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Why Investors Should Avoid El Pollo Loco Stock at the Moment

Zacks

Shares of El Pollo Loco Holdings, Inc. LOCO have underperformed the Zacks categorized Retail-Restaurants industry in the last one year. While the stock gained 2.8%, the industry registered an increase of 9.1%.



Moreover, this Zacks Rank #4 (Sell) company that specializes in fire-roasted chicken has been witnessing downward estimate revisions for current quarter and year earnings, reflecting analysts’ pessimism about its growth prospects.

In fact, El Pollo Loco has a number of other aspects that make it an unattractive investment option at this point.

Lackluster Earnings Growth: While El Pollo Loco has historical (3-5 years) earnings per share (EPS) growth rate of just 1.5% compared with the industry’s average of 7.9%, investors should really focus on its projected growth. Here, the company’s EPS is estimated to rise a mere 3.3% year over year, lower than the industry average, which calls for EPS growth of 6.9%

We note that earnings growth is often an indication of strong prospects (and stock price gains) ahead, for the company in question and is thus one of the most important factors to consider. Evidently, El Pollo Loco falls weak on this front according to current estimations.

Industry Headwinds: Over the last few quarters, the U.S. restaurant space has not been too enticing. Despite economic growth, somewhat lower energy prices and higher income, consumers increased their spending only modestly on dining out that resulted in low consumption. This is because, along with wage growth, inflation is also on the rise, which translates to lower real income and in turn less disposable income. In fact, the situation has taken a worse turn, thanks to higher health care costs and tightened credit availability in the country.

Moreover, as consumers demand high-quality products at lower prices, it is pushing grocery stores to decrease their food prices in order to remain competitive. This, in turn, is resulting in a bigger gap between food-at-home and food-away-from-home indices.

Consequently, same-store sales growth has been dull in a difficult sales environment. Traffic too has been weak. In fact, the first quarter of 2017 marked the fifth consecutive quarter of negative comp sales for the restaurant industry as a whole, thereby continuing the somber mood. El Pollo Loco is no exception to the trend and thus the company’s sales have come under pressure.

Notably, in first-quarter 2017, system-wide comps fell 0.3% due to a decrease in comps at both company-operated and franchise restaurants.

Rising costs putting pressure on margins: Of late, the company’s profits have been under pressure owing to a rising wage rates scenario. Moreover, pre-opening costs of outlets given the company’s unit expansion plans, and expenses related to sales initiatives are adding to the costs and are likely to continue hurting profits.

Meanwhile, El Pollo Loco has recorded trailing 12-month net margin of just 4.6% compared with the industry average of 15%. Given the continual rise in expenses, the trend is not expected to reverse for the company any time soon.

Stocks to Consider

Better-ranked stocks in this sector include Dave & Buster's Entertainment, Inc. PLAY, Red Robin Gourmet Burgers, Inc. RRGB and McDonald's Corporation MCD. While Dave & Buster's and Red Robin sport a Zacks Rank #1 (Strong Buy), McDonald's holds a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

Dave & Buster's earnings surpassed the Zacks Consensus Estimate in the trailing four quarters, with an average beat of 30.50%. Meanwhile, for fiscal 2017, EPS is projected to witness a rise of 23.2%.

The Zacks Consensus Estimate for Red Robin’s 2017 earnings climbed 5.5%, over the last 60 days. Moreover, the company’s trailing four-quarter average earnings surprise is a positive 17.27%.

McDonald's earnings have beaten estimates in all of the trailing four quarters, delivering an average positive surprise of 7.01%. Moreover, for 2017, EPS is expected to improve 12.3%.

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