Fast-Casual Eateries Are Hot... But a Good Investment?

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Americans lately have been transferring their love of fast-casual restaurant food to stocks of companies in the segment. Late last month, "better burger" specialist The Habit Restaurants (HABT) launched an initial public offering that doubled in price within hours of hitting the market.

Like a meal from one of The Habit's more traditional fast-food rivals, though, the feeling of satisfaction didn't last: The shares started to drop after the initial euphoria. But that isn't stopping other fast-casual operators from listing on the exchange. They're finding, though, what works in the kitchen isn't necessarily successful on the market.

IPOh Yes

IPOs of fast-casual chain operators are coming to the market faster than you can get a refill at a soda machine. This year alone has seen the market debut not only of The Habit, but also the Mediterranean-flavored Zoe's Kitchen (ZOES) and West Coast chicken griller El Pollo Loco Holdings (LOCO), among others.

Like The Habit, the stocks of the latter two saw impressive first-day rises (although they didn't pop quite as high as those of the burger purveyor).

Why the excitement? Some of it can certainly be ascribed to the IPO market itself, which has had a frothy year. As of this writing, 262 companies have gone public, a 25 percent rise over the same period of 2013. In terms of total proceeds from IPOs, 2014 is set to be the best year for at least the past decade.

Building a Better Burrito

But likely a bigger factor is that the fast-casual segment has one great model that investors are hoping the newcomers can at least partially replicate -- Chipotle Mexican Grill (CMG).

Since going public in 2006, the stock of the now-ubiquitous chain has gone through the roof. Its IPO was priced at $22 a share and doubled in its first day of trading. Since then, its shares have ballooned -- at the moment, they trade at nearly $660, for a hard-to-believe 2,900-plus-percent rise from the issue price.

It's not the only company in the segment that has enjoyed such lofty success. Artisan sandwich joint Panera Bread (PNRA) began its stock market life in the early 1990s, typically selling for under $10 a share in its first year or so of trading. But the company's business picked up, and like Chipotle, its restaurants cover the country these days. From that sub-$10 level, the stock now changes hands at over $165.

Chipotle and Panera are stock market stars because over the years, both have demonstrated their ability to consistently and meaningfully grow revenues, net profit, and store count. Take Panera in just the last five years: Its top line grew from $1.4 billion in 2009 to $2.4 billion in 2013, rising every year across that stretch. Ditto for net profit, which sloped upward from $86 million to $196 million.

A Thinner Sandwich

So the hopes are very high for the new fast-casuals coming to market. Unfortunately for some, investor expectations are lofty, too -- the market seems to be hoping that every IPO in the segment will put up Panera-like fundamentals.

Those that don't have been punished. Sandwich shop Potbelly (PBPB) went public a little over a year ago, with its first-day price bursting at the seams like an overstuffed turkey-and-Swiss (the stock closed 120 percent above its issue price of $14 a share).

Since then, however, the company's results haven't justified this wild optimism. Profitability has been scarce, and earlier this year it significantly reduced its outlook for full-year earnings. Investors didn't take kindly to this, trading the stock down sharply. After flirting with $32 in the wake of its IPO, Potbelly shares now trade at around $12 apiece.

Meanwhile, another graduate of the fast-casual IPO class of 2013, Noodles & Co. (NDLS), is experiencing a similar dynamic: a first-day trading surge (from $18 to $36.75), then gradual stock price decline in the face of disappointing fundamentals. These days, the carbohydrate-string-slinger can be had for around $24 a share.

Take a Number

In spite of the performance of some stocks in the sector, the surge of fast-casual IPOs is continuing. J. Alexander's filed for an IPO this past October, while one of the big names in the sector -- popular burger-flipper Shake Shack -- is busy securing investment bank help for an upcoming stock market debut.

Those restaurants are popular, thanks to good word of mouth. But satisfying the appetites of hungry customers and performing well on the stock exchange are two very different talents. As we've seen with some fast-casual chains recently, not every company can handle both orders.

Motley Fool contributor Eric Volkman has no position in any stocks mentioned, although he really likes to eat. The Motley Fool recommends Chipotle Mexican Grill, Panera Bread and Zoe's Kitchen. The Motley Fool owns shares of Chipotle Mexican Grill and Panera Bread. Try any of our Foolish newsletter services free for 30 days. Check out our free report onone great stock to buy for 2015 and beyond.
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