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Restaurant stocks stay sluggish, but profit multiples remain rich

FILE - In this Friday, Oct. 4, 2013, file photo, a McDonald's restaurant sign is seen at a McDonald's restaurant in Chicago. The company reports quarterly earnings. McDonald's said Monday, Dec. 9, 2013, that a key sales figure rose 0.5 percent in November, even as the world's biggest hamburger chain faced tough competition and basically flat traffic in the U.S. (AP Photo/Nam Y. Huh)

The restaurant stocks that trounced the market last year are continuing to struggle halfway through 2014 as the food frenzy, unstoppable mere months ago, has slowed both on menus and in investor portfolios. And more weakness may be looming if upcoming profit reports don't impress investors.

As of July 14, a group of 42 restaurants surveyed by Yahoo Finance had a loss of 2.8% since the close of trading Dec. 31. That's nearly identical to the end of the first quarter, when the decline for the same stocks was 2.6%. What has changed is the market overall, and how much it's left these stocks behind. Through the first quarter, the S&P 500 was up 1.6%, but that's now risen to a gain of 6.5% year to date, giving the index a 9.3-percentage point lead over the group. In March, it had a 4.2-point advantage.

This is particularly notable for the restaurants because they've been tremendous since 2009, the year after the financial crisis, topping the market every time despite flat or even declining guest counts and stagnant revenue at many chains. Strong traffic at fast casuals such as Chipotle (CMG) has made them operational standouts, but finding a money-making stock had gotten extremely easy, regardless of its fare.

Not now. Last year 40 stocks surveyed rose an average of 54.1%, easily surpassing the S&P's 29.6% gain. Only three in the group fell, as growth-stock buyers sought expanding companies capable of outpacing the already strong market. Food buzz (cronuts, ramen noodles, craft burgers) and IPO talk simultaneously kept the restaurants in the headlines with regularity.

In the first quarter, however, fewer than half -- 18 out of 42 tracked -- were positive. At the moment, the number is the same, though four names have changed columns. In total, 23 have improved from where they stood at the end of March, either by adding to the gain they already had or seeing their losses narrowed.

New direction

The biggest turnaround belongs to BJ's Restaurants (BJRI), one of 2013's downtrodden trio, which has gone from a 4.4% decrease to an 11.1% rise, bolstered by a deal with activist investors to restructure the board of directors, along with an upbeat earnings report. Another reversal is Starbucks (SBUX), up more than 10 percentage points from where it finished the first quarter. With that, it's erased the loss from January through March, and currently stands positive by 0.6%.


On the other side, Chuy's (CHUY) 8.3% first-quarter advance has become a 17.8% drop as of this week. Papa John's (PZZA) rose 6.5% in the first three months of the year, but now it's got a 7.5% loss. The worst stock of all in the first quarter is still at the bottom of the pack. That would be Potbelly (PBPB), whose 30% slump in the first quarter has become a 53% drop, influenced heavily by a steep selloff last Thursday on word that second-quarter sales were weak.

It certainly made sense that the industry's advance would mitigate this year, but the degree of it is something of a surprise, especially considering the S&P continues to climb.

Earnings near

What may be next? Valuations, measured by price-to-earnings ratios for the next 12 months, had gotten stretched amid the ongoing rally in these stocks. As of March 31, the forward multiple on the restaurant shares was 27.2, ahead of what, at the time, was a five-year average of 22. That's normalized a bit, with a reading of 24.5 vs. the current five-year average of 21.8. As a result, the premium to the average has fallen to 2.7 points from 5.2 points at the end of March.

Only seven stocks now have a higher P/E than they did three months ago -- McDonald's (MCD), Yum Brands (YUM) and Starbucks among them.

In isolation, these levels might not determine the buying and selling decisions for the restaurant stocks in the weeks ahead, but they will be an influence, because earnings season is right around the corner. In the first quarter, restaurants and retailers in general complained repeatedly that winter snows had kept their customers away, denting their financial results. Whether they got passes or not back then, that excuse is gone, meaning operational missteps had better have a very good reason behind them this time.

Otherwise, if results are bleak, those prices still have room to drop.