MorningWord 2/20/15: Fast Food Nation

by Dan February 20, 2015 9:34 am • Commentary

A prevailing market theme heading into Q4 reporting season was that lower gas at the pump would be a boon to middle and lower middle class Americans, manifesting itself in increased sales for discretionary items.  One consumer sub-sector that seemed like an obvious beneficiary of the oil “tax cut” would  be Fast and Quick Serve restaurants, but Q4 results and forward outlooks by many who have recently reported tell a slightly different story.

Last night on CNBC’s Fast Money we had the CEO of Red Robin, Steve Carley on to discuss their recent results and he hit on two things that caught my attention. First, the increase in beef costs and the company’s inability to pass through these costs to consumers, and second that it’s only been very recently that he has seen data suggesting consumers are spending more savings from lower gas. What would happen if gas prices were to increase and food costs were also to remain high or increase? Watch here:

The take-away for me is that higher end Quick Serve restaurant chains like Red Robin (RRGB) are very much weighing on lower end chains like McDonalds (MCD) & Yum Brands (YUM), as they offer value meals like $6.99 burgers with bottomless fries (as mentioned in the interview) for supposed much higher quality products.   Additionally Carley refereed to “data” that restaurants are benefiting from increased discretionary spending, but did not speak to their own specific data. I thought the response was squishy at best, and the recent results from Chipotle (CMG), Cheesecake Factory (CAKE), MCD, and Panera (PNRA) possibly tell a different story.  Most notably the dramatic one day declines following recent earnings results from CAKE & CMG down 7%, PNRA down 11% (and Noodles NDLS down more than 20% today) suggest that the perceived benefit of lower gas at the pump may only be offsetting other negative consumer trends for the industry. There have been recent success stories in the space, with stocks like Dominoes Pizza (DPZ), Jack in the Box (JACK), RRGB & Starbucks (SBUX ) all at or near all time highs, but they seem to be outliers.

Of the stocks that trade well, I think it is safe to say that SBUX is a very unique story where its core product is a cross between discretionary and staple. Prying that half caf vente latte out of consumers’ hands won’t be easy. Mommy needs her coffee.

Another of this latter group of restaurants that I am a bit skeptical of (given YUM’s recent commentary on Pizza Hut) is DPZ.  When YUM reported two weeks ago their Pizza Hut segment posted the slowest growth among Taco Bell and KFC, stating in their earnings release:

  • Pizza Hut Division system sales increased 1%, driven by 2% unit growth and offset by a 1% same-store sales decline. Restaurant margin decreased 3.5 percentage points to 8.2%. Operating profit decreased 13%.

If your watched the Super Bowl, it was apparent that Pizza Hut did their best to re-position their product to be more of a higher quality more tech-centric solution, as DPZ has done over the last couple years.  DPZ shareholders have been rewarded with the stock up 45% from the 52 week lows in August, trading a couple % from the all time highs:

[caption id="attachment_51124" align="aligncenter" width="600"]DPZ 1yr chart from Bloomberg DPZ 1yr chart from Bloomberg[/caption]

The stock is obviously overbought, and given the fact that it trades at 35x trailing earnings and 30x expected 2015 earnings growth of 19% the stock is also priced to perfection with expected sales growth of only 6%.

The company reports Q4 results Tuesday prior to the open, the options market is implying almost a 5% one day move, which is basically inline with the 4 qtr move which was skewed, by last quarters 11% rise.  This one is on our radar, and a rise in gas prices coupled with increased food costs could cause investors in stocks like DPZ to hit the pause button.