There's an interesting dynamic playing out in restaurant land. At the same time that there's a labor shortage, input costs are rising.
There has been a lot of debate about the existence of the former, but I am absolutely convinced it's true. A half-hour wait at a Maryland McDonald's (MCD) drive-through after ordering and paying (yes, it was stupid to wait), then ill-fated visits in Pennsylvania to two different Cracker Barrel (CBRL) locations in June, where staff was limited and wait times long, was pretty convincing.
Two weeks ago, one of my daughters and I went to our summer favorite breakfast place only to find it closed. I later found out that this formerly thriving business has closed for breakfast due to lack of help. It's a similar story at many other places. Some have been so short-staffed that angry customers have berated workers, and a few have had incidents so bad that the owners would close for a day or so just to give the staff a break.
I am not sure to what extent any of this will affect publicly traded names, and it should be a short-term phenomenon if you buy the notion that the labor shortage is due to the extended unemployment benefits that end in September but that for now make it more lucrative for some people to stay home than to go to work. However, the rising input costs will likely have an effect. Beef prices, for instance, rose 5.3% from May to June. If the inflation we are experiencing is not transient, restaurants will need to raise prices, accept lower margins, or perhaps both.
While restaurant stocks as a whole have pulled back since early June, the basket of 40-plus names I follow with market caps above $100 million are still up an average of 36% year to date versus an 18% increase for the S&P 500, 11.5% rise for the Russell 2000 Index and 20% increase for the Russell Microcap Index.
The "Big Five" -- a self-coined group that includes McDonald's (MCD) (up 16% year to date), Chipotle Mexican Grill (CMG) (up 32%), Yum Brands (YUM) (up 16.5%), Domino's Pizza (DPZ) (up nearly 41%) and Darden Restaurants (DRI) (up 27.5%) -- have rallied as a group since June, when they were up an average of 10% and collectively are now up an average of just over 26.5% year to date.
The top restaurant performers in 2021, all microcaps, include BBQ Holdings (BBQ) (up 186% year to date), Kura Sushi (KURA) (up 174%), The One Group Hospitality (STKS) (up 149.5%), FAT Brands (FAT) (up 100%), and J Alexander Holdings (JAX) (up 90%).
The "comeback kids" -- consisting of Potbelly Corp. (PBPB) (up 50%), Red Robin Gourmet Burgers (RRGB) (up 46%) and Noodles & Co. (NDLS) (up 50%), names that have faced big challenges in recent years -- all have pulled back significantly since early June.
The cheapest names on the basis of two-year forward price-to-earnings (P/E ) ratios include Bloomin' Brands (BLMN) (9.8x), Brinker International (EAT) (10.7x), Dine Brands Global (DIN) (10x), Del Taco (TACO) (12.7x) and Dave & Buster's (PLAY) (12.8x). The "Big Five" currently trade at an average of 27.5x forward earnings, with a high of 44x for MCD, and a low of 16x for DRI.
One other wild card for the sector is ever-changing Centers for Disease Control (CDC) guidance on the pandemic. It looks like we may be back to masks under certain circumstances. Let's hope we don't get back to reduced restaurant capacity or closures.
