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Finding Restaurant Investment Ideas as Traffic Slows

Lessons from the next generation of moats in the fast-casual restaurant industry.

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The restaurant industry would appear to have challenging times ahead, with year-over-over traffic declines across much of the industry and rising labor costs on the horizon. However, we believe it would be shortsighted for investors to overlook this category, as a number of compelling concepts are redefining the way consumer discretionary companies adapt to constantly evolving consumer expectations regarding value, convenience, health, and technology.

Our analysis starts with the fast-casual restaurant category, which is not only changing consumers’ expectations regarding restaurant experiences but also influencing how the market values restaurant concepts and forcing traditional quick-service and casual-dining chains to reinvent themselves. One of the more underexplored developments in restaurants thus far in 2016 is a bifurcation within the fast-casual category, with a class of chains thriving but several other players aspiring to be the "next Chipotle" finding success more difficult (not to mention Chipotle’s (CMG) own struggles). We’ve spent 2015 and 2016 getting to know many of the up-and-coming privately held fast-casual players to gain a better understanding of what attributes restaurant concepts must have to develop an economic moat and drive traffic in today’s environment. We also spoke to a number of operators that are changing their business models to better adapt to the constantly evolving consumer environment. We then examined our restaurant coverage to see where we can locate similar traits and, more important, where the market may not be giving restaurant chains enough credit. We believe a framework for identifying the most successful limited-service restaurant chains will help investors find names best positioned to outperform industry traffic trends over the near term and identify potentially mispriced securities in the category.

R.J. Hottovy does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.

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