Boom in Restaurant Stocks Starts Getting Stale
Stocks of new restaurant companies may be where biotech issues were a year ago: At their speculative zenith, ready for a disastrous fall.
Like biotech last December, restaurant stocks have been stellar performers for nearly two years now. Investors have latched onto a handful of updated restaurant concepts--like steakhouses, salad bars and drive-thru burger joints--and bid the stocks’ values sky-high on expectations of phenomenal growth in the ‘90s.
Wichita, Kan.-based Lone Star Steakhouse, for example, made its initial public offering (IPO) of shares at $6.75 each last March. The stock has since rocketed 433% to $36 as of Friday, and now sells for 42 times its expected 1993 earnings per share.
In contrast, the average blue-chip stock sells for about 17 times next year’s expected earnings.
Closer to home, Santa Clara-based Fresh Choice Inc., which operates about two dozen soup-and-salad restaurants mostly in Northern California, went public at $13 on Dec. 9 and now sells for $23.50--about 75 times the 30 cents a share it has earned over the past 12 months.
And in a related genre, there’s Starbucks Corp. of Seattle, the trendy coffee house/retailer whose stock has jumped from $17 at its June IPO to $36.75 now.
Of course, shareholders of these chains insist their stocks are worth such high price-to-earnings multiples for one simple reason: They expect the companies’ earnings growth over the next few years to far exceed the paltry 15% to 20% best-case annual earnings gains of blue chip firms, such as those in the Standard & Poor’s 500 index.
Robert Mescal, analyst at New Issues newsletter in Fort Lauderdale, Fla., says wild demand for small stocks in general and restaurant stocks in particular reflects investors’ frustration with the subdued outlook for struggling large companies--many of which had been the stars of the 1980s.
“People are looking for places to make money, and you sure as hell can’t make it in the S&P; 500,” given those companies’ collective outlook, Mescal says.
In the search for better ideas, perhaps no sector of the restaurant field has captivated Wall Street more than the steakhouse. Investors believe they can smell a sure winner in the aroma of burning fat that is creating long lines at Lone Star and its competitors.
For whatever reason, baby boomers are hot to eat red meat again, cholesterol warnings to the contrary. Outback Steakhouse Inc. of Tampa, Fla., for example, saw its earnings zoom 94% in the first nine months of this year, to 35 cents a share from 18 cents a year earlier, thanks to booming sales and the addition of new stores.
But with each new entry into the already crowded restaurant field, the current mania for these stocks begins to resemble all of the restaurant-stock manias that have preceded it. And there have been plenty of them, all terminating in the same fashion--with most of the stocks crashing to earth.
Remember Minnie Pearl’s Chicken? It was a fast-growing chain of the late-’60s, seemingly a sure bet to emulate the success of Kentucky Fried Chicken. But it didn’t take long for Minnie to unplug her deep-fryer.
Ditto for a long list of other faddish restaurant chains that in their heyday fascinated Wall Street, at least for a brief moment.
Craig T. Weichmann, restaurant-industry analyst at brokerage Morgan Keegan & Co. in Memphis, recently looked back on the last restaurant-stock mania, which occurred in the early-1980s. He found 42 then-fledgling restaurant chains that went public between 1980 and 1984.
Weichmann’s version of where-are-they-now is sobering:
* Fully one-third of the 42 failed, winding up either in liquidation or in bankruptcy reorganization, with virtual total losses to shareholders. The losers included chains like D’Lites of America and G. D. Ritzy’s, firms that had been “touted by brokerage firms as the next McDonald’s,” Weichmann says.
Other failures included “new, fresh concepts that turned stale after a few years, like Fresher Cooker, 1 Potato 2 and People’s Restaurants,” he says.
* Another third of the 42 were acquired by other companies, though not necessarily at a big premium to their share prices. Also, some of the acquisitions proved to be less than wise investments by the buyers. El Torito, for example, purchased by conglomerate W.R. Grace, survives today in a “smaller, less successful niche than had been hoped for in brighter times,” Weichmann says.
* The final third of the group of 42 still are publicly traded stocks. Of those, however, only six were trading above their original IPO prices when Weichmann wrote his report in September--a pathetic showing by any measure.
The few big winners from the restaurant class of the early ‘80s include Cracker Barrel Old Country, Brinker International (the Chili’s chain) and Ryan’s Family Steakhouse, Weichmann says.
Naturally, as each new restaurant chain has hit the market during the past two years, the brokerages selling the stocks inevitably have made comparisons to one of the few success stories, forgetting to mention the many duds.
Why do restaurant themes come and go so quickly? “You’re talking about an extremely competitive business,” says Jon Merriman of Merriman Capital Management in Beverly Hills, a small firm that targets overpriced stocks for “short selling,” a bet on falling prices.
Besides the simple fact that American consumers’ tastes change with the speed of light (steakhouses today, broccoli juice bars tomorrow?), Merriman notes that restaurant managers are at the mercy of wide potential fluctuations in food costs.
What’s more, if a restaurant chain franchises for growth’s sake, it risks losing control of whatever competitive edge it had in the first place, should franchisees not live up to the founders’ expectations.
That doesn’t mean there can’t be major long-term success stories in the current restaurant IPO crop, Merriman says.
But at this point in the cycle it’s a game with bad odds, he and others say: With the stocks already bid up to astronomical levels, any slowdown in the companies’ growth will bring the shares spiraling down.
It only took a few disappointments in biotech a year ago to finally burst that balloon. Result: Most biotech stocks plunged 20% to 30% or more in the first half of this year.
To buy high-flying restaurant stocks now is to play the Greater Fool Game: You know you’re a fool to pay such a high price, but you figure there’s a greater fool out there who’ll pay even more if you want to sell in a few months.
If you’re a short-term trader with nerves of steel and deep pockets, there may well be some money left in restaurant stocks. But if you’re a buy-and-hold investor, these are probably among the last stocks you should be adding to your portfolio now, many experts warn.
Between their stratospheric stock prices and the inevitably high mortality rate in the industry, the chance of a decent long-term payoff in new restaurants from this point is woefully tiny.
Restaurant/Coffee Stock Mania New restaurant and coffeehouse concepts have made exceedingly popular stock issues over the last two years--perhaps too much so. Here’s a look at the performance of eight such initial public offerings, or IPOs, and the stocks’ prices relative to expected 1993 earnings per share.
IPO IPO Fri. Pct. ’93 Restaurant/coffeehouse Date Price Price Gain P-E* Lone Star Steakhouse 3/92 $6.75 $36.00 +433% 42 Outback Steakhouse 6/91 5.00 27.75 +355% 41 Checkers Drive-In 11/91 5.32 22.00 +313% 41 Au Bon Pain 5/91 9.00 25.75 +188% 38 Sonic Corp. 3/91 12.50 28.25 +124% 24 Starbucks Coffee 6/92 17.00 36.75 +112% 73 Bertucci’s 7/91 8.67 18.25 +107% 23 Quantum Restaurant 6/92 10.00 16.25 +63% 17
*Stock price divided by estimated 1993 earnings per share (analysts’ consensus estimate from Zacks Investment Research) All stocks trade on NASDAQ market. Source: Merriman Capital
