Here's the Dish on Fast-Food Stocks

 | Mar 30, 2017 | 10:00 AM EDT
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Stock quotes in this article:

sonc

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unfi

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mkc

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ko

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pep

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dps

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iff

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sxt

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pnra

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dri

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mcd

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wen

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kr

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wmt

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cmg

We received yet another indication earlier this week that restaurant pain continues when Sonic Corp. (SONC) reported a 7.4% decline in same-store sales. The company's management team chalked the drop up to "a sluggish consumer environment, weather headwinds and share losses" amid a "very intense" competitive environment. Predictably, the company is retooling its menu offering -- and even though it is late to the party, it too is jumping on the smartphone bandwagon.

Stepping back, there is a larger issue that Sonic and other restaurants have to contend with -- declining restaurant traffic due to lower prices at grocery stores and the shift in consumer preferences to healthier foods. That preference shift is toward natural and organic offerings -- as well as paleo, gluten-free and others, and that's one of the reason's I've favored shares of United Natural Foods (UNFI) . While more people eating at home is a positive for Kroger (KR) and Walmart (WMT) , my "buy the bullets, not the gun" approach continues to favor shares of McCormick & Co. (MKC) , which are even more attractive for longer-term investors, given this week's post-earnings pullback.

Even as companies like Coca-Cola (KO) and Action Alerts PLUS holding PepsiCo (PEP) are tinkering with their carbonated soft drink formulas to reduce sugar -- the new enemy -- they have to do so without sacrificing taste. Older Real Money subscribers may remember the whole New Coke thing back in 1985, which was ultimately a failure given the different taste. As Coca-Cola, PepsiCo and even Dr. Pepper Snapple (DPS) look to reformulate to ride either the lower-sugar or better-for-you shift, it bodes rather well for flavor companies like International Flavors & Fragrances (IFF) or Sensient Tech (SXT) .

That shifting preference has guided developments at several restaurant companies, such as Panera (PNRA) and Darden's (DRI) Olive Garden. Over the last several years, Panera has been working to eliminate artificial additives to its food to make it "cleaner" for consumers, and in 2015 it released a "no no" list of more than 96 ingredients that it vowed to either remove from or never use in foods. Darden is shifting to lighter-fare recipes that have far less calories than prior ones, and even Chipotle (CMG) , the one time poster child for "food with integrity" -- until its food safety woes last year -- has come to fulfill its pledge of using no added colors, flavors or preservatives of any kind in any of its ingredients.

Against that backdrop -- the shift to eating not only at home, but food that is better for you -- this thematic investor has serous doubts when it comes to the quick service restaurant industry. According to the data research firm Sense360, which analyzed data from 140 chains and 5 million limited-service visits, 38% of heavy quick-service restaurant users reduced their visits in February, compared with the period before Christmas. Not exactly an inspiring reason to revisit shares of Sonic or several other QSR restaurant chains, like McDonald's (MCD) or Wendy's (WEN) , at a time when bank card delinquency rates are climbing, subprime auto issues are doing the same, student debt levels loom over consumers and real wage growth has been meager at best.

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