What’s The Deal With These Expensive Restaurant Stocks?

By: Spencer Israel

 McDonald’s ($MCD) has the PLT. Popeyes ($PLKI) has the spicy chicken sandwich. Wendy’s ($WEN) has breakfast (again).

All of these new menu items have customers on Main Street buzzing. But on Wall Street, there’s an entirely different group of restaurants that have investors lining up for more.

The price-to-earnings ratio tells us which stocks trade at the highest premium relative to their earnings. Restaurants are generally slightly more expensive than the broader market, meaning they have slightly higher P/Es. The current P/E ratio for the S&P 500 is 21.91, while the average for the restaurant industry is around 34.

There are six restaurant stocks that trade with extremely high P/E multiples, dwarfing the industry average. And of those six, there are three in particular that have dramatically outperformed the broader market in 2019: Shake Shack ($SHAK), Wingstop ($WING), and Chipotle ($CMG).

These three stocks have P/E ratios of 184, 130, and 92 respectively. (Because not all of these companies have given future earnings projections, we’re using trailing P/E as opposed to forward P/E.) Even Domino’s ($DPZ), which would love for you to think of it as a tech company, trades at a relatively low P/E of 27 compared to this group.

So, what gives? Why are investors willing to pay so much more for Shake Shack earnings than a stock like McDonald’s (and its P/E of 27)?

Part of it comes down to how these stocks are categorized. Shake Shack, Wingstop, and Chipotle are in the fast-casual group—the high-growth segment between fast food and casual dining that has exploded in popularity in the last decade-plus.

But these high valuations really come down to one thing: expectations of growth.

Same-Stores Sales Growth

All three companies have shown a propensity for growth in recent years, but none more so than Chipotle.

After the stock endured three years of punishment due to food safety concerns, it has rebounded to become the gold standard for restaurant stocks as growth stories. Since bottoming out in February 2018, the stock is up 230%.

Same-store sales—the measurement of sales growth from locations open for at least 12 months—rose 10% in Q2 2019, the biggest increase for the restaurant chain since Q1 2017 and well above the 8.3% consensus estimate. Online sales, one of the biggest growth drivers in the industry right now, nearly doubled in the second quarter, accounting for 18.2% of total revenue.

Chipotle’s same-store sales growth in Q2 was the second-best of any restaurant, according to Wells Fargo. Only Wingstop’s 12.8% increase was higher.

Speaking of Wingstop, shares of the wing chain are up 166% since the start of 2018. Management has said they expect to grow their domestic locations from 1,100 to 3,000, including 2,000 new units in the top 25 markets. In a note to clients in June, Stifel said they believe sales growth will remain in the mid-to high teens for the foreseeable future due in part to this expansion.

But while both of these stocks have had outstanding 2019’s, they pale in comparison to Shake Shack. Its 107% increase in 2019 makes it the best performer of the group.

In its most recent earnings report on August 5, the burger chain raised its full-year 2019 sales growth guidance from 25-27% to 27-28%. Investors also liked the 3.6% same-store sales growth (above analyst estimates) and the announcement of Shake Shack’s delivery partnership with Grubhub ($GRUB).

Bullish Analysts

Despite their high valuations, this trio of stocks has received a lot of love from sell-side analysts, with the majority leaning neutral-to-bullish (though most would admit these elevated prices don’t make for good buying opportunities). Since July:

  • Of 11 ratings, Shake Shack has received four Buys, seven Holds, and no Sells
  • Of 24 ratings, Chipotle has received 12 Buys and eight Holds, and Four sells
  • Of 12 ratings, Wingstop has received five Buys and seven Holds

Goldman Sachs exemplifies this bullish attitude. The firm-initiated coverage of Chipotle, Shake Shack, and Wingstop (as well as McDonald’s and Starbucks ($SBUX)) with Buy ratings in July, adding Chipotle to Conviction Buy list.

The question investors have been asking is how long the run in this group—we’ll call it ChipWing Shack—can continue. All three stocks stopped making new highs with the early September rotation from growth to value but continue to trade at valuations well above their peers. A weak August consumer spending reading certainly isn’t a great sign. But it will take more than some weak economic data—such as lower same-store sales, digital sales, or openings—to put a damper on these story stocks.

The author has McDonald’s, Starbucks, and Chipotle in his 401(k) via a large-cap mutual fund.

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