Investors Lose Appetite for Restaurant Stocks as Rally Fadesby
Leaders become laggards as El Pollo Loco and Noodles hit lows
Weakness for restaurant chains follows slump in retail stocks
Restaurant stocks are facing lean times after a six-year runup.
After shares of eateries such as Domino’s Pizza Inc., Kona Grill Inc., Ruth’s Hospitality Group Inc. and Popeyes Louisiana Kitchen Inc. soared more than 1,000 percent, the industry is facing its first annual loss since 2008. Some of the leaders are now laggards, as more than 20 restaurant stocks have slumped at least 10 percent in 2015, while El Pollo Loco Holdings Inc. and Noodles & Co. are among those that hit all-time lows within the past month.
The selloff comes amid a pocket of weakness within the consumer-discretionary industry and follows a recent decline for many retailers. Investors who’ve made healthy returns on restaurant stocks may be moving on to chase gains elsewhere amid a broader sector rotation within the market, according to Tom Lee of Fundstrat Advisors LLC in New York.
“In 2016, I do think there’s a broader trend that investors are going to start to look more closely at laggards, and restaurants have been one of the leaders for the last few years,” said Lee, head equity strategist at Fundstrat.
The selloff in restaurant stocks has been broadbased, ranging from low-priced, quick-service chains to high-end steakhouses, and has intensified in the past four months. Since July 31, the Bloomberg U.S. Full-Service Restaurant Index has tumbled 19 percent while the Bloomberg U.S. Limited-Service Restaurant Index is down almost 11 percent. The full-service group rose 1.5 percent as of 9:49 a.m. in New York, while the limited-service index was up 1.4 percent.
Even if fundamentals haven’t deteriorated significantly, with many companies reporting positive sales trends while broader retail sales data remain positive, that may not matter as much to investors, Lee said. After six years of betting on the U.S. consumer, Lee downgraded the consumer-discretionary sector to a neutral recommendation on Nov. 13, primarily because wage pressures could start to compress margins.
“Restaurants are one of the most labor-intensive groups in the S&P 500. It gives them some vulnerability on margin pressure when wages and labor inflation start to take root,” Lee said. Wages rose 0.6 percent in October, the biggest gain in five months, while incomes accelerated to 0.4 percent from 0.2 percent the prior month, according to figures from the Commerce Department.
After so many good years for restaurant stocks, they’ve become “a victim of their own success,” said Larry Miller, founder of MillerPulse.com in Atlanta, which provides an industry performance benchmarking service. “Now, most companies and the industry in general are lapping some really difficult comparisons.”
As a result, investors may be bracing for slower or declining sales ahead and have a hard time justifying increased valuations, said Miller, a former analyst. In addition, data he collects show that consumers’ visits to restaurants have been about flat compared with 2014 and that they’re spending “a little less,” on average, when they’re out, he said.
This year has been better than expected for the industry, but still somewhat counters other figures that show Americans are financially in “decent shape” as job gains, income growth and confidence measures have held up, Miller said. As a result, the selloff in restaurant stocks isn’t necessarily a harbinger of broader consumer weakness but rather indicative of how investors’ expectations have tempered.
Shares of Bravo Brio Restaurant Group Inc. tumbled 13 percent on Nov. 6, the most in three years, after the company trimmed its guidance for fiscal 2015 sales, even though its third-quarter earnings and revenue beat median analysts’ estimates.
Shake Shack Inc., which soared 342 percent within four months of going public in January, has fallen each day following its three most-recent quarterly reports even as sales and earnings beat estimates. Bearish bets on the chain peaked at 24 percent of shares outstanding on Nov. 9 and currently sit at 18 percent, according to data compiled by Bloomberg and Markit Ltd. Similarly, short interest for Habit Restaurants Inc., which went public in late 2014, spiked at almost 44 percent last week.
For Lee, a six-year bullish outlook on consumer stocks was justified by the group’s return on equity, along with contained wage pressures and lower commodity costs. With those tailwinds “nearing an end” it was time to look for bigger gains elsewhere -- and in his case in energy.
“The risk-reward just changes,” Lee said.