From fast food to fine dining, restaurants play a vital societal role. But the side dish is that they’re quite difficult to operate because high inventory and labor costs generally lead to thin margins at the store level. This leaves little room for error if demand dries up, and it seems like the market has some reservations as the industry has tumbled by 5.9% over the past six months. This drop is a stark contrast from the S&P 500’s 11.1% gain.
Some companies can grow regardless of the economic backdrop, but the odds aren’t great for the ones we’re analyzing today. Taking that into account, here are three restaurant stocks we’re passing on.
CAVA (CAVA)
Market Cap: $8.2 billion
Starting from a single Washington, D.C. location, CAVA (NYSE: CAVA) operates a fast-casual restaurant chain offering customizable Mediterranean-inspired dishes.
Why Does CAVA Give Us Pause?
- Operating margin of 4.6% falls short of the industry average, and the smaller profit dollars make it harder to react to unexpected market developments
- Earnings per share have contracted by 15.6% annually over the last two years, a headwind for returns as stock prices often echo long-term EPS performance
- Push for growth has led to negative returns on capital, signaling value destruction
At $70.52 per share, CAVA trades at 128.1x forward P/E. If you’re considering CAVA for your portfolio, see our FREE research report to learn more.
Denny's (DENN)
Market Cap: $321.4 million
Open around the clock, Denny’s (NASDAQ: DENN) is a chain of diner restaurants serving breakfast and traditional American fare.
Why Are We Out on DENN?
- Disappointing same-store sales over the past two years show customers aren’t responding well to its menu offerings and dining experience
- Subscale operations are evident in its revenue base of $457.2 million, meaning it has fewer distribution channels than its larger rivals
- High net-debt-to-EBITDA ratio of 5× increases the risk of forced asset sales or dilutive financing if operational performance weakens
Denny's is trading at $6.23 per share, or 15.3x forward P/E. Read our free research report to see why you should think twice about including DENN in your portfolio.
Red Robin (RRGB)
Market Cap: $73.65 million
Known for its bottomless steak fries, Red Robin (NASDAQ: RRGB) is a chain of casual restaurants specializing in burgers and general American fare.
Why Do We Think RRGB Will Underperform?
- Weak same-store sales trends over the past two years suggest there may be few opportunities in its core markets to open new restaurants
- Earnings per share have dipped by 19% annually over the past six years, which is concerning because stock prices follow EPS over the long term
Red Robin’s stock price of $4.10 implies a valuation ratio of 9.1x forward EV-to-EBITDA. Dive into our free research report to see why there are better opportunities than RRGB.
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