Inflation appears to be increasingly accelerating in recent months, especially in the “non-core” areas of food and energy. Given our current monetary and fiscal policies - and continued growth in the emerging markets - this is a trend that bears watching as it could be with us for quite a while. It is also already showing up in the earnings reports and statements of firms from Walmart (WMT) to McDonald's (MCD).
Specifically higher food, energy, and to some extent labor costs (on the benefit side) could negatively impact the profit margins of restaurants given the percentage of operating costs those three items make up. In addition, restaurants could be impacted by a continued drop in consumer sentiment.
Quite a few restaurants have had a very good run over the last twelve months, but I think they are due for a pullback over the summer months. Here are three that look particularly vulnerable based on valuation.
- BJ’s Restaurants (BJRI) – BJ’s Restaurants, Inc. owns and operates casual dining restaurants in the United States. The company operates restaurants under the BJ’s Restaurant & Brewery brand name, which includes a brewery within the restaurant; BJ’s Restaurant & Brewhouse brand name that receives the beer it sells from one of its breweries or an approved contract brewer of its proprietary recipe beers; and BJ’s Pizza & Grill brand name, which is a smaller format, full service restaurant. BJ’s sells at 46 times this year’s earnings, and over 40 times next year’s earnings. It has more than doubled off its 52 week look, insiders have sold approximately $20mm in shares over last six months, and operating cash flow did not keep pace with net income growth from fiscal year 2009 to fiscal year 2010. BJRI took a 30% hit in the energy price run up in the first half of 2008.
- Chipotle Mexican Grill (CMG) - Chipotle Mexican Grill, Inc. develops and operates fast-casual, fresh Mexican food restaurants in the United States. It also operates restaurants in Toronto, Canada and in London, the United Kingdom. It is selling at forty times this year’s earnings and 32.5 next year’s consensus earnings. It is selling at 4.5 yearly revenues, a PEG over 2, with revenue growth predicted to be the 17-18% range over the next two years. Operating cash flow has also not kept pace with net income growth over the last two fiscal years. Operating margin decreased by almost one full percent in the earnings report last week due to higher food and labor costs. Finally, the last time energy prices ran up so sharply in the first seven months of 2008; CMG lost 53% of its value.
- Panera Bread (PNRA) - Panera Bread Company, together with its subsidiaries, owns, operates, and franchises retail bakery-cafes in the United States. Its retail products include baked goods, soups, salads, custom roasted coffees, cafe beverages, and other complementary products. PNRA is selling at just under 28 times this year’s expected earnings and approximately 24 times 2012’s consensus. Insiders have sold over 20% of their shares in last six months. Panera could be vulnerable as consumers could trade down to the “Subways” of the world if gas prices continue to rise and/or consumer sentiment drops further. Panera looks stretched here as it is trading at the high end of its 5 year valuation range based on a P/E, P/S, P/CF, and Price/Book basis.