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Waitress??!! Where’s the Casual Dining Stock Rally We Ordered?

Dee Gill

Restaurants like Chili’s, Olive Garden and BJ’s Brewhouse thrive when the masses are working and feeling secure about their finances, so investors often pick up their shares early in economic recoveries. But you wouldn’t know it from their mixed performance lately. Share valuations for several casual diners have fallen just as strong economic data has taken the S&P 500 to record levels. Is there an underappreciated recovery play here?

Consider companies like Darden Restaurants (DRI), owner of Olive Garden, Red Lobster and LongHorn Steakhouse; BJ’s Restaurants (BJRI); and Chili’s and Maggiano’s owner Brinker International (EAT). Shares of each have underperformed the S&P 500 in the past six months, even as the news focus shifted from scary election predictions to jolly employment figures.

DRI Chart

There’s good reason for investor reluctance here. Darden has put out two profit warnings in the past four months, and Brinker issued one in February. BJ’s, a growing chain that was quite the darling of the sector in previous years, has seen profit margins narrow quickly. All of them are expecting negligible, if any, same-store sales gains for the current fiscal year.

In other words, those nice gains in housing starts and jobs have done little for these companies yet. That would seem to make now a good time for investors to buy in, ahead of stronger economic gains that usually boost their profits. A couple of issues, however, make that bet more problematic this time.

Despite investor confidence, consumers have been slow to buy into economic recovery. Higher payroll taxes (2% higher as of Jan. 1) and gasoline prices (up 12% since Jan. 1) have cut into discretionary spending. A Reuters consumer poll earlier this month found two-thirds expected to spend less this year, not more, and restaurant meals were the first expense to go.

This dining niche is particularly vulnerable to household budget tightening. National Restaurant News reported a significant drop in sales of premium entrees at restaurants after the beginning of the year. Cheaper versions of their other meals at places like Chipotle Mexican Grill (CMG) and Panera Bread Co. (PNRA) have hurt badly. Shares of Chipotle and Panera lost steam in recent months after rising to very high valuations. But profits at both companies gained more than 20% in the past four quarters, which is quite a contrast to the others.

DRI Net Income TTM Chart

Yet each of those depressed casual diners has proven to be a more than decent long-term investment in and out of tough economic times. Five year returns ranged from Darden’s 62% to BJ’s 144%, compared to the S&P 500’s 18%. The chart below shows their significant 10-year total returns. If management decisions are as good during this current economic transition, one could reasonably expect their share prices to rise when more people can go out for (very high margin) drinks after a job.

DRI Total Return Price Chart

Which one stands to gain most? As the smallest and youngest, BJ’s has growth potential through new restaurant openings. But that profit margin problem, paired with a PE ratio that remains nearly 10 points above the others, puts off many investors. Darden’s earnings misses have done the same, and its profits are expected to decline some 12% this fiscal year. But its 4.2% dividend yield beats Brinker’s 2.2%. (BJ’s doesn’t pay one.) Brinker has attracted buy recommendations from many analysts in recent months. They expect the company’s earnings to grow some 17% this fiscal year (which ends one month later than the others).

Of course, the basic assumption here is that there really is a long-term economic recovery underway. Some question that. By the looks of market lately, many, many investors are firm believers.

Dee Gill, a senior contributing editor at YCharts, is a former foreign correspondent for AP-Dow Jones News in London, where she covered the U.K. equities market and economic indicators. She has written for The New York Times, The Wall Street Journal, The Economist and Time magazine. She can be reached at editor@ycharts.com.

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