Restaurants - The DARK SIDE of the earnings season

Select restaurant companies have crushed the Q1 recession educed estimates and raised guidance from the Armageddon forecast given last December!  Now we need to keep in mind that business is still soft!


Restaurant industry valuations are significantly higher in a very short period of time.  Looking at EV/EBITDA valuations across the restaurant landscape, it would appear that some companies may even be factoring in “growth” again! Right now the average casual dining chain is trading at 6.4x EV/EBITDA.  We may have hit a 4 handle in December 2008.


With another big week left in the earnings season, I don’t want to fight the tape yet, but this is what I don’t get!  This week we saw massive run ups on cost reductions and “less bad” sales trend.  That is all good!


The upside to the “Great recession” is lower commodity prices and less labor pressure.  Believe me, the restaurant industry needs the help but margins will only improve so much in a declining sales environment.  I guess you just lay off everyone but the servers and a cook to keep it going... we need the top line to come back!    


The dark side to the massive cost reductions implies zero (or little) growth!  If this is the case going forward, and then company XYZ earns a buck, then another buck next year and a buck after that – you get the picture.   Why does that make a stock go up?  I guess we want to pay more and more for the same dollar?


The easy answer is a massive short squeeze on the “stabilization cut the fat” trend – things are bad, but not getting any worse cover the short!  


If this is true, then should we expect a big fade?  Usually the advice is to sell restaurants stocks in the spring.  I don’t think this is a bad idea. 


Let’s take CAKE for example.  The stock is up 259% from its 52 week low and 76% year-to-date.  On Friday the stock was on up 19% on a “stabilization cut the fat quarter.”  After CAKE reported earnings on February 12, the stock traded as low as $7 and was trading at 4.8x EV/EBITDA.  Today the stock is $18 trading at 9.1X EV/EBITDA.  Remember in 2008 Bain paid roughly 9.5x for Outback Steakhouse in a booming economy!   That was a peak!


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