Top 3 Restaurant Stocks to Buy Despite Industry Woes

The Zacks Retail – Restaurants industry’s performance continues to be impacted by high wages and food cost inflation. However, rapid increases in menu prices, average check growth and expansion efforts bode well. Industry participants also benefit from partnerships with delivery channels and digital platforms. Sales have steadily risen, which is a good sign for the industry. Stocks like Yum China Holdings, Inc. YUMC, Shake Shack Inc. SHAK and Brinker International, Inc. EAT are well-poised to benefit from the aforementioned factors.

Industry Description

The Zacks Retail – Restaurants industry comprises several owners and operators of casual, upscale casual, fine dining, full-service and fast-casual restaurants. Some industry participants operate as roasters, marketers and retailers of specialty coffee. Some companies develop, operate and franchise quick-service restaurants worldwide. A few restaurant operators offer cooked-to-order dishes, which include noodles and pasta, soups, salads and appetizers. Some industry players develop, own, operate, manage and license restaurants and lounges worldwide. A few companies also operate technology-enabled Japanese restaurants in the United States and provide Japanese cuisine through a revolving sushi service model.

4 Trends Shaping the Future of the Restaurant Industry

Traffic Woes & High Costs Linger: The restaurant industry has been facing declining traffic for quite some time. A rapid increase in menu prices is the primary reason behind traffic erosion. Restaurant operators are grappling with the high cost of operations. Intense competition, high wages and food cost inflation are a concern. The industry continues bearing increased expenses, which have been affecting margins. Higher pre-opening costs, marketing expenses and costs related to sales-boosting initiatives are exerting pressure on the company’s margins.

Sales Continue to Increase: Despite inflationary pressures, sales at U.S. restaurants continue to rise, fueled by a growing number of Americans opting to dine out. According to the Commerce Department, sales at food services and drinking establishments increased 6.3% year over year. Most restaurant operators are also gaining from implementing ghost or virtual kitchens. The idea of providing off-premise offerings and a connected curbside service is steadily garnering positive customer feedback.

Digitalization to Drive Growth: Restaurant operators’ focus on digital innovation, sales-building initiatives and cost-saving efforts has been a catalyst. With the growing influence of the Internet, digital innovation is the need of the hour. Restaurant operators constantly partner with delivery channels and digital platforms to drive incremental sales. Partnerships with delivery channels like DoorDash, Grubhub, Postmates and Uber Eats and the rollout of self-service kiosks and loyalty programs continue to drive growth. Restaurant operators focus on driverless delivery systems to augment sales amid the coronavirus crisis.

Off-Premise Sales Acting as a Key Catalyst: The industry is gaining from the increase in off-premise sales, which primarily include delivery, takeout, drive-thru, catering, meal kits and off-site options such as kiosks and food trucks. Most restaurant operators have initiated the testing of ghost or virtual kitchens. The idea of providing off-premise offerings and a connected curbside service has been garnering positive customer feedback.

Zacks Industry Rank Indicates Dismal Prospects

The Zacks Gaming industry is grouped within the broader Retail-Wholesale sector. It carries a Zacks Industry Rank #158, which places it in the bottom 37% of more than 252 Zacks industries.

The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates dull near-term prospects. Our research shows that the top 50% of the Zacks-ranked industries outperform the bottom 50% by a factor of more than 2 to 1.

The industry’s position in the bottom 50% of the Zacks-ranked industries results from a negative earnings outlook for the constituent companies in aggregate. Looking at the aggregate earnings estimate revisions, analysts are gradually losing confidence in this group’s earnings growth potential. Since Jan 31, 2024, the industry’s earnings estimate for the current year has decreased by 0.4%.

Before we present a few stocks that you may want to consider for your portfolio, let’s take a look at the industry’s recent stock-market performance and valuation picture.

Industry Underperforms the S&P 500 & Sector

The Zacks Retail – Restaurants industry has underperformed the Zacks S&P 500 composite and its sector over the past year.

Over this period, the industry has increased 6.9%, compared with the Zacks S&P 500 composite’s gain of 29.4%. The sector has increased 33.8%.

One-Year Price Performance

Restaurant Industry's Valuation

Based on the forward 12-month P/E, a commonly used multiple for valuing restaurant stocks, the industry is currently trading at 23.48X compared with the S&P 500’s 20.92X. It is marginally above the sector’s forward 12-month P/E ratio of 20.44X.

Over the last five years, the industry has traded as high as 34.68X and as low as 21.7X, with the median being at 25.15X.

3 Key Restaurant Picks

Yum China: The company is benefiting from menu innovation, unit expansion and digitalization efforts. Also, collaborations with prominent eCommerce and social media platforms have extended the brand's reach beyond physical outlets, facilitating the acquisition of new customers and cost-effective promotional strategies.

YUMC carries a Zacks Rank #2 (Buy). Yum China sales and earnings for the fiscal 2024 are anticipated to improve 8.7% and 9.5% year over year, respectively. In the past year, shares of the company have decreased 31.2%. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Price and Consensus: YUMC

Shake Shack: The company is benefiting from digital marketing strategies, strong Same-Shack sales and unit expansion efforts. It plans to open nearly 40 company-operated openings and 40 licensed Shack during the fiscal 2024. The company’s digital retention continues to remain strong. It has also been making more investments in digitization to sustain its digital guest enhancement strategies in the near term.

SHAK carries a Zacks Rank #2. Shake Shack earnings for fiscal 2024 are anticipated to improve 91.9%. In the past 30 days, the consensus mark for 2024 earnings has been revised upward by 51.1%.

Price and Consensus: SHAK

Brinker International: The company is notably benefiting from improved menu pricing and a favorable menu item mix. Margins expanded on the back of sales leverage, menu pricing, favorable commodity mix, lower delivery and off-premise supplies.

Shares of this Zacks Rank #2 company gained 23.7% in the past year. EAT’s sales and earnings for fiscal 2024 are anticipated to rise 4.9% and 30.4%, year over year, respectively.

Price and Consensus: EAT

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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