Inside Wall Street: This Trio of Restaurant Stocks Look Tempting

Gene Marcial's Inside Wall Street
Gene Marcial's Inside Wall Street

The New Year brings new hope to the restaurant industry, which suffered heavily during the harsh, eat-at-home recession. As a result, the number of restaurants have dwindled nationwide. Some 11,000 closed during the downturn, bringing the eatery count to lows last seen in 1986. And with construction of new restaurants continuing to crawl, supply will be constrained for the next two to three years, according to estimates by analysts at Goldman Sachs (GS).

So to these investment pros, this clearly suggests that the restaurant industry is one of the best investment opportunities in this new year.

"We see the restaurant supply-demand dynamics as the most accommodative they have been in the past 25 years," says Goldman in a report on the industry. Goldman restaurant industry analysts Michael Kelter and Chris Cerrone note that restaurant sales are highly correlated with changes in nominal GDP. Economists' forecasts at Goldman suggest 10% to 15% restaurant growth over the next three years at a time of limited supply. So the surviving eateries should benefit with accelerated gains.

A "Fleeting" Setback

The industry's expected strength ahead would be among "the best investment opportunities today" because the restaurants experienced a temporary slowdown during the recession, argue the Goldman analysts. "Our analysis suggests these setbacks were cyclical and not secular, and as such they will likely prove fleeting."

So which of the restaurant companies get five-star billing as the sector's most appetizing? Here are the tree stocks that Goldman believes will outperform the rest of the pack in 2011:

  • Starbucks (SBUX), the world's No. 1 specialty coffee roaster and retailer, with more than 16,850 coffee shops in about 40 countries. Its stock is currently trading at $32, up from its 52-week low of $21.28.

  • Chipotle Mexican (CMG), owner and operator of 950 quick-and-casual eateries that are popular for their burritos, tacos and other Mexican dishes. Its shares are selling at a mighty $212 apiece, up from a low of $86.52 in January 2010. The stock hit a high of $262 in late November.

  • Tim Horton's (THI), Canada's leading quick-service restaurant chain with more than 3,500 coffee and donut shops north of the border and about a dozen in the U.S. Its stock is trading near its 52-week high at $41 a share. It hit a 52-week low of $28 in February 2010.

Starbucks, Goldman's "best idea" in restaurants, is well positioned on all key metrics. As large as the company has grown in recent years, Starbucks still has room for more in the U.S. At the same time, it's at an inflection point in emerging markets where potentially strong future growth is expected. Says Goldman: "The company has strong brand equity in its domestic market, which should support strong same-store sales. SBUX should be able to manage commodity inflation from pricing power, leverage and company-specific efficiency initiatives."

Estimates Higher Than the Consensus

Although already globally popular, Starbucks appeal has yet to peak. In the U.S., it hasn't yet saturated the market. "We see the potential for a healthy domestic new-unit growth trajectory that may extend through 2025," says Goldman's Kelter. In the 1990s, when Starbucks was at the height of its mass appeal, it posted a lofty same-store sales growth rate of 6% to 7% through mid-2007. Goldman believes it may be able to hit that high level again over the next few years.

Part of such growth will be augmented by sales in the emerging market countries. "We project 20% to 25% of its systemwide units will be in emerging markets within five years," says Kelter.

Equally important is Starbuck's valuation. The company is "attractively valued" based on Goldman's expectation of sustained 20% earnings growth. Kelter sees the stock hitting $44 a share in 2011. He forecasts 2011 earnings of $1.54 a share vs. the consensus analysts' estimate of $1.49. For 2012, Kelter projects earnings of $1.86, higher than the consensus estimate of $1.74.

"Still Very Much in the Adolescent Phase"

Chipotle is another company in the industry that Goldman forecasts a lot more growth for in the years ahead. "CMG is only at around 25% of the potential U.S. capacity, and growth could last for another 10 to 20 years," says Kelter. Clearly, he adds, Chipotle is "still very much in the adolescent phase of its growth." He concedes that Chipotle's valuation is "rich" but not overvalued.

Chipolte's third-quarter results showed the company's financial muscle. Net income jumped 39%, to $132.5 million, or $4.18 a share, and revenues increased 23%, to $476.9 million. Comparable-restaurant sales climbed 8.3%. The jump in sales was primarily the result of increased traffic. The company opened 22 new restaurants during the quarter, bringing the total to 1,023. For the year, Chipotle opened a total of 67 new restaurants

Goldman forecasts Chipotle will earn $6.83 a share in 2011 and $8.51 in 2012, up from 2009's $3.95. Its 12-month price target for Chipotle's stock is $285 a share.

A Resumption of Robust Growth

At Tim Horton's, one thing that's been underappreciated by investors is its strong growth and prospects for further expansion outside of Canada. In particular, Goldman is encouraged by its foray into the U.S. market.

Goldman's thesis on Tim Horton's is similar to what it expects of Starbucks. It was able to increase same-store sales in its domestic market by 6% to 7% throughout the 1990s and 2000s, until the recession hit. Goldman expects the robust growth rate to resume in 2011, along with the expected leap in Canada's GDP growth, which Goldman forecasts to exceed that of the U.S.

"Our saturation analysis implies that THI's Canadian unit growth could continue for 10-plus more years, and we see the potential for its U.S. expansion to accelerate," says Kelter. He sees Tim Horton's earning $2.41 a share in 2011 and $2.87 in 2012, up from 2009's $1.80.

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The bottom line: Not many sectors of the economy have the potential for the powerful growth that the restaurant industry has. Goldman figures it'll thrive on supply-demand dynamics that "are the best in 25 years."

Indeed, in Goldman's view, Starbucks, Chipotle and Tim Horton's represent the best investment opportunities in growth stories around, "where the optics of the recession obscured the group's true long-term growth trajectory."

So for investors looking for companies with strong earnings potential, robust financials and outsize growth prospects, Starbucks, Chipotle and Tim Horton's are the menu's standouts.

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