Is Darden's Bad Quarter a Sign of Restaurant Stocks' Bubble Popping?

NEW YORK (TheStreet) -- Darden Restaurants' (DRI) worse-than-expected fourth quarter results are evidence that the restaurant-stock bubble may be popping. Darden, which recently announced the controversial sale of its struggling Red Lobster chain to Golden Gate Capital for $2.1 billion -- too cheap a price, in my opinion  -- missed the 94-cent consensus earnings estimate by 10 cents, on revenue that was in line with estimates.

Darden shares opened lower and are down 2.2% as of 11:30 a.m. and nearly 11% year to date. Shares are in the $48.40 range.

DRI Chart

DRI data by YCharts

The primary culprit for the shortfall was rising costs. Cost of goods sold -- which includes food, labor, and other restaurant expenses -- rose from 78.1% of sales for the same quarter last year, to 79.8% this quarter. Same-store sales were also weak at the company's flagship brands, falling 3.5% at Olive Garden and 5.6% at Red Lobster.

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The major question is whether the rising-cost theme will continue to play out in restaurant land, cutting margins and/or increasing costs to consumers.

We've already seen the prices of former dollar-menu items at McDonald's (MCD) and value-menu items at Wendy's (WEN) rise precipitously. While an increase from 99 cents to $1.39 for a Wendy's Jr. Cheeseburger Deluxe (a favorite of mine) may seem trivial, that represents a 40% increase. That's an extreme example, but other chains like Chipotle (CMG) have also recently said that they'll be raising prices. 

Some of the storm clouds for the industry are already here, and there are more on the horizon.

First, food prices are on the rise. Despite the rather benign inflation numbers presented by the Consumer Price Index, food prices are rising precipitously. According to the Bureau of Labor Statistics, the prices of meats, poultry, fish and eggs hit an all-time high in May and have risen 7.7% year to date.

Second, labor costs may also be on the rise, given the growing pressure to raise the minimum wage, the prospect of which could greatly affect the restaurant industry.

Restaurant stocks as a whole have enjoyed a great run the past five years, and shareholders have been well rewarded. A basket of 40 restaurant stocks I track has returned an average of nearly 30% per year for the past five years.

However, valuations, in my opinion are stretched. That same group now trades at about 40 times trailing earnings.

With the prospect of rising costs, concern over consumer's ability or desire to pay more and rich valuations, the bull market in restaurant stocks may be over.

Darden's results may just be yet another indication of what's to come for the industry.

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At the time of publication, the author held no positions in any of the stocks mentioned.

This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.

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