should already be nervous with the stock nearly 10% off its December high, and further weakness would likely trigger a mass push for the exits (click to enlarge).
High-End Dining More Stable
In keeping with the broad retail trend, higher-end restaurant chains are enjoying a more robust business environment. Many of these companies are privately owned, so the trading opportunities are limited. But as a quick example of the business metrics, take a look at McCormick & Schmick’s Seafood (MSSR) (click to enlarge).
Despite expectations for higher commodity costs and stubborn unemployment, analysts are expecting earnings growth of 44% next year. MSSR is in the process of rebounding after losing more than 90% of its market value during the financial crisis.
The stock is too thin to fit into our trading program, but a quick look into the business metrics implies that the higher-end restaurant industry is faring just fine in today’s market.
2011 began with a bull-fest… and all-out “risk-on” buying frenzy with expectations of great returns this year. As traders, we do our best to be agnostic when it comes to bullish or bearish long-term predictions – willing to trade in-line with opportunities as they arise.
But chasing extended stocks with vulnerable fundamentals is a recipe for losses, while waiting for confirmation and buying (shorting) at key inflection points keeps our capital protected and growing. The low to mid-tier restaurant area has separated itself from the broad bullish sentiment – and should be an excellent bearish opportunity set.
Disclosure: As active traders, authors may have positions long or short in any securities mentioned. Full disclaimer can be found here.