By: Jeff Pollock
June
8, 2017

Fewer are dining out, though you wouldn’t know it by solely looking at several of the restaurant stock charts. Last year, Americans made 433 million fewer trips to restaurants when compared to the year before. This represents a 2 percent drop in traffic in the US while Canada observed flat growth during the year.

There’s several reasons for the decline, some transitory but others secular.

In recent years, eating out has become increasingly more expensive. Along with the higher labour expenses brought about from changes to minimum wage levels, many restaurants increased their menu prices in order to protect margins. Beyond mere expense, as the brick-and-mortar retail environment continues to erode, fewer consumers are shopping at the stores and malls that once accompanied a restaurant visit. Furthermore, because of the contraction in commodity prices as well as intense competition between grocers, prices at the grocery store have become more favourable in recent years.

Based on its poor underlying fundamentals, several restaurant companies are nevertheless overvalued.

Apart from Darden Restaurants, which owns the Olive Garden and LongHorn Steakhouse, annual revenue growth isn’t expected to surpass 4% in 2018 for any of the companies listed below. Despite these poor top line expectations, the market surprisingly continues to pay lofty high-teen to low-twenty multiples for the industry. On a PEG ratio measure, computed by dividing the price-to-earnings metric by the earnings growth rate, Cracker Barrel, Ruth’s Hospitality, and Cara Operations (Swiss Chalet, Milestones, Montana’s) continue to look expensive.

Our clients lack exposure to the restaurant industry. While we are stock pickers that allow our analysis of the financial statements to guide our investment decisions, the macroeconomic environment for the industry is unlikely to recover any time soon. Until we see either signs of improvement or more appealing valuations, better ideas exist elsewhere.

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