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I read an excellent blogpost by Bruce Krasting Saturday on rising gas prices. I think the risk of rapidly rising gas prices is not reflected in the markets. I believe some consumer discretionary stocks will take significant hits if gas prices hit $4.50 or $5 a gallon. Consumers have been bolstered over the winter by mild temperatures and low fuel oil and natural gas prices. As we push into spring, those tailwinds will recede, and the marginal consumer will be hit hard by rising costs to fill up the tank. I also think restaurants will be hit by rising food costs, and they could possibly take a margin hit as Obamacare is implemented. Here are two restaurant stocks I would avoid based on current valuations.

Chipotle Mexican Grill (NYSE:CMG) - "Chipotle Mexican Grill, Inc. develops and operates fast-casual, fresh Mexican food restaurants in the United States, Canada, and England. Its restaurants primarily offer burritos, tacos, burrito bowls, and salads. As of December 31, 2011, it operated 1,230 restaurants, which includes 1 ShopHouse Southeast Asian Kitchen" (Business Description from Yahoo Finance).

4 additional reasons to avoid CMG at $387 a share.

  • The company has done a marvelous job in adding restaurants and growing sales at existing restaurants. However, the stock now sells at just under 36 times forward earnings and priced at more than 2 times projected growth (2.08 projected five year PEG).
  • Revenue growth is expected to slow from 21% in FY2012 to 17% in FY2013 as the laws of large numbers come into effect. It should also start to encounter more competition in the space such as from Baja Fresh.
  • Insiders have taken advantage of the recent run up in the stock by selling over 10% of their shares since the first of the year.
  • Earnings estimates for FY2013 have actually decreased over the last month even as the shares have significantly appreciated.

Starbucks (NASDAQ:SBUX) - "Starbucks Corporation purchases and roasts whole bean coffees. It operates 6,705 company-operated stores and 4,082 licensed stores in the United States; and 2,326 company-operated stores and 3,890 licensed stores in Canada, the U.K., China, Germany, Thailand, and internationally. The company provides regular and decaffeinated coffee beverages, Italian-style espresso beverages, cold blended beverages, iced shaken refreshment beverages, premium teas, packaged roasted whole bean coffees, and soluble coffees." (Business Description from Yahoo Finance).

4 additional reasons to avoid SBUX for now at $48 a share.

  • The stock is selling near the top end of its five year valuation range based on P/B, P/E, P/S and P/CF.
  • An investor is paying over 21 times forward earnings for a company that grown earnings at a 16% annual clip over the past five years. Given Starbucks huge store base, replicating that growth rate over the next five years could prove very difficult.
  • Insiders have sold over $50mm in shares during the last three months.
  • Operating cash flow only went up approximately 20% from FY2009 to FY2011. Net income more than tripled in same time period.

I personally like both Chipotle's and Starbucks' products. In fact, I go to Starbucks on a daily basis (mainly for the wi-fi). I just believe the stocks are overvalued and due for a breather, and their tailwinds are about to increase. The marginal consumer buying $4 lattes and $8 burritos will be affected if gas prices hit $4 or $5 a gallon.

A good way to play the increase in gas prices is to invest in railroad stocks, which should steal market share from the truckers as gas prices cut into their margins. This should help lessen the impact from decreased coal traffic as well, which has impacted many railroad stock prices. Two stocks I like here in that space are Norfolk Southern (NYSE:NSC) and CSX (NYSE:CSX) as noted in this previous article.

Source: Rising Gas Prices Will Put Ceiling On These 2 Restaurant Stocks