Are These 3 Restaurant Stocks Worth a Bite?

Are These 3 Restaurant Stocks Worth a Bite?

Investing in restaurant stocks can be a simple, yet frustrating, pursuit. Developing a successful concept that can easily be duplicated across the country is easier said than done. While a good plan in theory, restaurants can quickly come in and out of favor. Very few successfully make the trek from a strong regional play to a truly national company. Investors crave the successes of Chipotle Mexican Grill or Panera Bread, which quickly spread nationwide and provided huge gains for early investors.

Now a new set of restaurant stocks hope to replicate that success, from relatively new public firms Chuy's (NASDAQ: CHUY) and Noodles & Company (NASDAQ: NDLS) to recent turnaround Jack in the Box (NASDAQ: JACK). All three stocks have market valuations of less than $2 billion compared to the $12 billion valuation of Chipotle.

Burger specialist
Jack in the Box is a leading hamburger chain based in San Diego. The concept currently has 2,255 restaurants in only 21 states, providing tons of room for a national expansion plan. The company also owns the fast-casual Qdoba Mexican Grill, which competes directly with Chipotle. Qdoba is already a nationwide chain with approximately 600 locations in 45 states and Canada. It unfortunately has undergone a restructuring that has scaled back some operations while providing plans for expansion in other locations. These restaurant totals compare favorably to the thousands of McDonald's locations and the 1,500 Chipotle stores that compete against Qdoba.

The company has seen a surge in earnings lately from a shift toward converting company-owned stores into franchises. This shift naturally causes revenues to stall, but it has helped earnings jump. Analysts expect earnings to surge roughly 20% a year, with fiscal year 2014 expectations gaining by nearly 28% to $2.15. The company's forward price-to-earnings ratio is very favorable with earnings growing that fast.

With the Jack in the Box concept flourishing now, the key to long-term success will be whether Qdoba can be turned around and return to profitable expansion. Even with the closure of 64 restaurants, the company has focused expanded efforts on this concept with plans for up to 70 new stores this year, ironically almost equal to the amount closed. The company does have a transition at the CEO position taking place on January 1, 2014, which can always disrupt operations.

Tex Mex made fresh
Chuy's is a full-service restaurant focused on made-from-scratch Tex Mex. The concept has only 46 locations in 13 states. Since going public back in mid-2012 the stock has seen huge gains, opening the first day below $15 and now trading close to $40. The company expects to open eight to nine locations this year providing at least 20% store growth.

This hot stock trades at a pricey 42 times next years earnings, even with analysts only expecting a tamer 25% growth rate. In fact, analysts only forecast a 21% gain in 2014, from $0.70 expected this year. Revenue is expected to grow at a 20% clip, with roughly 15% store base growth and 5% growth from comparable store gains.

The stock gain appears unjustified because Chuy's will have a difficult time growing fast enough to justify this valuation. Long-term investors might want to keep this stock on a shopping list to purchase on any sell offs. Chuy's has the vast majority of the country for expansion, with 37 states un-touched. Maybe the best comparison would be the former Brinker's concept On The Border that has 155 stores.

Noodle bowling
Noodles had one of the hottest IPOs of recent years. The stock surged to $40 after pricing at $18 back on July 2. The fast-casual chain that focuses on noodle dishes served in a bowl received net proceeds of $100 million to finance its store expansion plans. The company did have a slightly disappointing first quarter report, and the estimates don't back up the stock trading at over 80 times forward earnings estimates.

Noodles released its first quarterly report as a public company for the second quarter of 2013. Noodles only registered 18.2% revenue growth, with 4.7% comp sales growth at company owned restaurants. It operates 348 locations in 26 states as of July 2, with plans of opening a total of 46 to 48 total restaurants for the year or roughly 24 stores for the second half of the year. The company has plans to grow its store base at a 15% annual rate, and one can quickly see the possibility of matching the 1,500 store base of Chipotle.

With a focus on fresh food and a fast-casual concept like Chipotle, the Noodles IPO was particularly hot because of the direct comparison. Investors incorrectly placed too much emphasis on the comparison and not the facts. Noodles' recent growth rate doesn't justify this amazing valuation.

Bottom line
All three companies will see years of expansion, and likely higher stock prices down the road. One major key to successful long-term investing is buying at attractive prices, which aren't apparent in Chuy's and Noodles' current valuations. Investors should learn from the Chipotle lesson of how even one of the best-run restaurant stocks has had major sell-offs in its short time as a public company, whether due to market influences or company issues. The key is separating a company from a stock. Great companies with strong expansion plans will eventually see higher stock prices, but an investor buying at the right price will see the best returns.

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