Take the restaurant stock taste test

Some popular chains have become a little more palatable.

By InvestorPlace Jan 12, 2012 11:20AM

Image: Care © Moxie Productions/Blend Images/Getty ImagesBy Lawrence Meyers


With so many concept restaurants to choose from, one has to wonder whether the market can sustain them all. The answer is simple: They are sufficiently different from each other and are healthy competitors -- so they can all make a buck. That's the American way, and three cheers for being able to chow down on any kind of meal you please.


While the food at each of these places may be good, are their stocks worth buying? In the past, I've found these stocks to be perpetually overvalued. Let's see if they still are.


Cheesecake Factory (CAKE) is known not only for its dessert but for the mega-portions it serves up to customers. The consistency of the company's product has made it successful, and has won its share of fans and repeat customers. That might be why Cheesecake Factory is slated to grow 15% in 2011, in 2012 and for the next five years beyond. The company always has used debt wisely -- in this case, so wisely that it currently has no debt. In fact, CAKE has $81 million in cash on the balance sheet. With profit margins of 5.13%, Cheesecake Factory is the envy of most restaurants, which often struggle to crack 3%.


With restaurants, you want to see a lot of free cash flow, which allows them to expand. The company also is consistent in this regard, with FCF of $125 million to $150 million being regularly created each year. And while CAKE got hit with a 20% earnings haircut in 2009, it doubled those earnings in 2010. The company seems fairly priced at 16 times earnings, but I will say that's about half of what I remember seeing it at in the past.


P.F. Chang's China Bistro (PFCB) offers up a totally different food selection that also has proven, in my experience, to be consistent. Yet interest in its menu seems to be waning. This, of course, is the other big problem with concept restaurants. What if people just get tired of your food? Restaurants, like clothing retail, can be a fickle business.


Indeed, P.F. Chang's actually saw a 20% increase in 2009 net income, but then only grew 7% in 2010, with earnings expected to be flat in 2012. Still, analysts think things will pick up to the tune of 13% annualized growth going forward. But at 20 times earnings, I think you're paying way too much for Chinese food.


You probably never have heard of Brinker International (EAT), but I bet you are familiar with its Chili's brand, which boasts more than 1,500 worldwide locations. While Chili's is a more downscale restaurant than the others above, it is worth noting that Chili's menu is much more diverse and so appeals more broadly. It also suggests that the company would be less likely to struggle in tough financial times. And in fact, it didn't -- EAT grew earnings an amazing 30% in 2009, another 36% in 2010, and is on track to grow 21% in 2011, and another 15% in 2012. Wow!


Brinker does this with a half billion in debt, but more than $225 million in annual free cash flow. Yes, growth is slowing, with projected long-term growth of 13%. However, when you look at EAT stock trading at 13 times earnings and consider its competitors, one might do well eating at Brinker's trough.


That is, unless you prefer faster food...

As of this writing, Lawrence Meyers did not hold a position in any of the aforementioned stocks.


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