Every stock market portfolio should consider restaurant stocks if the risk tolerance allows for it.
This industry sector has a long track record of delivering good capital gains to investors, recognizing, of course, that all restaurant chains experience periods of turmoil and changes among consumer preferences.
Fierce And Slim
In the restaurant business, competition is fierce and because there are so many options, margins are slim.
Sonic Corp (NASDAQ:SONC) just reported its financial results for its third fiscal quarter (ended May 31, 2014).
The company’s system-wide store sales grew 5.3%, with total revenues (including both company-owned drive-ins as well as franchises) growing to $152 million, compared to $147 million in the same quarter last year.
Sonic’s two-year stock chart is featured below:
Chart courtesy of www.StockCharts.com
The company expects earnings-per-share growth of between 14% and 15% in fiscal 2014, and the position is fully priced on the stock market.
Operationally, Sonic is experiencing renewed momentum in its business, with most new store openings being new franchises.
The stock did incredibly well from the late 1990s to the end of 2007, until the company’s growth picture turned. It wasn’t until the beginning of 2013 (like so many other stocks) that the company was able to reenergize operations. The stock has doubled over the last 18 months.
Cyclical
All restaurant chains experience periods when they just can’t produce the same growth as they used to. Combined with changes in consumer preferences, general economic conditions and the wholesale cost of food, these stocks are cyclical.
Cracker Barrel Old Country Store (NASDAQ:CBRL) hit $118.00 on the stock market late last year but has since retrenched to the $100.00-per-share level as the company’s system-wide sales slowed.
This well-known chain has really done well over the last two years. (See “4% and Rising: This Company Consistently Growing Investors’ Income.”) From 1998 to 2008, the position did nothing on the stock market.
Timing Is Crucial
So the sector is very much about getting the cycle right. As the saying goes, 'timing is everything'.
Cracker Barrel is an income-producing stock, and with a current dividend yield of four percent and a forward price-to-earnings ratio of approximately 16, the position is attractive.
Earnings should grow about 12% this fiscal year and about 11% in fiscal 2015, according to current estimates.
What I like about Cracker Barrel, not to the exclusion of other operators, is that all of its stores are company-owned. Franchising is great and it has proven to work many times in the past, but corporate ownership allows for strong control over system-wide operations and typically, each location is more profitable.
Risk
Restaurant stocks are higher-risk and they aren’t blue chip. Today, “fast-casual” is the new buzzword for highly successful operations like Chipotle Mexican Grill (NYSE:CMG).
For those with less tolerance for risk, a company like Cracker Barrel would fit the bill with its reasonable valuation, solid operations, and higher dividend yield.
The company opened 10 new drive-ins during its fiscal third quarter and earnings grew to $16.8 million, or $0.30 per diluted share, from $14.8 million, or $0.26 per diluted share, for an earnings-per-share gain of 15%.