STAGFLATION OR NOT, with enough “BLOOD IN THE STREETS”, THE RESTAURANT STOCKS MAY HAVE BOTTOMED
We spend a great deal of time keeping the “Corporate Descriptions” section of our website (accessible from our Home Page) up to date, covering every publicly held restaurant company out there, as well as a handful of non-restaurant franchising companies. The section showing the relationship of current Enterprise Value to Trailing Twelve Month EBITDA is especially useful to us as investors. I’ve done the calculations myself, because I invest my hard earned capital based on these numbers, so they should be reasonably accurate and if you find a material error, please let me know.
After reviewing the “Corporate Descriptions” of over fifty companies last week, it seems that we could be at an inflection point in regards to the current valuation of restaurant stocks.
The negatives are now more than apparent, even to casual observers. Traffic was terrible for the two years of the Covid, now finally running ahead of 2019 at some chains. Similarly, efficient staffing was almost impossible for two years, and is still in a state of flux as customers tentatively return with sales stabilizing between dine-in and off-premise. At some junctures within the two-year Covid timeframe, it was a challenge to merely get the restaurant opened, let alone operate efficiently. The other major expense line, Cost of Goods, has also taken its toll on margins as higher protein prices were amplified by supply channel inefficiencies. Restaurant operators have therefore been penalized by the triple negative of challenged Traffic while Labor and CGS have simultaneously been climbing sharply. The normal remedy of higher menu prices has been difficult to impose on the dining public in the midst of an unprecedented health crisis. TODAY, however, management of publicly held chains has learned a great deal about managing the current situation as well as planning future growth. From an investment standpoint, stock valuations correlate strongly with the “2nd derivative”, which is the “change in the rate of change”. For example, if traffic has been down 5%, and it is still down, but by only 2%, that is a big positive. Similarly, if crew wages have been inflating at 10%, it is encouraging to hear about (only) a 5% expectation. Management cannot control commodity prices but have learned how to adjust the labor content to respond to the mix of business. We do not suggest that traffic will suddenly accelerate, or wages and commodity prices will come down, but there is a good chance that the worst of the “rate of change” is behind us. With that possibility in mind:
Valuations of Restaurant Equities are Historically Low – We cannot know where stock prices will bottom. We can say, however, that valuations are currently closer to historical lows than highs. With the exception of a couple of “best of breed” operators like Darden, TX Roadhouse and McDonald’s, as well as the pizza and chicken franchisors that benefited from the Covid (DPZ, WING, PZZA) restaurant stocks are down generally from 25-50% from their twelve-month highs. Acknowledging that each of the following companies has its unique set of opportunity and challenge, a group of mid to large cap, financially stable, generally well-run companies (BLMN, CHUY, EAT, CAKE, CBRL, PLAY, and BJRI) @6/11/22 sell for an average of under 6x trailing twelve-month EBITDA. A group of franchisors (RUTH, DIN, JACK and DENN) sell for an average of 10x trailing twelve-month EBITDA. More venturesome investors can look at smaller capitalization and/or troubled chains within a group (RRGB, BBQ, GTIM, NDLS, ARKR, STKS, FRGI and BDL) which sell for an average just over 5x trailing twelve-month EBITDA, a couple of them materially lower than that. Dining away from home and consuming food prepared outside the home will remain embedded features of today’s consumer behavior. Well run restaurant companies will once again prove to be relatively recession resistant, and the current prices of many of the above referenced companies should prove to be opportunistic over the long term.
Roger Lipton