2 Stocks to Play the Rebound in the Restaurant Sector

It’s been a solid quarter thus far for the AdvisorShares Restaurant ETF (EATZ) and the restaurant index as a whole, with the ETF and the index up 9% and 17%, respectively, thus far in Q4, a significant outperformance vs. the S&P-500 (SPY).

This outperformance can be attributed to the fact that many restaurant stocks were priced very attractively heading into Q4 after a violent 18-month bear market and because gas prices have been trending lower and inflation looks to have peaked, which both benefit restaurant brands.

The reason? Restaurant food traffic is sensitive to gas prices which impact discretionary budgets, and food costs and labor costs have been rising for two years, pinching the margins of many restaurant brands.

Unfortunately, while some names like Restaurant Brands Intl (QSR) are sitting at 52-week highs, others have remained under pressure, and Jack In The Box (JACK) and Dine Brands (DIN) are two examples of names that haven’t participated much in the recent rally. Given that both are well-run and trading at attractive valuations, I believe both make solid buy-the-dip candidates.

Jack In The Box (JACK)

Jack In The Box is a small-cap stock in the restaurant sector, with two brands, including Jack In The Box and Del Taco, after completing the $585MM acquisition earlier this year.

Unfortunately, the stock has lost over $300MM in market cap since the deal closed in March, with this attributed to weaker restaurant-level margins at both brands of 16.2% and 15.9%, respectively (Jack In The Box/Del Taco). At Jack In The Box, this represented a 390 basis point decline year-over-year, impacted by higher food, labor, electricity, and paper costs.

In the company’s most recent quarter (fiscal Q4), it reported revenue of $402.8MM, up 45% year-over-year, but this was largely due to the new contribution from Del Taco that made the results look much better.

Meanwhile, on a same-store sales basis, same-store sales were up just 4% at Jack In The Box and 5.2% at Del Taco in fiscal Q4, suggesting meaningful traffic declines when factoring in double-digit pricing.

This is not the end of the world, and the rest of the industry is also seeing traffic declines, but it is a little disappointing, given that the quick-service and fast-casual brands have been outperforming casual dining.

Hence, I expected a little stronger results from Jack In The Box.

While this certainly isn’t ideal, and another tough year could be ahead with inflation remaining sticky, the good news is that inflationary pressures are finally easing.

Meanwhile, gas prices remain well below $4.00/gallon, and Jack In The Box is a value option for consumers, suggesting that it should benefit from economic weakness (being a trade-down beneficiary).

Hence, the company is now up against easier year-over-year comps as it heads into FY2023 after a rough first year following its Del Taco acquisition, and we may see trough margins in H1 2023 for the company.

The combination of easier comps and more robust results beginning in H2 2023 alone doesn’t mean we have an investment thesis. I would never buy stock simply because it’s up against easier comparisons.

That said, the valuation is starting to become more reasonable, with JACK trading at just ~10.5x FY2024 annual EPS estimates ($6.46) vs. a historical multiple of 17.0x earnings.

Even if we use a more conservative multiple of 14.0x earnings to adjust for the tougher environment, this translates to a fair value to its 18-month target price of $90.45.

So, if we were to see the stock dip below $59.00, where it would offer a 30% margin of safety vs. fair value, I would view this as a low-risk buy zone.

Dine Brands (DIN)

Dine Brands (DIN) fundamentally is a much stronger name and sports a $1.1 billion market cap. It is best known for its two iconic brands: Applebee’s and IHOP.

The company may be in the less desirable casual dining space that has suffered severe losses in foot traffic due to the pullback in consumer spending.

Still, Dine Brands has consistently outperformed its peer group from a same-store sales standpoint, and it is unique in the fact that it has an entirely franchised model, meaning that while it does suffer from inflationary pressures and traffic declines, this impact is much more muted than those companies that operate their restaurants and are taking the full brunt of rising food, packaging, and labor costs, like Brinker (EAT).

Unlike Jack In The Box, which had a rough year and is more of a turnaround story, Dine Brands has had a very solid year. And while annual EPS is expected to decline ($6.14 vs. $6.54 in FY2021), it remains just shy of pre-COVID-19 levels ($6.95) and is expected to hit new all-time highs in FY2023 at $7.10.

However, the stock has unfortunately been painted with the same negative brush as its peers, given that sentiment is so poor on the casual dining space.

In my view, this is a case of the baby being thrown out with the bathwater, and if we look out longer-term to FY2024 estimates, Dine Brands is expected to see annual EPS climb to $7.95 per share, 13% above pre-COVID-19 levels.

Historically, Dine Brands has traded at ~16.0x earnings, a far cry from its current valuation of ~11.1x earnings. Even in the tougher environment, I believe the company can easily justify a multiple of 13.0x earnings based on its fully-franchised model but offset by its lower unit growth rate than some of its peers.

Using FY2024 estimates of $7.95 translates to a fair value of $103.40 to its 18-month target price, representing a 52% upside from current levels.

The company is paying an attractive 3.0% dividend yield as a kicker.

So, if I were looking to add exposure to the restaurant space, I see DIN as a Buy below $65.00 for an initial position, and I would not be surprised to see the stock trade back above $85.00 within the next year, translating to a better than 30% total return.

While several of the better names in the restaurant sector have already enjoyed strong rallies off their lows, Dine Brands is a clear exception and one name that continues to sit at depressed levels despite solid execution.

Meanwhile, Jack In The Box’s pullback is partially justified, but further weakness should set up a low-risk buying opportunity, assuming the stock heads to new lows below $59.00, which might trigger panic selling among weaker hands.

In summary, I see DIN’s low-risk buy zone at $66.00, with JACK’s at $59.00, and if I were looking for exposure, these two names look like interesting buy-the-dip candidates on further weakness to play an extended rebound in the restaurant sector over the next 18 months with headwinds finally easing.

Disclosure: I am long QSR

Taylor Dart
INO.com Contributor

Disclaimer: This article is the opinion of the contributor themselves. Taylor Dart is not a Registered Investment Advisor or Financial Planner. This writing is for informational purposes only. It does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Taylor Dart expressly disclaims all liability in respect to actions taken based on any or all of the information in this writing.