After yesterday's column, some associates quite naturally asked me what else I would avoid or look to short in the current market. Longtime readers know that I am not much of a short-seller, but from time to time will take what I call "chicken shorts" in certain stocks that I consider overvalued and vulnerable.
These short positions are a very small portion of my personal account, and I only use put options and spreads to limit risk. They are set-and-forget-it, hero-or-zero positions, so I keep the amount and size miniscule. Having said that, for the first time in many months I am seeing stocks that I believe could crack and give an asymmetrical payoff for aggressive investors.
One group that I follow pretty closely is an almost perfect reflection of consumer trends and willingness to spend. I should add a caveat that I absolutely despise casual-dining chains with the exception of the iconic symbol of greasy goodness that is Waffle House. I hate the mid-level chains and feel some trepidation about my wife's occasional desire to hit the Olive Garden or Carraba's Italian Grill.
With that out of the way, the casual-dining sector has pulled off an amazing sleight of hand over the past few years, and the stock prices in this group have been rewarded. When you look at the same-store sales growth over the past few years, it has been absolutely anemic. The chains have fiercely protected the bottom line by laying off employees at a fairly rapid clip and reducing portion sizes. The layoff pace has continued into 2013 as the specter of health insurance costs destroying what is left of the bottom line has caused restaurants to rely on more part-time employees who do not qualify for coverage.
It is simply not a great business right now. Consumers looking for a quick bite to eat while shopping or after a movie are turning more to the quick-service establishments such as Panera Bread (PNRA) or Chipotle Mexican Grill (CMG) in order to conserve cash and time. I am told by my twenty-something kids who double as consumer research associates that the food is on par with the causal sit-down chains and much faster and cheaper. Diners who are heading for a nice evening out are far more likely to choose a local establishment or one of the higher-end chains such as Ruth's Chris (RUTH).
In spite of this, the cost-cutting has been rewarded in the stock market. Industry leader Darden Restaurants (DRI), parent company of Olive Garden, Red Lobster, LongHorn Steakhouse and several other chains, has seen its stock price take a hit in the past few weeks, but it has more than tripled off the 2009 lows. The stock currently trades at what appears to be modest earnings multiple, but a little deeper look shows that the stock is not exactly cheap. Darden fetches more than 3x book value and the enterprise-value-to-EBITDA ratio is a more-than-healthy 8. The stock is not cheap, considering that the company's flagship chains are still relatively weak, and many analysts say that Darden could post an earnings decline for 2013. I am looking at the January 2014 and 2015 put options to see if I can create a favorable bet on the shares declining further.
DineEquity (DIN) Applebee's chain has experienced some modest same-store sales growth, but sales at IHOP have continued to decline. Both chains are seeing fewer diners, and those at IHOP are also spending less per visit. In spite of this, the news of the transition to franchise ownership and a generous dividend payout has driven the shares higher by more than 30% in the past year. The shares are up sevenfold form the lows of the recession in 2009. Again, the price-to-earnings looks low, but the stock fetches more than 4x book value, and the enterprise-value to-EBITDA is more than 10. I will be watching the September options to see if a trade with the right risk/reward characteristics presents itself in the next few days.
The story plays out pretty much across the casual-dining sector. Brinker International (EAT) trades at 9x book value and has an EV/EBITDA ratio of 8. Buffalo Wild Wings (BWLD), the stock I love to hate, fetches almost 4x book and has an EV/EBITDA ratio of 9.6. The whole group appears to be caught in the middle between finer dining and the new breed of quick-service restaurants. They have done all the cost-cutting they can do, and smaller portions and poorer service are not going to grow these companies enough to support valuations.
Again, I am a chicken short, but I am going to be trying to capture the collapse I see in casual-dining stocks with put spreads, using a small portion of my portfolio.