The Casual Dining Segment Is Showing Signs of Improvement

One part of the market that investors are worried about because of sequestration and the recent government shutdown is the casual dining segment. The thinking is that in times of uncertainty, consumers choose to eat out less and opt for cheaper dining options. However, things are looking up as retail sales in September showed a 0.9% gain at bars and restaurants. The key now is to look at the sector as a whole and find the best restaurant stocks for your portfolio.

You can have your cake and eat it too
The casual dining sector got a boost after The Cheesecake Factory reported solid third quarter results. Revenue actually came in higher than expected. The result is that many analysts raised their earnings per share estimates going forward. This is a bullish sign and good news for shareholders in The Cheesecake Factory.

Overall comparable restaurant sales grew 0.8% at The Cheesecake Factory and Grand Lux Cafe. What was most impressive is that this was the 15th consecutive quarter of positive comparable sales. This shows that the company is still able to grow its market share in a competitive environment.

Going forward, the company expects to open a total of nine new restaurants this year, four of which are already open. The company continues to grow internationally and will open one new location in the Middle East with its franchise partner there.

What I like is that the company generates strong cash flow and is using that money to repurchase shares. In the third quarter, the company repurchased 2.1 million shares for $90.2 million. So far this year, the company has repurchased $135.5 million of its shares, and plans to repurchase another $65 million in the fourth quarter.

Breakfast, lunch & dinner
For those of you not familiar with DineEquity , the company owns IHOP and Applebee's. Its concepts have a loyal following, particularly IHOP for its breakfasts and Applebee's for its daily lunch specials.

DineEquity reported results that blew away expectations. The company reported EPS of $1.10, which was $0.19 better than expected. Revenue also came in $4.4 million higher than expected. IHOP was the primary driver of this growth, as its comparable restaurant sales increased by 3.6%. This rise more than offset the 0.4% decline seen at Applebee's.

Like The Cheesecake Factory, DineEquity's restaurants generate a tremendous amount of cash that the company has returned to shareholders. In the first nine months of this year, DineEquity has returned $68 million to shareholders in the form of dividends and share repurchases. DineEquity has one of the highest dividend yields in the restaurant sector at 4.1%. The payout ratio is only 25%, so the company has the ability to increase its dividend, which I foresee happening.

Going forward, the company expects IHOP to continue outperforming Applebee's. DineEquity raised its guidance for the full year and sees IHOP posting comparable restaurant sales for the year of 2%-3%, up from prior guidance of -1.5%-1.5%. The company narrowed its expectations for Applebee's to between -0.5% and 0.5%, compared to prior guidance of -1.5% and 1.5%. DineEquity plans to develop 25 to 30 new Applebee's and 50 to 60 new IHOP locations this year.

A more upscale casual dining concept
Kona Grill followed in the footsteps of The Cheesecake Factory and DineEquity by posting strong earnings results for its latest quarter. Kona posted third quarter EPS of $0.08, which beat expectations by $0.01. Revenue rose 2.6% year-over-year, and comparable restaurant sales increased 2.6% as well.

What I like about Kona is that it's the smallest of the three with a market cap of only $112 million. I also like its concept in that it offers steaks, pizza and is known for its sushi and sashimi. With a great concept and a small footprint, the company has plenty of room to grow.

Next year, the company plans to open at least four new locations. Kona also has already signed leases for two locations that are slated to open in 2015. I like that the company is actively working on its development pipeline. The company's goal is to grow 15% annually and to double sales over the next five years.

Going forward, Kona expects comparable restaurant sales to grow 3% in the next quarter. Sales in the fourth quarter are forecast to be $24.5 million, compared to $23 million in the year-ago period.

Foolish assessment
In looking at all three companies, Kona Grill has the highest forward P/E at 28. The Cheesecake Factory comes in at 19 and DineEquity at 18. Kona Grill's higher multiple is warranted since it has the most room to grow. Where Kona is actually cheaper than both companies is in terms of price to sales and EV/EBITDA. Kona Grill trades at 1.17 times sales, whereas The Cheesecake Factory trades at 1.32 times sales and DineEquity at 2.28 times sales. Kona Grill's EV/EBITDA of 8.9 is the lowest of the three.

For an investor with a longer time horizon, the best bet looks to be Kona Grill. If an investor is looking for yield, DineEquity would be the best choice with its 4.1% dividend yield. All in all, I think the tide is turning for these casual dining stocks and I think the recent earnings results are the start of more gains to come.

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The article The Casual Dining Segment Is Showing Signs of Improvement originally appeared on Fool.com.

Mark Yagalla has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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