4 Restaurant Stocks To Avoid As Environment Remains Tough

The U.S. restaurant industry is facing a tough operating environment with factors like rising labor costs, increasing employee turnover, declining traffic and higher non-discretionary spending weighing on the sector. In fact, earlier this month, Moody's Investors Service revised its outlook for the U.S. restaurant industry from positive to stable. Industry operating income growth is now expected to increase 2% - 4% in the next 12-18 months instead of Moody's earlier forecast of 5% - 6%. Rising labor costs will become an even bigger issue once commodity prices start increasing.

Meanwhile, a TDn2K report published earlier this month indicates that Oct 2016 same-store sales growth was -0.9%, making this the eighth consecutive month of declining sales. Increasing costs are an issue with the use of promotions, discounts and similar inducements expected to remain high. According to Moody’s, it will be difficult to raise prices without impacting traffic.

Even though economic activity has been decent, more is being spent on non-discretionary items like healthcare than on eating out. Moreover, cheaper grocery bills and rising dining out costs are ensuring that people eat at home instead of in restaurants. As per data released last week, the food at home index has declined 2.3% over the last 12 months representing the largest 12-month decline since Dec 2009. In contrast, the index for food away from home rose 2.4% over the last 12 months.

While casual dining is expected to be the most impacted category within the restaurant industry, fast or quick casual restaurants are likely to outperform the restaurant industry as a whole. Meanwhile, the traditional QSR sector will remain affected by uncertain spending habits. According to Moody’s, the gap between the better players and those lagging the market will continue to grow.

Retail - Restaurants Industry Price Index

(Click on image to enlarge)

Retail - Restaurants Industry Price Index

Stocks to Avoid

Given this backdrop, this may be the right time for investors to reshuffle their portfolio and consider avoiding restaurant stocks that currently hold an unfavorable Zacks Rank #5 (Strong Sell) or #4 (Sell) and are witnessing downward estimate revisions.

Noodles & Company (NDLS - Free Report) : NDLS, which develops and operates fast casual restaurants that serve noodle and pasta dishes, soups and salads, reported a higher-than-expected loss in the third quarter. The company also lowered its outlook for the year and is seeing major estimate revisions. While loss estimates for 2016 have gone up by 63.6% over the last 30 days, 2017 loss estimates have also gone up considerably.

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