Should You Buy on Restaurant Weakness?

Surprisingly, the markets have been resilient to the reality of a government shutdown. For the most part, Wall Street has survived the doom and gloom forecast. However, with consumer sentiment and GDP expected to see a noticeable impact from the shutdown, restaurants have pulled back recently. Thus, is this an opportunity and if so, which stocks look most attractive?

Quick-service drops with marginal growth
After flirting with $100, shares of McDonald's have fallen 4% since last Thursday, including 2% on Wednesday. This recent weakness comes despite the rollout of a new loyalty program and changes in the marketing structure of the company.

The country's largest fast-food chain has suffered criticism in recent months amid sub-1% growth . Yet, McDonald's focus on improving its menu with new healthy options might appeal to some consumers. As of now, the fast-food giant is not expected to produce rapid growth. After a 5% hike to its quarterly dividend, the stock does pay a forward yield of 3.44%.

Following its recent weakness, McDonald's trades at 17.3 times earnings, consistent with the S&P 500. Thus, due to its dividend, McDonald's might make a good long-term investment for those seeking safety, security, and a consistent return. 

As for McDonald's largest competitor Yum! Brands , which owns and operates KFC and Taco Bell, its investment outlook appears more troublesome. Yum! does pay a dividend of 2%, but monthly sales declines of 13 % and 10 % during the last two months in its large Chinese market might hinder growth significantly.

At 23 times earnings, Yum! is more expensive than McDonald's, but its Chinese woes make an investment in the company very uncertain. Thus, with a better dividend and a cheaper valuation, McDonald's looks to be the clear winner of these two fast-food chains.

Midscale and family dining scattered in performance
According to NPD's consumer traffic data, mid-scale and family dining is growing faster than quick-service restaurants, at a rate of 2 %. While 2% growth looks dull, there have been a couple bright stocks in the space, including Bob Evans Farms and Cracker Barrel Old Country Store .

Bob Evans and Cracker Barrel have seen gains of 41% and 61% respectively in 2013, but both have seen modest pullbacks since the government shutdown.

In the case of Bob Evans, it has seen gains as activist shareholders seek a spinoff of the company's assets. Also, the company has been aggressive in returning capital to shareholders. It approved a $150 million incremental share buyback program and also increased its dividend 12.7% in the last quarter, giving it a forward yield of 2.2%.

Despite Bob Evans' dividend and buybacks, the company itself is actually growing slower than its mid-scale space. In particular, total revenue declines of 1.3 % and 1.4 % in the two most recent quarters show that Bob Evans is not a strong company in this space, but rather a laggard.

Cracker Barrel is the complete opposite in the mid-scale/family dining space, as a true growth driver. During the company's last two quarters, total sales grew 3.9 % and 5.2% respectively year over year, far above the industry average. Moreover, margins have continued to rise along with average ticket prices. Overall, Cracker Barrel is a top performer in this space, that pays a dividend of nearly 3%.

Fast-casual value
While Cracker Barrel remains a bright spot in the family dining space, fast-casual is without question the growth driver of the restaurant sector. According to NPD , store traffic has risen 8% during the last quarter alone throughout this space, including companies such as Chipotle, Noodles & Co, and Panera Bread .

In particular, Panera has not only posted a 4% decline in the last five trading sessions, but is also trading lower by 15% over a three month period. The company's growth has slowed in the last year, but it's still impressive nonetheless.

Just last quarter, sales grew 11 % -- above the fast-casual average - and margins improved with net income growth of 16% year over year. While Panera does not pay a dividend, neither do its peers. Given the recent share pullback and strong growth prospects, Panera's weakness might present a good opportunity.

Final thoughts
The bottom line is that there is value scattered throughout the restaurant space, but you must be careful not to compare all restaurants equally. This is an industry that is separated into three subsectors, and each is growing at a different rate. McDonald's, Cracker Barrel, and Panera Bread all present different levels of value and opportunity. Given recent losses, investors should perform due diligence on each, as you might find that one, or all, will be rewarding to your portfolio. 

The article Should You Buy on Restaurant Weakness? originally appeared on

Brian Nichols owns Cracker Barrel. The Motley Fool recommends McDonald's and Panera Bread. The Motley Fool owns shares of McDonald's and Panera Bread. 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.

Copyright © 1995 - 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

Read Full Story