The U.S. restaurant space, which thrives primarily on consumer spending, stands to rake in handsome gains backed by steady rise in wages, lower unemployment and upbeat consumer confidence. Federal Reserve's latest forecast calls for economic growth of 2.8% for 2018 which is likely to drive the industry's growth.
Given that the demand in the industry is relatively elastic, restaurant operators are continuously trying to strategize and retain their competitive positions. Further, with the growing clout of internet, digital innovation has become the need of the hour. Restaurant operators are continuously partnering with delivery channels and digital platforms to drive incremental sales. We believe that such efforts will continue to benefit the industry.
However, the restaurant giants are plagued with high costs of operation. Further, sales-building efforts such as promotional activities and a convincing pricing strategy are detrimental to the industry operators' margins. Apart from this, competition, high wage expenses and food cost inflation remain as concerns.
Industry Lags on Shareholder Returns
The restaurant industry has been witnessing declining comps through most of 2017. Even after delivering positive comps since the fourth quarter of 2017, the industry reveals a mixed bag when it comes to growth trend. After recording its highest growth in comps during April, the industry witnessed flat comps during May. Further, in June and July, restaurant comps inched up 1.1% and 0.5%, respectively.
Looking at shareholder returns over the past year, it is apparent that investors are not particularly confident about the industry's growth trajectory. As it is, the industry is highly dependent on the overall business cycle and recent tariff concerns are likely to affect consumer demand.
While stocks in this industry have collectively lost 7.2%, the Zacks S&P 500 Composite and Zacks Retail-Wholesale Sector have rallied 18.7% and 32.3%, respectively.
One Year Price Performance
One might get a good sense of the industry's relative valuation by looking at its price-to-earnings ratio (P/E), which essentially shows how much an investor is willing to pay for each unit of earnings. Typically, a lower P/E ratio is better, though the interpretation is not so simple for cyclical industries, like this one.
Valuation of the restaurant space doesn't look rational when compared with the market at large, as the forward 12-month P/E ratio for the S&P 500 is 18.78X while the industry is currently trading at 22.66X. Further, industry's valuation looks fair compared with its own range. The industry's current forward 12-month P/E ratio is higher than its median level scaled over the past year. When compared with the one-year high of 26.22X, there is still upside potential left.
Forward Price/Earnings Ratio Compared With S&P 500
However, comparison with the broader sector ensures that the group is trading at a decent discount as the sector is currently trading at 27.4X.
Does Earnings Projection Look Favorable For The Industry?
The most pressing concern at the moment is the persistent erosion in traffic plaguing the restaurant operators. Notably, same store traffic was down 2% in the second quarter of 2018, proving that it is only guest checks and not guest counts that are positively contributing to restaurant sales. Further, per the recent TDn2K's The Restaurant Industry Snapshot, same-store traffic in the month of July declined 1.8%.
As it is, what really matters to investors is whether this group has the potential to perform better than the broader market in the quarters ahead. While the above ratio analysis shows that there is a fairly value-oriented path ahead, one should look for convincing factors raising chances of a rebound in the near term.
One reliable measure that can help investors understand the industry's prospects for a solid price performance is the earnings outlook for its member companies. Empirical research shows that a company's earnings outlook significantly influences the performance of its stock.
One could get a good sense of a company's earnings outlook by comparing the consensus earnings expectation for the current financial year with the last year's reported number, but an effective measure could be the magnitude and direction of the recent change in earnings estimates.
The Price & Consensus chart for the industry shows the market's evolving bottom-up earnings expectations for the industry and the industry's aggregate stock market performance. The red line in the chart represents the Zacks measure of consensus earnings expectations for 2019, while the light blue line shows the same for 2018.
Price and Consensus: Restaurant Industry
This becomes clearer by focusing on the aggregate bottom-up EPS revisions trend. The chart below shows the evolution of aggregate consensus expectations for 2018.
Please note that the $3.06 EPS estimate for the industry for 2018 is not the actual bottom-up dollar EPS estimate for every company in the Zacks Retail-Restaurants industry, but rather an illustrative aggregate number created by our proprietary analytics model. The key factor to keep in mind is not the earnings per share of the industry for 2018, but how this number has evolved recently.
Current Fiscal Year EPS Estimate Revision
As you can see here, the EPS estimate for 2018 is down from $3.11 at the end of May 2018 and $3.12 at the end of January 2018. In other words, the sell-side analysts covering the companies in this Zacks industry have been slightly lowering their estimates.
Zacks Industry Rank Indicates Dim Prospects
Notably, undertaking efforts like increased promotions and technological advancements by restaurant giants come at the cost of poor margins. Moreover, rising wages remain as a primary hindrance for many players in the industry.
Notably, most restaurants reported that they are understaffed. With turnover rates escalating for both restaurant hourly employees and restaurant managers, a shortage of qualified skilled personnel has been hurting the restaurant operators.
Finally, recent data shows that there is an oversupply of restaurants in the United States, inducing fierce competition among operators. Rivalry is also rife from other sectors like grocery store prepared foods and convenience stores. Consequently, restaurants are cannibalizing each other's business, creating an aggressive competitive scenario.
These factors are also reflected in the group's Zacks Industry Rank , which is basically the average of the member stocks' Zacks Rank.
The Zacks Retail - Restaurants industry currently carries a Zacks Industry Rank #172, which places it in the bottom 33% of more than 250 Zacks industries. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.
Industry Promises Long-Term Growth
The long-term EPS (3-5 years) growth prospects for the industry look appealing when compared with the broader Zacks S&P 500 composite. The group's mean estimate of long-term EPS growth rate has been to reach the current level of 13.7%. This compares to 9.8% for the Zacks S&P 500 composite.
Mean Estimate of Long-Term EPS Growth Rate
In fact, the basis of this long-term EPS growth could be a steady top-line that the Zacks Leisure and Recreation Services industry has exhibited since 2017.
In the last issued Industry Snapshot by tdn2k, it can be seen that July marked modest growth in same store sales after spectacular improvement in April and May. Moreover, traffic has been declining raising concerns about the near-term fate of restaurant operators. Moreover, restaurants are highly susceptible to the inconsistent nature of consumer discretionary spending. If each of them does not make pragmatic use of advanced technologies to innovate across value chains, they have high chances of fading out.
Having said that, it is also notable how restaurant giants are thriving on innovation and large-scale digitization. Restaurant operators are continuously partnering with delivery channels and digital platforms to drive incremental sales. We believe that such efforts will benefit the industry in the long term.
Consequently, the restaurant space might not be able to tide over the broader challenges in the near term. So, it may not be a good idea to bet on this space right now. However, keeping the long-term expectations in mind, investors could take advantage of a few restaurant stocks that have been showing steady growth potentials.
Below are five stocks with positive earnings estimate revisions and a bullish Zacks Rank.
BJ's Restaurants, Inc. (BJRI), a leading full-service restaurant, sports a Zacks Rank #1 (Strong Buy). Earnings estimates for the current year have increased 6.5% over the past two months to $2.12. This suggests that earnings per share will improve 50.4% year over year in 2018.
Price and Consensus: BJRI
Darden Restaurants, Inc. (DRI) is a restaurant company featuring a portfolio of differentiated brands that include Olive Garden, LongHorn Steakhouse, Cheddar's Scratch Kitchen, Yard House, The Capital Grille, Seasons 52, Bahama Breeze and Eddie V's. Earnings estimates for the current year have moved up 0.4% over the past two months to $5.50, suggesting an increase of 14.4% from the prior year. Darden carries a Zacks Rank #2 (Buy). You can see the complete list of today's Zacks #1 Rank stocks here.
Price and Consensus: DRI
Dine Brands Global, Inc. (DIN) carries a Zacks Rank #2. The company operates and franchises under both the Applebee's Neighborhood Grill & Bar and IHOP brands. Over the past two months, earnings estimates for 2018 has moved up 2%. The Zacks Consensus Estimate for current year earnings is pegged at $5.21, reflecting year-over-year growth of 25.5%.
Price and Consensus: DIN
The famous steakhouse company, Ruth's Hospitality Group, Inc. (RUTH) carries a Zacks Rank #2. The consensus estimate for current year earnings is $1.39, suggesting growth of 26.4% from the year-ago level. Further, estimates have moved upward by 2.2% over the last 60 days, reflecting analysts' optimism surrounding the company's upside earnings potential.
Price and Consensus: RUTH
With over 800 restaurants, Carrols Restaurant Group, Inc. (TAST) is the largest BURGER KING franchisee in the United States. Earnings estimates for the current year have increased 5.9% over the past two months to 36 cents. This suggests that earnings per share will grow 80% year over year in 2018. The restaurant carries a Zacks Rank #2.
Price and Consensus: TAST
Best Electric Car Stock? You'll Never Guess It.
Zacks Research has released a report that may shock many investors. One stock stands out as the best way to invest in the surge to electric cars. And it's not the one you may think!
Much like petroleum 150 years ago, lithium battery power is set to shake the world, creating millionaires and reshaping geo-politics. Soon electric vehicles (EVs) may be cheaper than gas guzzlers. Some are already reaching 265 miles on a single charge. With battery prices plummeting and charging stations set to multiply, revenues that were already at $31 billion in 2016 are expected to blast to over $67 billion by the end of 2022.
Want the latest recommendations from Zacks Investment Research? Today, you can download 7 Best Stocks for the Next 30 Days. Click to get this free report
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.