Don't eat up restaurant stocks after the selloff

If you find a few gems, by all means have at it, but the risks remain high for the broader sector.

By InvestorPlace Feb 14, 2013 3:03PM
Businessman devouring fries whilst driving car copyright Ryan McVay, Photodisc, Getty ImagesBy Jeff Reeves

iplogoIt hasn't been a great run lately for some of the biggest restaurant stocks on Wall Street.


Darden Restaurants (DRI), which operates Red Lobster and Olive Garden among other franchises, is off almost 15% since Thanksgiving while the S&P 500 has added about 8%. Yum Brands (YUM), which operates KFC, Pizza Hut and Taco Bell, is off about 13% in the same period spanning the last three months or so. Ruby Tuesday (RT) is down too in the same period, as are Burger King (BKW) and Panera Bread (PNRA).


The market has been rallying strongly, but these picks have been on the sidelines. So what gives?


There are a host of reasons, but a short list of the main troubles include:


Payroll Tax Hike: The federal government is collecting more in tax revenue after the lapsing of a payroll tax cut, but that means middle-class families have less to spend. Cutting back on eating out is an easy way to save a few bucks, so restaurants have been under pressure as a result.


Gas Prices: As oil continues to hover around $100 a barrel and gas prices jump, it's the same story -- fear that family budgets will need to trim the fat and that restaurant spending is what will have to go.


Weak Spending Data: Casual dining figures as measured by the Knapp-Track survey of same-store sales came in weak for January after a disappointing end to 2012 that boasted a contraction last fall, too. And while some broader reports have been more optimistic about consumer spending, it's important to note that while we have three consecutive months of retail sales gains there was just 0.1% growth in January. Hardly encouraging.


Minimum Wage Fears: Raising the minimum wage will adversely affect restaurant payrolls, which have a large pool of unskilled workers. Wall Street is very focused on margins, and this fact didn’t sit well with many traders immediately after Obama's proposal hit the airwaves.


Some other headlines are noteworthy to a lesser extent. A bad earnings report from massive restaurant supplier Sysco (SYY) that pointed to softer demand for one. Another worth pointing to is a big miss and subsequent selloff for shares of cult sports bar Buffalo Wild Wings (BWLD) thanks to deteriorating margins and rising food costs.


There are a range of issues at play here in the short-term, keeping pressure on shares. But should you see this as a buying opportunity?


Maybe. If you are looking to stake out a long-term position in a company like McDonald's (MCD) that has a massive brand, global growth prospects and a good dividend, the investment might serve you well. MCD pays a 3.3% dividend yield currently and five-year growth rate of 19%. You could do much worse than that.


However, it's unclear if the worst is over. A broader contraction in the market coupled with a rollback in consumer sentiment could weigh further on discretionary plays like restaurant stocks.


If you believe consumer spending will continue to rise unhindered and that a sustained rally is in order for cyclical stocks over the next few years, then by all means, buy in. And if you spot a particular growth story you like in the industry that allows for outsized performance, that's the icing on the cake.


However, if you don't think consumers are coming back in a big way over the next 12 to 18 months, then you're probably better served shopping around. After all, you can find a 3%-plus dividend multinational in a host of sectors. Why settle for a restaurant amid these other concerns?


Related reading

Jeff Reeves is the editor of InvestorPlace.com and the author of “The Frugal Investor’s Guide to Finding Great Stocks.” Write him at editor@investorplace.com or follow him on Twitter via @JeffReevesIP. As of this writing he did not own a position in any of the stocks named here.


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