3 Restaurant Stocks to Buy Despite Industry Challenges

The Zacks Retail – Restaurants industry has been impacted by high wages and food cost inflation. Rising prices are also hurting the industry’s traffic. These factors have been affecting margins of late. However, the gradual improvement in demand, menu innovation, robust off-premise sales, sales-building efforts and digital initiatives bode well. Stocks like, McDonald's Corporation MCD, Yum! Brands, Inc. YUM and Darden Restaurants, Inc. DRI are well-poised to counter the scenario.

Industry Description

The Zacks Retail – Restaurants industry comprises several owners and operators of casual, upscale casual, fine dining, full-service and fast-casual restaurants. Some industry participants operate as roasters, marketers and retailers of specialty coffee. Some companies develop, operate, and franchise quick-service restaurants worldwide. A few restaurant operators offer cooked-to-order dishes, which include noodles and pasta, soups, salads and appetizers. Some industry players develop, own, operate, manage, and license restaurants and lounges worldwide. A few companies also operate technology-enabled Japanese restaurants in the United States and provide Japanese cuisine through a revolving sushi service model.

4 Trends Shaping the Future of the Restaurant Industry

Traffic Woes & High Costs Linger: The restaurant industry has been facing declining traffic for quite some time now. A rapid increase in menu prices and coronavirus are the primary reasons behind traffic erosion. Restaurant operators are grappling with the high cost of operations. Intense competition, high wages and food cost inflation remain concerns. The industry is persistently bearing increased expenses, which have been affecting margins. Higher pre-opening costs, marketing expenses and costs related to sales-boosting initiatives are exerting pressure the company’s margins. The rise in meat and seafood costs, including ribs, prime rib, ribeye and tri-tip and salmon, is hurting the industry.

Sales Declined in December: Per the industry body, the National Restaurant Association (NRA), restaurant sales declined in December to $88.3 billion compared with $89.2 billion generated in November. The association also said that October and November sales were $1.6 billion lower than preliminary numbers reported by the U.S. Census Bureau.

Digitalization to Drive Growth: Restaurant operators’ focus on digital innovation, sales-building initiatives and cost-saving efforts has been acting as a catalyst. With the growing influence of the Internet, digital innovation has become the need of the hour. Restaurant operators are constantly partnering with delivery channels and digital platforms to drive incremental sales. Partnerships with delivery channels like DoorDash, Grubhub, Postmates and Uber Eats and the rollout of self-service kiosks and loyalty programs continue to drive growth. Restaurant operators are focusing on driverless delivery systems to augment sales amid the coronavirus crisis. This is anticipated to reduce expenses substantially and ensure safety amid the pandemic as companies do away with delivery personnel.

Off-Premise Sales Acting as a Key Catalyst: The industry has been gaining from the increase in off-premise sales, which primarily include delivery, takeout, drive-thru, catering, meal kits, and off-site options such as kiosks and food trucks, owing to the coronavirus pandemic. Per the National Restaurant Association, more than 60% of restaurant foods are consumed off-premise. By 2025, off-premise will likely account for approximately 80% of the industry’s growth. Most restaurant operators have initiated testing of ghost or virtual kitchens. The idea of providing off-premise offerings along with a connected curbside service has been garnering positive customer feedback.

Zacks Industry Rank Indicates Dismal Prospects

The Zacks Gaming industry is grouped within the broader Retail-Wholesale sector. It carries a Zacks Industry Rank #161, which places it in the bottom 36% of more than 250 Zacks industries.

The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates bleak near-term prospects. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.

The industry’s position in the top 50% of the Zacks-ranked industries is a result of a positive earnings outlook for the constituent companies in aggregate. Looking at the aggregate earnings estimate revisions, it appears that analysts are gradually losing confidence in this group’s earnings growth potential. Since Aug 31, 2022, the industry’s earnings estimate for the current year has gone down 0.7%.

Before we present a few stocks that you may want to consider for your portfolio, let’s take a look at the industry’s recent stock-market performance and valuation picture.

Industry Outperforms the S&P 500 & Sector

The Zacks Retail – Restaurants industry has outperformed the Zacks S&P 500 composite and its own sector over the past year.

Over this period, the industry has increased 4.7%, compared with the Zacks S&P 500 composite’s decrease of 14%. The sector has declined 14.8%.

One-Year Price Performance

Restaurant Industry's Valuation

On the basis of the forward 12-month P/E, which is a commonly used multiple for valuing restaurant stocks, the industry is currently trading at 25.45X compared with the S&P 500’s 18.1X. It is marginally above the sector’s forward 12-month P/E ratio of 20.44X.

Over the last five years, the industry has traded as high as 34.64X and as low as 20.53X, with the median being at 24.74X.

3 Key Restaurant Picks

McDonald's: McDonald's, operates and franchises quick-service restaurants under the McDonald’s brand. McDonald’s increased focus on menu innovation and loyalty program expansion is commendable. The company is also undertaking every effort to drive growth in international markets. Robust digitalization is likely to help the company to drive long-term growth and capture market share.

Shares of this Zacks Rank #2 (Buy) company have inched up 2%. McDonald's earnings for fiscal 2023 are anticipated to rise 3.9% from 2022 anticipated levels. In the past 30 days, the consensus mark for 2023 earnings has been revised upward by 1.1%. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Price and Consensus: MCD

Yum! Brands: The company has been benefitting from continued focus on off-premise channels, strategic investments in digital technology and refranchising efforts. Moreover, it has implemented various digital features in mobile and online platforms across all brand segments to enhance the guest experience. The company has been working toward accelerating its delivery services and the results have been positive so far.  

YUM carries a Zacks Rank #2. Yum! Brands earnings for fiscal 2023 are anticipated to improve 15.6% from 2022 anticipated levels. In the past 30 days, the consensus mark for 2023 earnings has been revised upward by 0.2%. In the past three months, shares of the company have gained 4.2%.

Price and Consensus: YUM

Darden Restaurants: Darden Restaurants is one of the largest casual dining restaurant operators worldwide. The company is gaining from business-model enhancements and menu simplifications. This and a focus on technological enhancements in online ordering, the introduction of To Go capacity management and Curbside I'm Here notification bode well.

Darden Restaurants carries a Zacks Rank #2. The Zacks Consensus Estimate of the company’s current financial year sales and EPS suggests growth of 7.9% and 5.4%, respectively, from the prior-year comparable figure. Shares of the company have increased 5% in the past year.

Price and Consensus: DRI

Want the latest recommendations from Zacks Investment Research? Today, you can download 7 Best Stocks for the Next 30 Days. Click to get this free report

McDonald's Corporation (MCD) : Free Stock Analysis Report

Yum! Brands, Inc. (YUM) : Free Stock Analysis Report

Darden Restaurants, Inc. (DRI) : Free Stock Analysis Report

To read this article on Zacks.com click here.

Zacks Investment Research