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Forget Chipotle, Invest in These Restaurant Stocks Instead

Zacks

Chipotle Mexican Grill, Inc. CMG had been an investor favorite with revenues exhibiting an extraordinary CAGR of over 23% til 2014 from the time it went public. The stunning performance was supported by solid comparable restaurant sales (comps) growth.

However, Wall Street’s darling fell from grace toward 2015-end, as a slew of E. coli and norovirus contamination incidents derailed its growth story. In fact, despite various food-safety initiatives, Chipotle continues to reel under the negative publicity associated with food-borne illnesses which has impacted its share price by nearly 17% year to date.

Over the past 60 days, the Zacks Consensus Estimate has decreased 11.5% for 2016 earnings, adding to the company’s woes. Moreover, for 2016, sales and earnings are projected to decline nearly 10% and 75%, respectively, raising questions over this Zacks Rank #4 (Sell) company’s prospects.

What’s Hurting Chipotle?

Chipotle’s performance has been largely dented by the food-safety issues. As a safety measure, the fast casual chain was forced to close several outlets. Although these were reopened later with fresh ingredients and extensive cleaning and sanitizing activities, the incidents dealt a severe blow to Chipotle’s sales.

The fact that Chipotle uses only healthy ingredients has long been its marketing strength and has been attracting customers despite its comparatively high prices. Thus, given the negative publicity related to food-borne illnesses, Chipotle’s popularity among health-conscious diners is declining. The company thus expects both earnings and revenues to remain under pressure in the near term.

At its fourth-quarter 2015 conference call, Chipotle stated that it is not possible for the company to provide any meaningful comps outlook for 2016 in the wake of the prevailing volatile sales trends. The company added that future sales prediction is difficult as it awaits further developments and other announcements from health authorities.

Meanwhile, other restaurants have been working on providing customers with healthier food and innovative menu options in the fast casual restaurant space, intensifying competition for Chipotle. In fact, owing to food-safety issues and increased competition, in Jun 2016, Chipotle lost the tag of the most popular Mexican restaurant, per an annual survey from Harris Poll, which is likely to further hurt traffic.

Moreover, a recent CNNMoney report revealed that nearly 10,000 of Chipotle’s workers have joined a class-action lawsuit against the company for wage theft, thereby compounding its woes.

Going forward, Chipotle expects combined marketing and promo expenses to remain at elevated levels as the company plans to continue to connect with its customers to reclaim their trust and loyalty and bring them back to its stores. Thus, the costs associated with these and the expenses to support the company’s newly designed food safety program will continue to impact profitability.

Also, implementation of food safety practices has increased the amount of labor required to prepare and serve food, resulting in higher labor costs which may continue to keep profits under pressure.

5 Alternate Picks

Chipotle might be going through a rough patch but there are other restaurant stocks that are performing well at the moment.

With the help of the Zacks Stock Screener, we have zeroed-in on five stocks in the Retail-Restaurants industry with a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Below are five stocks that have had a good run on the bourse so far and have better prospects than Chipotle. So let’s dig in!

Headquartered in Louisville, KY, Papa John's International Inc. PZZA operates & franchises pizza delivery and carry-out restaurants under the Papa John's brand. To gain a leading position among pizza delivery restaurants in each of its targeted markets, the company has developed a strategy to enhance customer satisfaction and retention, as well as establish recognition and acceptance of the brand. In this regard, the company’s focus on menu innovation, promotional offers and technology-driven initiatives bode well.

Notably, the stock has rallied over 39% year to date and upward estimate revisions for 2016 and 2017 earnings, over the past 60 days, add to the optimism. Moreover, for full-year 2016, sales and EPS are projected to grow a respective 4.6% and 17.4%.

Headquartered in Dallas, TX, Wingstop Inc. WING, together with its subsidiaries, franchises and operates restaurants under the Wingstop brand. Its restaurants offer cooked-to-order, hand-sauced, and tossed chicken wings. Solid unit development, investments in technology along with migrating to a national advertising platform, should continue to drive growth at Wingstop.

Interestingly, the stock surged nearly 29% on a year-to-date basis. Moreover, over the past 60 days, the company has been seeing an upward trend in earnings estimate revision for 2016 and 2017 earnings. Further, for full-year 2016, sales growth is pegged at 17.2% while EPS is expected to grow a solid 17.6%.

Headquartered in Syracuse, NY, Carrols Restaurant Group, Inc. TAST operates through its subsidiaries and is one of the largest restaurant companies in the U.S. The company is the largest Burger King franchisee, based on restaurant count. The company’s astounding earnings growth, significant improvement in the top line and operating margin along with innovative product introductions hold well for long-term growth.

The stock has returned over 8% on a year-to-date basis and has been seeing an upward trend in earnings estimate revision for 2016 and 2017, over the past 60 days. Additionally, for full-year 2016, sales growth is pegged at 10.2% while EPS is likely to improve a solid 55.3%.

Headquartered in Spartanburg, SC, Denny's Corp. DENN is one of the largest restaurant companies, operating moderately-priced restaurants: Denny's, Hardee's, Quincy's, El Pollo Loco, Coco's and Carrows. The company restaurants are poised to benefit from the diversity of the restaurant concepts, the benefits of a centralized support system for purchasing, menu development and other initiatives.

The company has returned over 6% year to date. Also, upward estimate revisions for 2016 and 2017 earnings, over the past 60 days, reinstate hope on the stock’s prospects. Further, for full-year 2016, sales growth is poised at 3.1% while EPS is expected to grow 20.2%.

Headquartered in Lake Forest, CA, Del Taco Restaurants, Inc. TACO is the second largest Mexican-American QSR chain by units in the United States, serving more than three million guests each week. The company’s increased focus on enhancing menu offerings along with driving guest experience raise optimism.

Notably, year to date, the stock has returned nearly 5%. Further, for full-year 2016, sales are expected to grow a healthy 20%.

Bottom Line

At this juncture, it does seem like dumping Chipotle might be a prudent move. Meanwhile, though the restaurant industry has its share of pitfalls in the form of sluggish comps growth and traffic trends along with rising labor costs, effective sales initiatives undertaken by the companies should keep it going. We expect the industry to sustain the momentum going ahead, and thus investors should not shy away from investing in this space.

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