Below we highlight relatively new products and business models that are displacing the more traditional ones, as they appeal to both the Baby Boomer and Millenial generations.
- Tesla premium electric vehicles
- Chipotle’s food and preparation process
- Whole Foods’ holistic approach to selling food and health
- E-Cigs’ new experience for smokers
- LinkedIn redefining professional networking, recruiting and job searching
Baby Boomers and Millenials Converge
Consumers are constantly making decisions regarding the choice, purchase and use of products and service. As we have seen in this new consumer landscape, a product or service that can span two generations is a game changer. I’m the father of three wonderful children, two girls and one boy, who are all in fact Millenials. It is becoming more and more common that we enjoy shopping and eating out at the same places. And, while I would say that our taste in music differs, that statement may lack validity, as the Zac Brown Band and Jimmy Buffet have recently come together to perform “Knee Deep.” The point is, this Baby Boomer and Millenial convergence is fairly widespread.
Whole Foods is an example of a company that spans multiple generations and is driving incremental visits in large part to their multifaceted approach in which they seek to attract new and old consumers. The following quote from the CEO of WFM is highly indicative of this theme, which leads us to search for companies that are leveraging new business models, while avoiding companies with traditional business models that are coming under pressure:
“We were built by boomers, we are boomers, and I think the boomer you got – you basically have, what a million people retiring every day or something now? You've got people who are coming into that time of their life where their health really matters. And that's just a statistical fact and the alternative around your healthcare, if you don't take care of yourself, it's pretty bad and it's pretty expensive. So, I think a lot of people, who have realized that this is the time to shift around diet and lifestyle and that all the noise in the world around us basically saying – pointing folks in that direction too. I think what I've seen with the millennial generation, that we have a lot of team members who obviously are Millennials is that, they are coming to Whole Foods a lot because of that, but because they also like the way the company, the decisions it makes, the values that it stands for, the change it's trying to create in the world. And increasingly, are looking for companies that they can line up with, in a way that feels right to them.”
-Walter E. Robb, CEO Whole Foods
From our perspective, we see three main themes embedded in this quote from Walter Robb:
- The aging Baby Boomers desire healthy alternatives from high integrity companies.
- Millenials put a high priority on healthy food options and high integrity companies.
- Technology, in particular mobile, has emerged as the best channel of communication for producers and suppliers, giving them a competitive advantage and the ability to appeal to a widespread, growing base of consumers.
It All Starts With Stressed Consumers
In today’s consumer environment, with a bevy of public information now available, people consistently seek to make smarter choices, leading them to purchase items with a higher perceived value. Value is not simply about price and varies from industry to industry. For example, in the restaurant industry, value is now a combination of price, quality, environment and experience, with an added emphasis to experience. This is why a $7.50 burrito from Chipotle may have a higher perceived value than a $4 Big Mac from McDonald’s.
With disposable income and confidence coming under pressure here in the U.S., the consumer base is being stretched. Between 2000 and 2009, disposable income per capita grew on average 3.8%, as opposed to the 1.1% growth we have seen year-to-date in 2013. Over the same time periods, the Bloomberg Consumer Comfort Index was on average 13.4, as opposed to -31 so far in 2013. The point is, consumers want to go out to shop and eat, but what they get from their experience is now more important than ever before. We believe this is driving consumers toward higher perceived stores and restaurants and away from lower perceived, traditional ones.
Higher Rates = Lower Multiples
Restaurant industry finance guru, John Hamburger, recently shed light on a few developing casual dining issues. Most notably, in our opinion, was his take on the private equity sector. He highlighted how a majority of the new private equity investments in the restaurant industry have been to scoop up large pools of franchised stores, rather than ponying up for the brand itself.
In the past, private equity investors were willing to pay a premium to what the same company would receive on the public market. In the late 1990’s, which marked the beginning of a decade of growth for the casual dining industry, the average cash flow multiple was 7x. Today, the average cash flow multiple is 8.1x and most of the larger, more mature names in the space have little to no growth. Specifically looking at DIN and DRI—the two largest casual dining companies—you can see that despite having limited growth opportunities, both companies trade at a premium valuation of 9.9x and 8.0x cash flow, respectively. Additionally, both companies carry a high dividend yield of 4.5%.
This leads us to one of our Macro Team’s 3Q13 themes, which is #RatesRising. We here at Hedgeye believe that the low for the 10Y treasury yield was set back in November 2012. Part of the #RatesRising theme suggests that growth is accelerating and the economy is strengthening, which likely means one thing: the Fed will begin to taper. If this happens, we believe the 10Y treasury will begin mean reverting back its 50-year average. This type of environment would be particularly challenging for both DIN and DRI. In our opinion, neither company would be able to raise its dividend fast enough to maintain its relative value in a #RatesRising environment.
New Era Growth Stocks
Restaurants – Recent IPOs in the restaurant space have come from companies that are helping to change the consumer retail landscape. The most recent IPO, and one of the most successful IPOs across all sectors year-to-date, came from Noodles & Company (NDLS). The company, which is up 152% since its June 27th IPO, offers a wide variety of high quality, cooked-to-order dishes, including noodles and pasta, soups, salads and sandwiches, all of which are served on real china – fancy!
Importantly, customization is becoming a “must” in the restaurant industry and NDLS plays into this theme very well. Because each dish is cooked-to-order, it can be customized to each customer’s personal tastes and preferences (they even have gluten free, vegan, vegetarian or low sodium items). Noodles participates in the ‘fast casual’ segment of the restaurant industry as they strive to provide a medium between quick service and casual dining restaurants. In other words, fast casual restaurants attempt to provide customers with a combination of impressive speed of service, high quality food and a quality environment.
Other notable fast casual chains include Chipotle (CMG), Smashburger (private), and Qdoba (owned by JACK). The NPD Group recently reported that the number of fast-casual restaurants grew by 7%, while traffic grew by 9% for the FY ended May.
Food Retail – Similarly, in the food retail space, recent IPOs such as Sprouts Farmers Market (SFM), Natural Grocers (NGVC) and Fairway Group Holdings (FWM) have expanded natural and organic product selections in addition to fielding extensive perishables departments. Of the group, Natural Grocers' IPO has enjoyed the largest percentage gain as the stock is up 140% since its first trading day.
On the margin, these new competitors in the Food Retail space will begin to take occasions away form traditional casual dining companies.
Below we highlight a number of relative, recent IPOs and their respective performance.
We currently like high growth stocks that should continue to benefit from the aforementioned trend, including NDLS, KKD, CMG, and OPEN.
We continue to dislike traditional quick-service and casual dining names, including MCD, DRI and RRGB.