Investors get a taste for restaurants

The Bottom Line: Industry stocks are up thanks to sales improvement and tax reform, but they lag the broader markets.

The Bottom Line

This might be a good year for the restaurant industry, but so far investors are hedging their bets.

Restaurant stocks are up nearly 4% so far this year, according to the S&P 500 Restaurants Index. That continues a relatively strong showing started late last year.

But that is far behind the broader markets, which have been on a major rally so far in 2018. The S&P 500 index, for instance, is up more than 9% this year alone amid a continued rally on Wall Street.

Still, restaurant stocks overall are up 26% over the past year, ahead slightly of the broader markets over that period. Much of that has been spent on larger names, such as McDonald’s and Yum Brands, while smaller names have struggled.

In general, restaurants have a lot of wind at their backs. Tax reform, in particular, promises to boost many chains’ profits, which helped fuel some late-year increases in industry stocks in 2017.

In addition, the industry could be set for some stronger sales in 2018. Tax reform could fuel some sales this year. And weak sales in 2016 and 2017 should make for easier expectations.

Indeed, a number of companies have flourished on Wall Street early in 2018 thanks to improving sales trends.

Wingstop stock is up 18% this year, largely after announcing that same-store sales grew 5.2% in the quarter ended Dec. 30. Likewise, Denny’s stock is up nearly 13% after reported 2.2% same-store sales growth in the quarter ended Dec. 27.

Investors are starting to gain faith in Chipotle’s comeback, meanwhile. It is up 13% so far this year.

Likewise, Papa John’s International is up 17% so far this year.

Both Chipotle and Papa John’s recently opted to replace company founders who were their CEOs—Steve Ells, at Chipotle, chose to leave last year, and the company is still searching for a replacement; Steve Ritchie is replacing John Schnatter at Papa John’s.

That might be coincidence. It’s also possible tax reform could be bolstering investor enthusiasm about profits in future years. Restaurant operators are certainly enthused about the prospects for improved profits this year.

But some big-name stocks that carried the industry in 2017 are at high valuations, and investors are wary of paying much more for them. Analysts are notably bullish about McDonald’s, for instance, whose stock rose 40% in 2017 but is up only slightly so far in 2018 in advance of the company’s fourth quarter earnings announcement set for next week.

And some chains that have reported difficult sales have been punished. Dave & Buster’s, which had been one of the stronger performing restaurants on Wall Street, is down more than 9% this year after saying same-store sales were down 5.1% in the fiscal fourth quarter through Jan. 6.

There remains plenty of skepticism about broader market improvement, which is certainly understandable.

That’s because many of the same challenges that likely hurt sales the past two years haven’t gone away. The industry is still full of restaurants, and many chains are aggressively adding units. Pricing remains a problem as labor costs go up, forcing operators to raise prices even as grocers keep theirs steady.

And competition from independents and prepared food at convenience stores and supermarkets also threatens to take away some business.

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