Updated on June 28th, 2019 by Bob Ciura
After a few years of decline, the restaurant industry is on its way back to growth. The steady U.S. economic growth has fueled rising traffic and sales across the restaurant space, although not all restaurants are thriving. The industry remains highly competitive, with casual restaurants facing particularly fierce competition from newer, fresher concepts.
You can download a free Excel spreadsheet of our list of ~100 restaurant stocks (with metrics that matter) by clicking the link below:
However, McDonald’s stock is significantly overvalued today, and does not rank as a buy in the Sure Analysis Research Database.
While we currently do not rate McDonald’s a buy, there are many restaurant stocks that have higher expected rates of return over the next five years. Due to a combination of valuation, EPS growth, and dividends, the following stocks represent our top 5 picks in the restaurant industry now.
Table of Contents
The 5 best restaurant stocks are listed below in order of total expected returns over the next 5 years, from lowest to highest.
- Wendy’s Company (WEN)
- Domino’s Pizza (DPZ)
- Jack in the Box (JACK)
- Dine Brands Global (DIN)
- Darden Restaurants (DRI)
Restaurant Stock #5: Wendy’s Company (WEN)
Wendy’s is the third-largest hamburger quick-service restaurant chain in the world, with more than 6,700 restaurant locations globally and a market capitalization of $4.5 billion. More than 90% of the company’s locations are in the United States.
On May 8th, 2019, Wendy’s reported their first-quarter results. The company grew its global sales by 3.3%. Net restaurant openings were slightly negative with one net closure for the quarter. North America same-restaurant sales growth, which measures sales at locations open at least one year, came in at 1.3% for the quarter, while global systemwide sales increased 2.3% year-over-year. Adjusted earnings-per-share of $0.14 jumped 27% over the prior year, primarily due to increased adjusted EBITDA and fewer shares outstanding.
Source: Earnings Presentation
For 2019, Wendy’s expects 1.5% growth in net store count, 3.0%-4.0% sales growth and 3.5%-7.0% adjusted earnings-per-share growth. Future growth will be generated by new services, such as delivery. About 80% of its North American stores are expected to offer delivery services by the end of this year, up from 60% at the end of last year. They are expecting to roll out mobile ordering across North America by the end of 2019.
Share repurchases are another driver of Wendy’s EPS growth. In the last five years, Wendy’s has reduced its share count by 39%. Given the current 1.5% net store count growth, low-single digit same-store sales growth in the upcoming years and some share repurchases, Wendy’s can be reasonably expected to grow EPS at a 7% average annual rate in the next five years.
Wendy’s stock trades for a 2019 price-to-earnings ratio of 31. The stock has traded at an average price-to-earnings ratio of 28.7 over the last decade. Our fair value estimate is a P/E ratio of 25. If the stock approaches its fair P/E ratio over the next five years, it will incur a 4.2% annualized drag due to contraction of its valuation level.
The combination of 7% annual EPS growth, P/E contraction of 4.2% per year, and the current dividend yield of 2% result in expected total returns of 4.8% per year through 2024. Wendy’s earns a hold recommendation from Sure Dividend.
Restaurant Stock #4: Domino’s Pizza (DPZ)
Domino’s Pizza is the largest pizza company in the world based on global retail sales. The company operates more than 16,100 stores in over 85 countries. It currently generates 48% of its sales in the U.S. while 98% of its stores worldwide are owned by independent franchisees. Domino’s stock has a market capitalization of $11.5 billion.
In late April, Domino’s reported (4/24/19) financial results for the first quarter of fiscal 2019. The company continued its impressive trajectory of sales growth, generating global retail sales growth of 4.6%, U.S. same store sales growth of 3.9%, and international same stores sales growth of 1.8%. The company grew its store count by 200 in the quarter, net of store closures. The company grew its earnings-per-share by 10% year-over-year, due to revenue growth as well as a 5% reduction in its share count.
Domino’s has made significant growth investments over the past several years, which have paid off as the company maintains an excellent long-term track record. Last quarter marked the 101st consecutive quarter of positive international same store sales growth and the 32nd consecutive quarter of positive U.S. same store sales growth.
Source: Investor Presentation
We expect 13% annual EPS growth over the next five years, made up of 10% sales growth, 2% growth from buybacks, and 1.0% annual margin expansion.
Domino’s has ample room to keep growing moving forward. Its management sees potential for the addition of 5,400 new stores in its top 15 markets. Management expects to grow sales by 8%-12% per year for the next five years.
Domino’s has traded at an average price-to-earnings ratio of 21.1 over the last decade. Using our 2019 EPS estimate of $9.60, the stock is trading at a P/E ratio of 29 today. The stock is richly valued at current prices, relative to Domino’s historical average. If Domino’s P/E ratio reverts to its 10-year average over the next five years, this will reduce its total returns by 6.2% per year during this time period.
Annual EPS growth (13%) and dividends (0.9%) can offset the impact of overvaluation. Domino’s is close to a buy recommendation, but with expected total returns of 7.7% per year over the next five years, the stock remains a hold due to valuation concerns.
Restaurant Stock #3: Jack in the Box (JACK)
Jack in the Box is a fast-food chain that operates and franchises hamburger chains in the U.S., with more than 2,200 restaurants in 21 states and Guam. It has a market capitalization of $2.1 billion. Jack in the Box previously owned the Qdoba brand, but sold it to Apollo Global Management last year to focus on its core brand.
In mid-May, Jack in the Box reported (5/15/19) financial results for the second quarter of fiscal 2019. Its comparable sales increased 0.6% and its restaurant-level margin expanded from 26.4% in last year’s quarter to 27.6% thanks to the benefit of refranchising and lower maintenance expenses, partially offset by wage and commodity inflation. Operating EPS increased 24% for the quarter.
One of the company’s major growth catalysts is accelerating its drive through-only strategy. The company expects to roll out this model to 80% of system restaurants over the next three years.
Source: Investor Presentation
Management revised its guidance for same-store sales growth from 0%-2% to 0%-1% and reiterated its guidance for flat EBITDA this year. More importantly, on May 15th, Jack in the Box completed its review of strategic and financing alternatives. As the company did not sell itself, it will increase its leverage (Net Debt/EBITDA) to 5.0 in order to reward its shareholders via aggressive share repurchases. Over the next four years, management expects to return $1.0 billion to its shareholders in the form of dividends and buybacks.
Jack in the Box has repurchased its shares at an aggressive pace in the last four years. During this period, it has reduced its share count by 30%. Share repurchases will be a major component of future EPS growth. During the last decade, the company has grown its EPS at a 5.9% average annual rate. Given the strong level of buybacks, we expect the company to grow EPS by 7.0% per year on average over the next five years.
Jack in the Box is currently trading at a price-to-earnings ratio of 18.7, which is slightly higher than its 10-year average of 18.1. If the stock trades down to its average valuation level five years from now, it will incur a modest 0.7% annualized drag due to the contraction of its price-to-earnings ratio over this period.
The combination of EPS growth (7%), dividends (2%), and valuation changes (-0.7%) is expected to lead to annual total returns of 8.3% per year over the next five years. Jack in the Box earns a hold recommendation.
Restaurant Stock #2: Dine Brands Global (DIN)
Dine Brands Global (Dine Equity until early 2018) is a casual and family dining restaurants company that owns and franchises restaurants. Its brands include Applebee’s and IHOP. The company has over 3,600 restaurants in the U.S. and multiple international markets, and the stock has a market capitalization of $1.7 billion.
Dine Brands Global reported its first quarter earnings results on May 1. Revenue of $237 million increased 26% from the same quarter last year. The strong revenue growth was the result of higher royalties and franchise fees. Applebee’s comparable sales rose 1.8% year over year, while IHOP comparable sales were up 1.6% compared to the previous year’s first quarter. For the quarter, adjusted EPS soared 71% from the previous year’s quarter.
Dine Brands has engineered a remarkable turnaround over the past few years. Slowing sales at Applebee’s caused the company’s sales and earnings to suffer. It invested heavily in renovating restaurants, closing under-performing locations, and adding new items to its menu to win back customers. The turnaround effort also included a 35% dividend cut in February 2018.
However, Dine Brands is a rare example of a stock that performed extremely well after a dividend cut. Since the dividend cut, Dine Brands shares have increased over 50% in value. The company also raised its quarterly dividend by 9.5% in February 2019, another signal of its successful turnaround thanks largely to its return to growth at Applebee’s.
Source: Investor Presentation
During 2018 Dine Brands Global reported a solid sales growth rate at its existing restaurants, with the majority of that growth being generated from Applebee’s restaurants, where comparable restaurant sales rose by 5% year-over-year. Dine Brands Global’s franchisees are openings new restaurants while also closing down underperforming restaurants. The decision to close down underperforming restaurants will be positive in the long run, as this allows for focusing on more promising restaurants that generate higher margins.
IHOP restaurants delivered weaker comp sales growth than Applebee’s during 2018, but the IHOP restaurant count is rising due to new restaurant openings by franchisees. These new restaurants do not require any capital investment from Dine Brands Global. The low need for capital expenditures is why Dine Brands Global produces high free cash flows. Dine Brands Global generated free cash flows of $141 million during fiscal 2018. This strong cash generation allows the company to make dividend payments and to reduce the share count at the same time.
Dine Brands management expects 2019 to be another step forward in its transformation. For the full year, the company forecasts same restaurant sales growth of 2%-4%, while earnings-per-share are forecasted to fall into a range of $6.90 to $7.20, which would result in an earnings-per-share growth rate of ~31% for 2019.
With expected EPS of $7.05 for 2019, Dine Brands stock trades for a P/E ratio of 13.6, slightly below our fair value estimate of 15. A rising valuation multiple could add 2% to annual shareholder returns. Combined with 3.5% expected EPS growth and the 2.9% dividend yield, we expect total returns of 8.4% per year for Dine Brands stock over the next five years.
Restaurant Stock #1: Darden Restaurants (DRI)
Darden Restaurants Inc. is a restaurant company with a portfolio of brands including Olive Garden, LongHorn Steakhouse, Cheddar’s Scratch Kitchen, Yard House, The Capital Grille, Seasons 52, Bahama Breeze, and Eddie V’s. The company ended its fiscal year with over 1,700 restaurants in the United States and Canada, the vast majority of which are company-owned. Darden stock has a market capitalization of $15 billion.
On June 20th the company reported financial results for its fiscal fourth quarter and full fiscal year. For the fourth quarter, total sales increased 4.5% to $2.23 billion driven by the addition of 39 net new restaurants and a blended same-restaurant sales increase of 1.6%. Adjusted EPS from continuing operations increased 27%, due to sales growth, margin expansion, and share repurchases.
For the full fiscal year, total sales increased 5.3% to $8.51 billion due to 39 net new restaurants and a blended same-restaurant sales increase of 2.5%. The best-performing brands for Darden in fiscal 2019 were Olive Garden, LongHorn Steakhouse, and The Capital Grille which each grew same-restaurant sales by 3% to 4%. Eddie V’s grew same-restaurant sales by 2.8% for the fiscal year.
Source: Earnings Presentation
The company’s remaining brands all posted declines for fiscal 2019. Adjusted EPS from continuing operations increased 21% for fiscal 2019.
For the upcoming fiscal year, Darden expects total sales growth of 5.3% to 6.3%, including 2% growth from a 53rd week. Same-restaurant sales growth is expected at 1% to 2%, while Darden expects to open 44 to 50 net new stores. Diluted EPS from continuing operations is expected in a range of $6.30 to $6.45 for fiscal 2020. We expect annual EPS growth of ~10.3% through 2024.
At the midpoint of EPS guidance, Darden is likely to generate EPS of $6.37 in fiscal 2020. Based on this, the stock trades for a P/E ratio of 19.1. Our fair value estimate is a P/E ratio of 16, which is equal to the 10-year average valuation. A declining P/E ratio would reduce annual returns by 3.5% per year.
Along with its recent earnings report, Darden increased its dividend by 17%. The forward annual payout of $3.52 per share represents a 2.9% yield. As a result, total expected returns for Darden are 9.7% per year, making Darden out top-ranked restaurant stock today.