3 Stocks to Buy in the Improving Restaurant Sector
Robinson is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
The overall economy seems to be improving. Consumer confidence in June soared to 81.5, which is the higher reading in the last five years. The unemployment rate is slowly declining, and more jobs are being added.
This implies that citizens go to restaurant more often. Therefore, investors should gain exposure to the booming restaurant sector. The stocks herein mentioned present a great investment prospectus, and they should be considered for growth-oriented portfolios.
Bring me the pizza, Domino's
Domino’s Pizza (NYSE: DPZ) is a large pizza restaurant with an international presence. The company trades with a price-to-earnings ratio of 26.7, slightly above the industry’s average of 22.9. The company posted upbeat revenue and net income for the first three months ending in March. Its revenue rose 10% to $418 million, and its net income increased by 50% to $34 million.
The company recently issued a $0.20 per-share dividend payment and repurchased 362,000 shares. I believe Domino's is in a great position to bring capital appreciation to its investors in these forms. Its cash from operations more than doubled to $48 million, and free cash rose from $17 million to $43 million. What’s more is that the free cash flow has been improving since 2008. I would expect dividend hikes and continuing share-repurchase programs from rising cash flow to bring capital appreciation.
Although the company faces competition in the United States from other pizzerias, its competition in the international markets is significantly lower. As global economic conditions improve, particularly in the emerging markets, revenue from overseas should improve significantly. China is of particular interest because its middle class is growing by the millions and the population is eating out more thanks to higher disposable income. Overall, same-stores overseas have experienced 5% growth. Continuing expansion in the Asia Pacific region will be key for future revenue growth.
The company submerged in debt in order for it to continue its expansion plans. It carries $1.5 billion in debt on its balance sheet, but it has a stockholder deficit of $1.3 billion. Its total liabilities/assets ratio is 337. Although several analysts do not agree with the company financing expansion through debt, I believe it was a great move. Domino's took advantage of the ultra-low interest rates to finance the expansion, and its revenue should increase substantially.
Finally, the company is tackling the mobile-order market. The pizzeria just released a Windows 8 app for customers. It is claimed that it will reduce order-taking time, and it should increase order volume.
Overall, Domino’s Pizza is a great opportunity in the long run, and investors should have this stock in their portfolios.
The father of the pizzas (by personal taste)
Papa John's (NASDAQ: PZZA) is another pizza restaurant with carry-out or dine-in options. Its domestic market is great, but its international market is small. The company trades with a P/E of 23.6 compared to the 22.9 industry average. In the most recent quarter, revenue rose 10% to $356 million and net income rose 5% to $19 million, or $0.85 per share.
I do not expect Papa John’s to initiate a dividend payment or start a share-buyback program soon because Its free cash flow shrunk from $38 million to $17 million in the last quarter. However, I believe the company still has room for growth.
It is expanding in the U.S. and overseas. Last year, the company opened 280 stores overseas. Tackling China and India will be fundamental to overseas revenue growth, as its middle class continues to increase. For the fiscal year 2013, the company expects to open 134 additional stores. Also, capital expenditures are expected to rise to between $55 million and $60 million, up from $43 million last year.
Finally, Papa John’s was rated number one among all national pizza chains by the American Customer Satisfaction Index (ACSI) due to superior quality pizzas and great customer service. There is a positive correlation between customer satisfaction, sales and ultimately stock price. In conclusion, it would make sense that customers are attracted to the pizzeria. However, investors should delve into the next earnings report for signs of revenue growth.
In brief, Papa John’s offers a great investment prospectus and it should be considered as a long position in a growth-oriented portfolio.
Comparing apples to apples
One last ticker that deserves mentioning is Yum! Brands (NYSE: YUM). The company operates Taco Bell, KFC and Pizza Hut. It trades with a P/E of 21.9, slightly below the industry’s average. The company posted decreasing revenue and net income for the three months ending in March. Revenue declined 10% to $2.5 billion, and net income decreased 28% to $33 million.
Yum! Brands' revenue was severely hit in April and May due to the “Bird Flu” in China. KFC's same-store sales declined 25% in May and 36% in April. However, the company has countered this by eliminating 1,000 small chicken suppliers to control quality. It has also started TV commercials endorsing food quality. As the bird flu gets under control, revenue from stores in China should recover.
One positive aspect that may drive the company’s sales upward is the expansion strategy in emerging markets. Last year, the company opened 949 stores worldwide, and an expansion in India is underway.
Further, the sales of Taco Bell continue to be the growth driver with 8% growth in the last quarter. The inauguration of new Taco Bell stores may be a key driver in the company’s revenue.
In addition, the company is coming up with novel products that are appealing for consumers. The launch of Doritos Locos Tacos was a success that brought record sales of $375 million last year. The ability of Yum! Brands to realize novel ideas will be another key driver in upbeat revenue.
Finally, the company has paid a dividend since 2004. It was hiked during the third quarter of 2012 by 17% to $0.33 per share. What’s more is its free cash flow does not jeopardize the dividend offer in the near future. The company closed the first quarter of 2013 with free cash flow of $164 million.
In conclusion, the expansion of Yum! to emerging markets such as China and India should be important for growing revenue. Also, the company is bringing novel products that are well received by customers. Finally, investors should continue to expect safe dividends. Solid free cash flow indicates that increments in the dividend payment may be possible.
The Foolish take-home note
Economic conditions have been improving globally. Consequently, customers go out to restaurants more often. These pizza and restaurant companies offer great investments, and they could be bought in a basket to gain exposure to the restaurant sector. They have aggressive expansion strategies that are currently being implemented in China and India, two major emerging markets where potential for profit is huge. For the reasons, I strongly recommend these stocks for your growth-oriented portfolio.
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Robinson Roacho has no position in any stocks mentioned. The Motley Fool owns shares of Papa John's International. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!