Today's Market: Restaurant Names That Still Look Like Buys

Includes: CAKE, DIN, DRI, MCD, YUM
by: Matthew Smith

Yesterday's Federal Reserve action pleased all parties involved and paves the way for an organized end to the quantitative easing bond purchases. The fixed income guys liked the move, equity investors liked the move and most importantly the overall market approved. The Fed's decision appeased everyone and also threw all parties involved a bone; no one was a loser yesterday.

With the Fed signaling that they are still on board to continue assisting the market with low interest rates it appears that the current market environment will continue. That indicates to us that we shall see further economic gains, even with the disappointing jobs numbers today, and possibly further outperformance in the restaurant industry.

Chart of the Day:

With interest rates still being controlled by the Fed and not rallying too hard after yesterday's announcement we think that the consumer shall continue to see improving family balance sheets and build up savings to spend later on. This is bullish for the economy but also for the restaurant chains.

(Click to enlarge)

Source: Yahoo Finance

We have economic news today and it is as follows:

  • Initial Claims (8:30 a.m. EST): Est: 333k Actual: 379k
  • Continuing Claims (8:30 a.m. EST): Est: 2760k Actual: 2884k
  • Existing Home Sales (10:00 a.m. EST): Est: 5.00M Actual:
  • Philadelphia Fed (10:00 a.m. EST): Est: 5.0 Actual:
  • Leading Indicators (10:00 a.m. EST): Est: 0.6% Actual:
  • Natural Gas Inventories (10:30 a.m. EST): Est: N/A

Asian markets finished mostly higher today:

  • All Ordinaries -- up 2.08%
  • Shanghai Composite -- down 0.95%
  • Nikkei 225 -- up 1.74%
  • NZSE 50 -- UNCH
  • Seoul Composite -- up 0.05%

In Europe, markets are trading higher this morning:

  • CAC 40 -- up 0.89%
  • DAX -- up 0.90%
  • FTSE 100 -- up 0.78%
  • OSE -- up 1.31%


Early on in the recovery we were quite bullish of the restaurant group, putting investors into the sector at just the right time. The rotation back into those names followed and most of the early gains were investors anticipating a turnaround rather than an actual turnaround in those individual companies' operations. One name which has troubled us during this bull market run has been Darden Restaurants (NYSE:DRI) which has been unable to get its two main brands to perform well together. When Red Lobster has done well investors watched as Olive Garden floundered, and when Red Lobster was performing poorly it was Olive Garden performing better. Most importantly though one has to point out that even when one of the two brands was performing strongly, it was still lagging peers and sometimes not even showing growth.

The situation at Darden Restaurants has gotten so bad that now the company is looking at separating the Red Lobster brand from the rest of the restaurant group. Darden is also looking at ways to increase profitability and margins and it appears that the company is set to cut capital expenditures as well as restaurant purchases. The goal is to increase cash flow and create an environment for increased dividends and share repurchase programs. This is obviously a win for Barington Capital Group, the activist investors who owns roughly 2% of Darden shares and has been agitating for change in recent months.

We think that initially this move will create value for shareholders, but longer-term it will ultimately cause more problems. Not investing in restaurants and growing the brands under the company's umbrella will eventually catch up with the company and after the initial gains in free cash flow are realized it will be quite difficult for the new Darden to ramp up again.

Other names in the restaurant space which have run into operating issues are McDonald's (NYSE:MCD) and YUM! Brands (NYSE:YUM), both having been big winners for readers before their recent underperformance. These two names are not at all plagued by the issues at Darden, which does have a focus problem but more importantly a true disconnect with its customers. McDonald's has been aggressively reinvesting in its restaurants and menu and believes that once food inflation begins rising again that they will be able to post better results. It is clear that the company has disappointed investors, but McDonald's is not a name one wants to bet against - especially considering how poorly their competitors have performed in recent years. The company remains a compelling buy for those conservative investors looking for a solid dividend stream and potential capital gains.

We initially went bullish on Dine Equity in the $30-40/share range, and even after the spectacular run think that we could see further upside as the company continues to see improving finances and returns cash to shareholders.

(Click to enlarge)

Source: Yahoo Finance

Even though YUM! Brands has disappointed in recent quarters, it still falls under the same category as Dine Equity (NYSE:DIN), which owns Applebee's and IHOP. These two names are still buys in our book and we think that the companies will continue to find themselves in the top tier of restaurant companies when it comes to allocating their capital. YUM! was one of the restaurants which began selling its company owned sites in order to reinvest in its franchising business and overseas and has used the excess capital to repurchase shares and return cash to shareholders. Dine Equity followed suit and has been improving its balance sheet while also rewarding shareholders, all of which has contributed to it outperforming the sector. With the company paying a $3.00/share dividend and yielding 3.6%, we like the name as both a play on growing consumer spending as well as a dividend name.

The stock had been dead money in 2012, but this year moved to the upside. We think that an improving economy could create an environment where the shares could outperform in 2014.

(Click to enlarge)

Source: Yahoo Finance

Looking forward our opinion is that the name that might provide the most upside based on an improving economy and increased spending by the consumer is The Cheesecake Factory (NASDAQ:CAKE) which has been seeing same store sales increase for almost four years now. The portions are big and the menu can be overwhelming, but as consumers begin to have more disposable income they will want to once again indulge and this leads us to believe that should these undercurrents begin to form in our economy that The Cheesecake Factory will see their operating results improve dramatically.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.