The restaurant industry typically has razor-thin profit margins, but one analyst sees plenty of return potential in three popular chains. MKM Partners’ Brett Levy (a 3-star analyst according to Tip Ranks) initiated Buy ratings on Outback Steakhouse parent Bloomin’ Brands, McDonald’s, and Papa John’s Pizza. All have interesting stories behind them, and each presents a different case for investors. Levy lays out a clear bull case for each stock.
Bloomin’ Brands, Inc. (BLMN)
Best known for its chain of Outback Steakhouse restaurants (whose signature ‘Bloomin’ Onion’ dish gives the parent company its name), Bloomin’ recently beat its Q2 earnings expectations by 2.8%, reporting EPS of 75 cents. It was the fourth quarter in a row that BLMN had reported an earnings beat, although Levy notes that the company’s annual sales have been steady in the range of $3.5 to $4.5 billion for the past several years, and says, “Posting in-line results or even modest beats versus a long-term growth profile won't be enough to impress investors.”
Levy sees the company making the necessary changes, however, and positioning itself to improve those annual sales numbers. He writes, “Bloomin' Brands' top strategic priorities consists of improving sales through store remodels and relocation, enhanced menu through a focus on value, enhanced promotions, and superior in-store execution… At the same time the company is focusing on growing segments of the restaurant industry, including take-out growth, delivery expansion, and a new multi-branded loyalty program.”
In line with his approval of BLMN management’s forward plans, Levy started coverage on this stock with a Buy rating and a $20 price target. BLMN currently sells for $16.78 and has a 30% upside based on the $21 average price target. The stock’s Moderate Buy consensus rating is derived from 6 buys, 1 hold, and 1 sell assigned in the past three months. It is worth noting here that even Bloomin’s lowest price target, $18, implies an upside of 7%; even those analysts hedging their bets on the restaurant chain believe it has potential for growth.
McDonald’s Corporation (MCD)
The early innovator in the fast food industry has long been a staple of the stock market. And while founder Ray Kroc was notoriously close-fisted, the company has a history of generously rewarding investors. The stock has shown consistent gains over the last three years, is up 23% year-to-date, and the dividend, while yielding a modest 2.11%, pays out a lucrative $4.64 annually due to the high share price. It’s no wonder that Mickey Ds would draw the attention of a stock analyst opening coverage of the restaurant sector.
In his note on McDonald’s, Levy writes, “McDonald’s valuations continue to test new highs, but the company has continued to produce strong and consistent results, outpacing other highly franchised global concepts. We believe the combination of strong domestic and international sales growth is sustainable and when coupled with strong cash flow generation and consistent returns to shareholders, is supportive of a premium valuation...”
McDonald’s is the strongest of the stocks in this article, with a Strong Buy from the analyst consensus, based on 17 buys and 5 holds given in the last three months. MCD shares are currently trading for $219, and have a 4.5% upside based on an average price target of $229. Levy’s price target, $250, suggests room for a substantially higher 13% upside.
Papa John’s International, Inc. (PZZA)
It’s no secret that Papa John’s Pizza has been hurting in the past year. From founder and now-former CEO John Schnatter’s mouthing-off problems, to basic issues like menu and product quality and franchisee relations, Papa John’s has faced a series of challenges that have impacted the bottom line. To underline the trouble, starting in Q3 of last year the company reported three quarterly losses in a row.
That is starting to change with Q2, as PZZA has just reported its first quarterly profit in a year. The $8.4 million in net gains for the quarter was less than Q2 2018, but still a dramatic improvement from losses, and the 28 cent adjusted EPS was a welcome boon for investors. The company’s new CEO, Steve Ritchie, described Q2 as, “our third quarter of sequential improvement…” and said of the turnaround efforts, “I’m not going to say that we are out of the woods. But the franchisees do have confidence that we have a strong brand and new leaders.”
Analyst Levy, in examining PZZA, noted three key points in the company’s strategy: “Greater value focus and new marketing initiatives [they have taken on Shaquille O’Neal as brand ambassador]; Fostering a better relationship with franchisees, including financial assistance; and, Bringing new operational and strategic talent, including the recent appointment of activist investor and Starboard Value CEO Jeff Smith as chairman.”
He goes on to say, “Papa John's is implementing a return to basics, back to its ‘Better Ingredients, Better Pizza (BIBP)’ motto, but a turnaround is never easy... The case for buying Papa John's isn't made solely on easy comparisons from recent operating struggles. Rather, a new collaborative approach across the entire company and a willingness to bring new products and ideas could potentially result in a fundamentally led stock performance recovery.” PZZA gets a Buy rating from Levy, who quips that, in the pizza business, “it’s better to be early than late.” His price target of $55 indicates confidence in a 21% upside.
Overall, Papa John’s has a Moderate Buy rating based on an even split – 3 buys and 3 holds given in the last three months. The stock sells for $45, and the average price target matches Levy’s at $55.
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