Ranking the Restaurant Stocks

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 |  Includes: BWLD, CAKE, CBRL, CMG, MCD, PFCB, PNRA, PZZA, QSR, RRGB, SBUX, SONC, YUM
by: Consumer Contrarian
Below I rank the 13 restaurant companies I follow based on key operating statistics, namely growth – in terms of comparable sales and units – and operating profit margins. At the end I compare each, based upon valuation, and add my own analysis throughout. (All figures for FY 2011 are based on my own estimates.)
Growth – Comparable Sales
Comparable Sales
Average
11E
10E
09
08
07
'09-11E
'07-11E
4.4%
9.4%
2.2%
5.8%
10.8%
5.3%
6.5%
5.5%
7.9%
0.7%
5.8%
1.9%
4.7%
4.4%
4.0%
5.0%
4.5%
6.9%
6.8%
4.5%
5.4%
THI
3.0%
4.7%
2.9%
4.4%
6.1%
3.5%
4.2%
5.0%
7.0%
-6.0%
-3.0%
5.0%
2.0%
1.6%
1.8%
0.6%
3.1%
5.9%
6.9%
1.8%
3.6%
2.5%
2.0%
-2.5%
-4.0%
0.6%
0.7%
-0.3%
1.8%
0.8%
-1.7%
0.5%
0.7%
0.3%
0.4%
0.0%
-1.5%
-0.5%
1.7%
0.5%
-0.7%
0.0%
2.0%
0.4%
-5.4%
-3.3%
0.9%
-1.0%
-1.1%
1.0%
0.0%
-5.0%
2.0%
0.0%
-1.3%
-0.4%
1.0%
-0.3%
-11.1%
-1.4%
2.4%
-3.5%
-1.9%
-1.0%
-7.8%
-4.3%
0.9%
3.1%
-4.4%
-1.8%
Avg.
2.3%
2.2%
-1.8%
1.7%
3.5%
0.9%
1.6%
Click to enlarge
The single most important investment characteristic among restaurant stocks is comparable sales growth, in my opinion. That’s why Chipotle (NYSE:CMG) and Panera (NASDAQ:PNRA), which are on pace to grow comparable sales the fastest, have the best stock returns over the past five years. (Sonic (NASDAQ:SONC) and Red Robin Gourmet Burgers (NASDAQ:RRGB), with the steepest average sales comp sales declines, have been punished the most.)
The group’s two fastest growers have taken very different paths to their outsized 2010 comparable sales growth. At CMG, increased traffic accounted for virtually the entire 9.4% increase in comparable sales, after a multi-year program to improve efficiency. Meanwhile, transaction count only contributed about one third of the nearly 8% increase in 2010 comparable sales, and two-thirds arose from price and mix-customers trading up.
Besides Starbuck’s (NASDAQ:SBUX), where the average ticket rose 3% in 2010, and Tim Horton’s (THI) – which only gives a qualitative breakout of the components of comps – most restaurant chains have had to concede price to maintain volumes in 2010. Best at that was McDonald’s (NYSE:MCD), where it enjoyed its best domestic volume improvements in recent history, but kept prices about flat in the US.
But with key commodity costs (e.g., grain, beef, coffee, sugar) rising in Q4 2010 for the first time since 2008, and restaurant traffic levels firming, look for restaurants to push harder on price in 2011. At MCD, SBUX, PNRA and Cracker Barrel (NASDAQ:CBRL), I have assumed price/mix will account for at least two percentage points of the comparable sales increases I forecast.
Growth – Units
Unit Growth
Average
11E
10E
09
08
07
'09-11E
'07-11E
BWLD
14.6%
12.3%
16.4%
15.5%
13.1%
14.4%
14.4%
CMG
12.9%
13.4%
14.2%
18.9%
21.2%
13.5%
16.1%
PNRA
5.3%
5.3%
4.2%
7.7%
19.8%
4.9%
8.4%
THI
4.0%
3.4%
4.1%
6.7%
5.7%
3.8%
4.8%
PFCB
4.1%
1.7%
4.3%
10.1%
22.0%
3.3%
8.4%
PZZA
2.9%
4.2%
2.6%
5.4%
6.4%
3.2%
4.3%
RRGB
1.8%
2.5%
3.8%
10.2%
10.7%
2.7%
5.8%
CAKE
4.9%
1.9%
0.6%
4.6%
15.2%
2.5%
5.4%
CBRL
1.3%
0.9%
1.9%
2.7%
3.5%
1.4%
2.1%
YUM
1.0%
0.8%
2.2%
2.7%
2.2%
1.3%
1.8%
SBUX
2.5%
1.3%
-0.3%
11.1%
20.7%
1.2%
7.1%
SONC
0.6%
0.8%
2.0%
3.9%
4.9%
1.1%
2.4%
MCD
-0.3%
0.4%
1.6%
1.9%
1.1%
0.6%
0.9%
Avg.
4.3%
3.7%
4.4%
7.8%
11.2%
4.2%
6.3%
Click to enlarge
Unit growth, while an important success factor for restaurant companies, is largely a function of comparable sales. Essentially, next year’s expansion is a function of last year’s comparable sales. For instance in 2008, Starbuck’s (SBUX) had just suffered its first ever full year of negative comps, prompting it to retrench – especially overseas – the following year.
Size is a mitigating factor of unit growth, subject to the rule of large numbers. Thus McDonald’s (MCD), with more than 32,500 units worldwide, has the slowest pace of new openings, despite the strong suggested by their solid comparable sales. PF Chang’s (NASDAQ:PFCB) and Red Robin (RRGB) initially growing their unit counts by double digits (percentages) each year but then, after reaching 350 (PFCB) or 400 (RRGB) restaurants and achieving critical mass in most attractive markets, expansion slowed considerably after 2008. Of course, the recession played a part in that slowdown, however, larger chains, like Buffalo Wild Wings (NASDAQ:BWLD) (730 units) and CMG (1,100) continue to grow at a low-teens percentage pace.
Domestically, unit counts in the restaurant industry fell 0.9% in 2010, following a 0.4% decline in 2009, according to NPD Group. Thus, the 3.7% growth among the companies I cover suggests publicly traded chains are taking share from private competitors. Over the past 10 years, the overall industry has grown just over 1% a year. The Bar and Grill segment had its first overall unit decline in several years, making BWLD's 12.3% expansion particularly impressive.
Most ongoing restaurant openings at the largest chains, especially MCD, Yum Brands (NYSE:YUM), Papa John’s (NASDAQ:PZZA) and Starbuck’s, are occurring overseas, primarily in Europe and Asia. Slow domestic growth at concepts like Sonic (SONC), as well as Wendy’s (NASDAQ:WEN) and Burger King, make clear that the US market is saturated with fast-food concepts.
Worldwide Papa’s, the Russian franchisee of PZZA, recently raised capital to grow outside its St. Petersburg hub. Domino’s Pizza (NYSE:D), listed in London as well as the US, operates throughout Europe.
With more of a niche orientation, several quick-casual and casual chains are only now beginning to look overseas for unit expansion. For example, CMG opened its first restaurant in the UK this past year and Buffalo Wild Wings (BWLD) will likely open restaurants in Europe, after opening its first units in the lower-risk Canadian market.
One must also take into consideration the manner of growth. All else being equal, I prefer a restaurant operator that can expand through company owned stores. That way, the restaurant operator keeps all the profits and can maintain greater control of its system.
Profit Margin
Operating Margin
Average
11E
10E
09
08
07
'09-11E
'07-11E
MCD
32.0%
31.0%
30.1%
27.4%
24.5%
31.1%
29.0%
THI
24.0%
23.0%
22.1%
21.8%
22.4%
23.0%
22.7%
YUM
16.3%
16.0%
14.7%
13.4%
13.0%
15.6%
14.7%
CMG
16.5%
15.7%
13.4%
9.3%
10.0%
15.2%
13.0%
SONC
15.9%
12.9%
16.1%
17.9%
19.1%
15.0%
16.4%
PNRA
12.9%
12.0%
10.4%
8.7%
8.4%
11.8%
10.5%
SBUX
14.8%
13.3%
5.7%
4.9%
11.2%
11.3%
10.0%
BWLD
9.5%
9.2%
8.2%
8.4%
7.8%
9.0%
8.6%
CAKE
8.2%
7.7%
6.3%
5.4%
7.3%
7.4%
7.0%
PZZA
6.6%
6.8%
8.6%
5.8%
5.0%
7.4%
6.6%
CBRL
7.3%
6.8%
6.0%
6.3%
7.2%
6.7%
6.7%
PFCB
5.4%
5.2%
5.3%
4.4%
4.9%
5.3%
5.1%
RRGB
1.6%
1.1%
3.3%
5.2%
6.9%
2.0%
3.6%
Avg.
13.2%
12.4%
11.6%
10.7%
11.4%
12.4%
11.8%
Click to enlarge
Nearly every one of the highest-margin restaurant chains on the list above generates the majority of its operating profits from franchising. CMG, the lone exception, owns all of its units, making its high margins (and rapid unit growth) even more impressive.
With investors placing greater emphasis on returns on capital, and companies in most industries looking to reduce the drag from spending, many restaurants re-franchise – selling company operated units to franchisees. Yum Brands has been at the forefront of this trend. In the third quarter alone it sold about all its restaurants (224 KFC’s, 123 Pizza Huts) in Mexico to a master franchiser. The re-franchising of these stores, along with hundreds of other units, accounts for the majority of YUM’s margin improvement from 2007.
In 2007, MCD re-franchised most of its operations in Latin America and the Caribbean, helping its operating margin rise more than four percentage points that year. The company’s gone from more than 26% of its store base company operated just four years ago, to less than 24% today, accounting for the bulk of the margin improvement over this time.
Franchising, despite its inherently higher operating margins (illustrated above), and lower capital needs and faster potential growth, has as its main disadvantage, the smaller profit dollars it brings in. Consider that the average Cheesecake Factory (NASDAQ:CAKE), which owns all 163 of its restaurants, delivers about $1.2 million in cash flows (EBITDA) to shareholders. It takes six to seven restaurants at THI, which owns nearly all its units, to generate this same cash return for shareholders.
Valuation
PE
EV/EBIT
11E
10E
09
08
07
11E
10E
09
08
07
CMG
36.9x
37x
22x
26x
67x
22.5x
28x
13x
15x
42x
Hold
RRGB
29.6x
46x
16x
10x
18x
23.5x
48x
17x
11x
13x
Buy
PNRA
24.6x
28x
25x
24x
20x
13.6x
18x
13x
14x
12x
Buy
SBUX
22.1x
26x
36x
22x
22x
14.6x
17x
30x
16x
15x
Hold
BWLD
20.1x
21x
24x
19x
21x
13.3x
16x
16x
12x
14x
Buy
PFCB
20.0x
24x
21x
18x
18x
15.3x
17x
13x
10x
12x
Hold
SONC
19.0x
24x
11x
12x
24x
13.3x
16x
10x
10x
15x
Hold
CAKE
18.5x
23x
19x
12x
24x
11.8x
14x
14x
10x
17x
Buy
YUM
18.3x
20x
16x
16x
23x
14.0x
15x
12x
12x
17x
Sell
THI
16.7x
20x
14x
6x
14x
10.4x
13x
9x
4x
10x
Buy
MCD
15.0x
17x
15x
17x
18x
11.0x
12x
11x
12x
14x
Sell
PZZA
13.3x
14x
12x
14x
21x
8.5x
10x
8x
10x
15x
Buy
CBRL
13.0x
15x
13x
7x
14x
9.8x
11x
11x
9x
11x
Sell
Avg.
20.6x
24.2x
18.7x
15.6x
23.3x
14.0x
18.0x
13.6x
11.2x
16.0x
Click to enlarge
The restaurants with the fastest comparable sales growth rates (CMG, PNRA, SBUX) have earned the widest P/E premium over the group. (Multiples for RRGB should be considered outliers, given their depressed current earnings levels.)
My recommendations are generally biased in favor of the smaller capitalization names (RRGB, BWLD, CAKE), lower value (PZZA), or a unique competitive advantage that offers sustainable organic growth (THI, PNRA).



Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.