If you’re looking for tasty returns in 2018 -- and why wouldn't you -- plenty of discounted restaurant stocks should be on your menu.
On Monday, on the heels of the Senate Republicans passing a bill overhauling the federal tax code, known as the "Tax Cuts and Jobs Act,” several analysts such as David Tarantino of Robert W. Baird issued bullish notes, touting the positive impact the tax cuts will have on the restaurant sector in 2018. Among the main catalyst the tax cuts will have is the increased funding for more M&A — something I mentioned on Monday.
This means, thanks to the recent federal tax overhaul, beaten up fast-casual names like Chipotle (CMG) (down 18.5% YTD), Zoes’s Kitchen (ZOES) (down 35% YTD), Cheesecake Factory (CAKE) (down 18% YTD) and El Pollo Loco (LOCO) (down 16% YTD) are poised to rebound. Take a look at the chart, courtesy of YCharts.
High labor costs, food inflation and tons of competition, among other things, have presented headwinds for the restaurant sector. All of these things have made it virtually impossible to maintain high profit margins. Even Starbucks (SBUX), which has done a slightly better job than its peers, has posted 2017 returns of only 5%. While that would be respectable in any other year, it lacks a caffeine-like jolt when compared to the 18% returns of the S&P 500 index.
It’s for these reasons restaurant and leisure ETFs such as the PowerShares Dynamic Food & Beverage ETF (PBJ) and the PowerShares Dynamic Leisure & Entertainment (PEJ) have also underperformed the S&P 500. But that’s all about to change if these recent Wall Street bullish notes proves true. And it’s even more significant for restaurant stocks since the sector’s only means of survival has been M&A.
Last week’s proposed takeover of Arby's by Buffalo Wild Wings (BWLD), backed by Roark Capital, was the most recent example. In the cases where M&A isn’t possible, individual names like Panera Bread, earlier this year, have been taken private. It would seem investors have already begun to connect these dots.
All told, on Monday about 90% of restaurant stocks, sporting a market cap of over $50 million, closed in positive territory for the day. The aforementioned Chipotle, Zoes’s Kitchen, Cheesecake Factory and El Pollo Loco ended the day up 2.6%, 3.4%, 3.19% and 3.62%, respectively. Because of these gains, the PowerShares Dynamic Food & Beverage ETF is now in positive territory for the year, up 1.58%.
Meanwhile, restaurant names that have been forced to go it alone, without the benefit of M&A, will be on the radar of several larger names that now have extra cash or private equity investors looking to extract value.
In either scenario, food is now in play. And in 2018, restaurants are poised to keep those who are hungry for profits well fed.