NEW YORK (
) -- The restaurant sector is poised for moderate growth this earnings season as uncertain economic times leaves consumers keeping a close watch on their limited discretionary funds.
Despite tepid expansion, some analysts remain optimistic for the short-term. "The combination of "still-recovering sales and still-benign costs (both food and labor)" makes for "a positive backdrop to
third quarter of 2010 results," noted Deutsche Bank analyst Jason West.
Stifel Nicolaus analyst Steve West said that "easy comps and extensive cost savings should offset strained sales from depressed consumer spending, boosting restaurant
third-quarter 2010 earnings-per-share growth of 6% (though still less than 10% on average)."
DB's West noted that "combining a fragile recovery and rising food costs with reasonably full valuations, suggests investors need to be selective when picking restaurant stocks." He recently downgraded shares of
Burger King Holdings
Chipotle Mexican Grill
Here then is a look at analysts' top restaurant stock picks.
Buffalo Wild Wings
Buffalo Wild Wings
is a top pick of DB's West.
He likes Buffalo Wild as the dominant player within the "sports bar" niche, noting that it has the highest new unit growth among casual dining chains, growing 13% annually, compared with industry average growth of 1% to 2%. The growth model carries lower-than-average risk because of a balanced mix of company- and franchise-operated stores.
Favorable chicken wing costs should help pad the wing-and-beer purveyor's operating margins through the first quarter of 2011, he added. West also likes Buffalo Wild's clean balance sheet, with $69 million in cash and no debt.
is DB's West's other top pick in the sector.
He said Wendy's Arby's is a good buy because it's one of the cheapest stocks in the group on an EV/EBITDA (enterprise value over earnings before interest, tax, depreciation and amortization) basis with a multiple of 6.7 times, compared with industry average 7.9 times. By comparison,
and Burger King Holdings have a combined average of 9.6 times.
He said the Wendy's brand is worth a conservative $4.40 per share. The Arby's brand's sales are approaching a bottom, and the analyst raised his same-store-sales forecast on the brand concept known for roast beef sandwiches. Wendy's comps should be flat-to-up slightly in the third quarter, the analyst noted, in line with forecasts, while Arby's comps will be down slightly.
Another upside is that expectations are low for Wendy's Arby's, given that management guided down for the second half of the year. Look for commodity costs to be a headwind, but comparisons will be easier in 2011, he added.
Investors should also keep a watchful eye on rumors that have been circulating on Wall Street that
Wendy's could be ripe for a private equity buyout.
The stock was down 4.7% year-over-year before speculative rumors hit The Street in mid-October. At such a low price point, Wendy's is likely viewed as a potential bargain for private equity groups willing to take it over and attempt to turn its operations around for the better.
Morningstar analyst Joscelyn MacKay noted that Wendy's is indeed a ripe takeover target and may be next to be taken private, adding that a Wendy's buyout remains purely speculative while conceding that the company said in a June regulatory filing that it had received a third party inquiry about a possible deal.
West noted that Wendy's is "one of the best values" in the restaurant space.
Ruth's Hospitality Group
DB's West also tapped
Ruth's Hospitality Group
as "interesting" for investors looking to own smaller names like the high-end steakhouse. The operator of Ruth's Chris Steak House restaurants has a market cap of $157.2 million.
"We believe RUTH deserves at least an in-line multiple given early signs of improvement in sales trends, easy compares, substantial room for margin upside relative to prior peaks, and a high free cash flow yield," the analyst said. A risk with Ruth's stock, however, is that its relative dependence on business-related spending, which could continue to chug along at a sluggish pace due to macroeconomic issues.
DB's West has a buy rating on McDonald's as well, and advised investors to focus on September-October comps, especially in Europe. September same-store sales should grow 3.6% globally, with 3.5% growth in the U.S. and Europe, and 4% growth in Asia Pacific, Middle East and Africa.
"We expect Europe to settle into a range of +3-4% in coming months as menu pricing, remodels, breakfast/drive-thru expansion, and McDonald's dominant competitive positioning drive healthy comps, despite some macro headwinds," he noted.
Stifel's West has a $77.32 price target on MCD shares, noting the Golden Arches "continues to pace the industry in sales and operating performance around the world."
He's looking for 5% comps growth in the U.S., 4% in Europe and 8% in APMEA.
The analyst noted that investors can expect 2.5% to 3% total revenue growth, year-over-year, including the impact of foreign exchange, and 40 to 45 basis points operating margin increase on lower labor and operating costs, leveraged by same-store sales momentum and cost controls.
Stifel's West also expects McDonald's to "continue its aggressive share repurchases " in the fourth quarter of 2010 and into 2011.
Janney Capital Markets analyst Mark Kalinowski also has a buy rating on McDonald's and an $83 price target. He sees comps improving in the U.S., and expects September revenue will rise 2% to 6.1%; October revenue figures will rise 2% o 5.7%, he noted.
Kalinowski forecast third quarter earnings to come in at $1.27, 3 cents above the consensus call.
Stifel's West's top EPS growth picks for third quarter are those with the best fundamentals, namely
and Chipotle Mexican Grill. He said quick-service names like
Jack in the Box
, restaurant concepts more highly exposed to rising ground beef costs and highly unemployed demographics, are likely to weigh on the overall group.
He has a $91.08 price target on Panera shares, and forecast revenue growth of 14% to 15% in the quarter, including nearly 5% unit growth, led by nearly 7% company growth and 3.5% franchised units.
Same-store sales are expected to grow 6% to 7%.
DB's West also likes Panera, expecting the sandwich and salad shop to book earnings per share of 74 cents for the second quarter, higher than the company's own guidance. He sees "solid" same-store sales trends, conservative margin assumptions for the second half of the year and the possibility of future buybacks paving the way toward upward revisions.
He expects wheat commodity prices to be flat in 2011, removing higher ingredient costs as a concern. Stifel's West added that lower wheat costs and "relatively flat other food costs plus moderate price increases and introduction of higher ticket items should lead to improved operating margins by 30 to 35 basis points."
-- Written by Miriam Marcus Reimer in New York.
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