Chow Down on Restaurant Stocks

Americans' appetite for eating out has given investors a craving for restaurant stocks. But few can be found on the value menu, as the average U.S. restaurant stock trades for 29 times projected 2014 earnings, according to S&P Capital IQ.

The restaurant business is intensely competitive. Companies rise and fall, as the recent bankruptcy filings of two debt-laden chains, Quiznos and Sbarro, show. So it’s best to focus on companies with strong balance sheets. Here are three worth a nibble (share prices are as of May 5).

The desire to spot the next Chipotle has led to lofty valuations and volatile share prices for a host of small “fast casual” chains. Perhaps the original Chipotle Mexican Grill (CMG) is a better bet. Sure, the stock sells for a rich 41 times projected 2014 earnings, but Chipotle has earned a reputation as one of the industry’s top operators, with well-above-average profit margins and returns on capital. The Denver company has 1,600 restaurants and expects to open 180 to 195 new ones this year.

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The primary objection to the stock is that it has climbed so much—some 2,000% since McDonald’s spun off Chipotle in 2006. Still, Argus Research analyst John Staszak says he expects the stock to reach $660 in a year.

Chipotle is benefiting from growing interest in fast-casual restaurants, which serve higher-quality fare than fast food, but do it faster and more cheaply than traditional sit-down chains. Still, some traditional eateries are worth a look, too. Del Frisco’s Restaurant Group (DFRG) owns 29 high-end steakhouses under the Del Frisco’s Double Eagle and Sullivan’s brand names. The company has thrived despite the tepid economic recovery and a miserable winter that kept many diners at home.

Analysts are especially enthusiastic about the firm’s newest idea: Del Frisco’s Grille, a less-expensive but still upscale chain that targets the young people who ordinarily shun classic wood-paneled steakhouses. The Southlake, Tex., company has only 12 Grille locations but expects to open five more this year. Stephens Inc. analyst Will Slabaugh says he expects Del Frisco’s to open more than 100 Grilles over the next few years, and that should help fuel rapid growth. Although the stock trades for 27 times estimated 2014 profits, Slabaugh thinks the shares are cheap. “Investors aren't giving enough respect to what I think is one of the more attractive growth brands,” he says.

The shares of Buffalo Wild Wings (BWLD) trade almost like an agricultural commodity: chicken wings, which make up the lion’s share of the company’s food costs. In 2012, wing prices took flight, and investors, worried that the Minneapolis company couldn't hold down its costs, flew the coop. The situation is now reversed. With wing costs taking a dive, BWW is forecasting rising profits and the stock is soaring; it has doubled since November 2012 and trades for 29 times estimated 2014 earnings.

The volatility of wing prices is important, but it shouldn't overshadow BWW’s growth potential, says UBS analyst Keith Siegner. He says the company plans to expand rapidly overseas, as well as along the U.S. and Canadian coasts. That should bring welcome geographic diversification to a chain that has one-fourth of its 1,000 restaurants in the slow-growing states of Illinois, Indiana, Michigan and Ohio. Siegner sees the stock hitting $180 within a year.