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Stock Analyst Update

What Closures Mean for Restaurant Industry

Investors should watch for names with value, technology, healthy balance sheets.

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Editor’s note: Read the latest on how the coronavirus is rattling the markets and what investors can do to navigate it.

The restaurant sector is under pressure as several U.S. markets have restricted dine-in service in an effort to curb the spread of COVID-19. Restrictions vary by state and city, but even in markets where carry-out and drive-thru orders are still permitted, we expect severe guest count declines for at least the next two months and an uneven traffic recovery into the back half of 2020. The situation is fluid, but our best guess is that most U.S. quick-service chains will experience at least high-single-digit to low-double-digit comp declines for the year while casual-dining chains are looking at comp declines of 30% or more. While restaurants find themselves with a difficult 2020 ahead, we believe the sector's pullback offers several investment opportunities.

What criteria should investors use to evaluate opportunities during heightened uncertainty? First, value-oriented players tend to outperform during economic shocks, positioning those players that can be more aggressive on pricing for relative transaction outperformance as the year progresses. Second, we believe those players that are further along with their mobile platforms--particularly personalized marketing efforts--should be better positioned to communicate with consumers during the social distancing and the coronavirus recovery period. Third, we'd look at companies and franchisee systems with healthy balance sheets. Because of recent refranchising activity, many operators and their franchisees are now overleveraged (many are now leveraged 6-7 times forward EBITDA), making it more difficult to navigate extended periods of restaurant restrictions.

We will be adjusting near-term estimates for our restaurant coverage list but would gravitate to names that best satisfy these three criteria, including wide-moat Domino's (DPZ) (limited disruption from dine-in restrictions), wide-moat McDonald's (MCD) (value leader and balance sheet health), and wide-moat Starbucks (SBUX) (technology investments and solid licensing partners).

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

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