Are These Falling Knives Worth Catching? (Part-2)

Sandeep is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

In one of my previous articles, I discussed investment opportunities in some of last month’s underperforming retail stocks. I have screened three more retail stocks that have seen a significant correction in October. The following is the list of these three stocks.

Company

Forward P/E

Stock Price Decline in October

Brinker International

(NYSE: EAT)

11.63

12.75%

Chipotle Mexican Grill

(NYSE: CMG)

24.95

19.83%

Starbucks Corporation

(NASDAQ: SBUX)

19.52

9.49%

Here’s a look at these stocks in detail.

Brinker International

Brinker International owns, develops, operates and franchises the Chilli’s Grill & Bar (generates ~85% of revenues) and Maggiano’s Little Italy (generates ~15% of the revenues) restaurant brands. While the market penalized Brinker for softening quarter to date trends, I believe a miss-modeling of workers compensation and overhead by the Street resulted in an EPS miss in what was an otherwise solid F2Q. The company has shown improvement—driving core menu and marketing, while finding productivity opportunities limiting the downside. Chili's is testing a new pizza product which is carrying very attractive food costs. I think introducing pizza as a new platform would separate Chili's from many competitors in the sector and enhance concept differentiation while boosting restaurant level contribution.

Moreover, the company has been proactive about returning cash to shareholders through steady share repurchases and increasing dividends. The company repurchased 2.5 million shares outstanding for $86.3 million in FQ1 and also raised its quarterly dividend by 25% to $0.20 per share. Overall, I remain optimistic about the stock as the cost efficiencies at the restaurant level appear to be working and opportunistic uses of free cash to buy back shares could help drive upside beyond consensus estimates.

Chipotle Mexican Grill

Chipotle is the largest fast casual Mexican chain with ~1,200 units in ~40 states. After outperforming for the last 3 years, Chipotle’s shares have underperformed recently as the company has been unable to sustain its sales momentum due to sluggish macro trends, reduced consumer activity and increasing competition from Yum! Brand’s (NYSE: YUM) owned Taco Bell. Taco Bell’s Cantina Bell upgraded offerings are chipping away at Chipotle’s market share and as a result the same store sales growth has moderated. The company’s Q3 SSS (same store sales) growth was just 4.8% as compared to the high single and low double digit levels regularly achieved over the past few quarters. Moreover, Chipotle will soon lap very tough comparisons in December through March associated with last year’s mild winter.

From a valuation standpoint, Chipotle looks expensive with respect to established and well diversified food chains like McDonald’s and Yum Brands. Despite the recent correction, Chipotle (with a forward P/E of 26.05) is trading at a ~38% premium to Yum! Brands and at a ~75% premium McDonald’s. Although analysts are projecting more than 21% annual growth over the next five years, I don’t think the company will be able to achieve such growth given the market share losses at the hands of Taco Bell. Thus, I recommend avoiding this stock.

Starbucks Corporation

Starbucks roasts high-quality whole bean coffee and sells bagged coffee, single-serve, fresh brewed coffee, various non-coffee beverages, and food items through its retail stores. After struggling for most part of October, the shares are recovering well in November as the company posted better than expected 4Q results with EPS beating both the Street's estimates and company expectations. Going forward, Starbucks has plans to expand internationally in high growth regions like China and Latin America. China is expected to become Starbucks' second biggest market by 2015 as the company is planning a bigger push into smaller cities in the country. Moreover, the company is eying the Nordic countries of Norway and Sweden which are among the highest per capita coffee consumers in the world with GDP per capita comparable to that of the U.S. Thus, I believe Starbucks has a huge growth opportunity in the international markets. In addition, the company has multiple growth drivers in K-Cups, Refreshers, Evolution Juice, Verismo system, VIA, La Boulange and packaged coffee. Thus, I recommend buying this stock.

To sum up, I am optimistic about both Starbucks as well as Brinker International. Brinker is driving core menu and marketing, while finding productivity opportunities. Moreover, the company has been returning substantial cash to shareholders with share buybacks and dividends. Starbucks has recovered well in the recent quarter and 4Q performance demonstrates the strength of business and brand. The company has multiple growth drivers and a huge long term growth opportunity in international markets. However, I don’t think investors should chase Chipotle despite a huge correction. The company is facing competitive pressures and will soon lap very difficult year ago comparisons. 

Eat Up, Investors

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sandeep2gupta has no positions in the stocks mentioned above. The Motley Fool owns shares of Chipotle Mexican Grill and Starbucks and has the following options: short JAN 2013 $47.00 puts on Starbucks. Motley Fool newsletter services recommend Chipotle Mexican Grill and Starbucks. 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.If you have questions about this post or the Fool’s blog network, click here for information.

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