Much like American consumers, investors can’t seem to get enough fast food. They will likely require a strong upcoming earnings season to stay satisfied.
Shares of the largest such companies set to report quarterly results this week have performed admirably lately.
Chipotle Mexican Grill
has rallied about 75% so far this year while
are up about 45% and 20%, respectively.
A basket of quick-service restaurant stocks now trades at 32 times forward earnings, or 1.8 times the average S&P 500 multiple. Meanwhile, there isn’t as much enthusiasm for shares of casual dining companies, which are trading in line with the market. That is the largest divergence between the two groups on record, according to analysts at Morgan Stanley.
Higher sales expectations help explain the valuation gap: analysts expect Chipotle and Starbucks to report same-store sales growth of 8% and 4%, respectively, according to FactSet. Sales projections are far more modest for sit-down restaurants.
Those projections aren’t unreasonable. Chipotle, for instance, grew its comparable sales by nearly 10% in the first quarter. But hitting the targets will be important with industry cost pressures are increasing.
A strong economy helps boost consumer spending but also makes it harder to attract workers. More than 7.5 million restaurant and hotel workers quit last year, the most since the Bureau of Labor Statistics began releasing that metric in 2001. That, coupled with higher minimum wage rates in certain states, means restaurants need to offer higher pay, all else being equal.
At the same time, the industry’s embrace of third-party food delivery services can bring in new customers but also adds complexity to operations and crimps profit margins. On the commodity side, the continued African swine fever epidemic in China is pushing pork prices higher.
Paying more for fast food has worked well for investors, but high valuations mean the fallout can sting when results disappoint. Domino’s Pizza shares fell nearly 9% after reporting disappointing quarterly results last Tuesday.
Given that backdrop, satisfactory growth on the top line becomes essential. Investors had better hope customers ask for large sodas on their next visit.
Write to Charley Grant at firstname.lastname@example.org
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