3 Restaurant Chains Profiting from the Great American Pigout

© Dana Neibert/Getty Images
© Dana Neibert/Getty Images

It’s not hard to see why so many Americans are obese.

Just about anywhere you go, dozens of restaurant chains offer tons of inexpensive, tasty and calorie-rich food — from burgers and fries, to Southern-style biscuits stuffed with Cajun chicken, traditional smoked barbecue and deep-dish pizza.

At a typical restaurant these days, you can now wash all this down with craft beer. And finish with decadent desserts like the Pizookie, which is basically a big deep-dish cookie with several scoops of ice cream on top, on the menu at one pizza chain.

Of course, entrepreneurs have caught on that Americans love to pig out on cheap eats, even if the food is unhealthy. So the restaurant industry is intensely competitive, and risky for investors.

That’s why if you venture into those stocks — a big temptation now that consumer confidence has jumped, wages are moving up and gasoline is cheap — it makes a lot of sense to let insiders be your guide.

1. Bojangles’ 

If you don’t know about Bojangles’, you don’t spend much time in the South. An iconic Dixie brand for decades, especially the Carolinas, Bojangles’ offers a tasty menu highlighting freshly baked biscuits, often stuffed with goodies like Cajun chicken fillets.

With an emphasis on quality and freshness, Bojangles’ is like the Shake Shack of chicken. Except that its stock hasn’t performed nearly as well. Bojangles’ shares have dropped since its initial public offering in May, compared with healthy gains for Shake Shack.

That seems odd, given how much diners love “Bo time,” the endearing phrase they use to describe Bojangles’ nosh.

Fans ate a billion dollars worth of Bojangles’ food last year. Total sales grew 12.8% a year from 2011 to 2014. Same-store sales, a gauge that strips out the effect of store openings and closings, rose an impressive 7% annually. Not bad, for a pretty sluggish economy. (Shake Shack has grown a lot faster, but off a smaller base.)

So why isn’t Bojangles’ stock dancing?

One of the knocks on this chain is that while it makes great Southern food that’s galvanized a cult-like following in the South, the food might not travel elsewhere, as Bojangles’ attempts to expand. There are several problems with this thesis.

First, Bojangles’ actually still has plenty of room to grow at home. The chain runs throughout the South stretching up into Pennsylvania, but it’s primarily in the Carolinas, Virginia and Georgia. Research shows it can grow in those states to 1,400 units, from about 635 now, says the company. The South is not such a bad place to expand, since population growth there is much higher than in the rest of the country (20% from 2000 to 2013 vs. 12%).

Next, mainstream Americans are venturing beyond the standard burgers and fries, as the popularity of non-burger joints like Chipotle attests. Bojangles’ research suggests it can expand to 3,500 locations nationwide. But William Blair analyst Sharon Zackfia puts the number at 5,000, one reason she has an “outperform” rating on the stock.

Third, Bojangles’ currently does much of its business at breakfast. But given its following, it can probably sell a lot more food at other mealtimes, if it tries harder.

There’s an interesting twist for investors here, behind the scenes. Unlike a lot of restaurant chains, Bojangles’ has third-party investment firms fund the purchase and development of sites. Then they rent them to Bojangles’. That helps Bojangles’ investors because it vastly lowers the start-up costs of restaurants. That boosts profits, and it makes outlets profitable much faster, points out Connor Browne, co-manager of the Thornburg Value Fund , which beats competing funds by a healthy 6 percentage points a year, annualized, over the past three years, according to Morningstar.

2. Famous Dave’s of America 

Unlike Bojangles’, Famous Dave’s isn’t doing so hot. Same-store sales at this hickory-smoked barbecue join fell by 4.9% in the first quarter. Franchised outlets did better, but revenue and earnings still slipped.

That doesn’t necessarily make Dave’s a bad investment, though. Wounded companies can often reward investors as turnarounds, especially when the overhaul is backed by insider buying, as it is here.

What’s wrong with Dave’s? One problem is that last year it eliminated 2013 price discounts, and it’s still paying the price in customer defections. But here’s some good news: Dave’s increased prices in June 2014. That means as of July this year, the negative effect on year-over-year results will trail off.

Otherwise, Dave’s is a basic block-and-tackle restaurant turnaround. It’s introducing new menu items and marketing initiatives, cutting costs and remodeling to lighten up and modernize restaurants. Part of this includes new music, which is supposed to help attract a broader clientele. Dave’s is also cutting back drastically on the number of company-owned restaurants by selling them to franchisees. That’s a good thing, since franchise restaurants do better.

One thing that makes Dave’s a bit less attractive is that the insider buying here was by institutional investors who have to report as insiders because they have such a big stake. While still a valid signal, this kind of “insider buying” is less attractive than buying by actual managers in the system I use to weigh insider activity at my stock letter, Brush Up on Stocks.

3. BJ’s Restaurants 

If Bojangles’ is a hot chain on the rise and Famous Dave’s is one on the mend, BJ’s Restaurants is right in between. First-quarter same-store sales at this pizza joint were up 3.2%, the best since 2012. Chalk it up to above-industry gains in customer traffic and bigger spending by those customers. Including new restaurants, revenue grew by an impressive 9.4%.

Just as important, more of the revenue from those new outlets will fall to the bottom line, thanks to a revamped restaurant design that cuts the launch cost by about $1 million, or around 25%. The new format also requires fewer workers, which helps lower costs.

The new, low-cost restaurant design is one reason why KeyBanc Capital Markets analyst Christopher O’Cull has a $60 price target and an “overweight” rating on this stock. It recently traded for $49.50. O’Cull expects impressive 20% annual earnings growth over the next three or four years. BJ’s will launch 15 new restaurants this year, on top of about 160, expanding its reach beyond its California and Texas base.

Alas, one cost-cutting measure is going to be a bummer for old-school pizza fans: BJ’s is eliminating the traditional pizza-making technique of spinning dough in the air to thin it out.

Unhappy customers can try to lift their mood with BJ’s “Pizookie” dessert, that deep-dish cookie with ice cream on top — also presumably never tossed in the air.

Written by Michael Brush of MarketWatch

(Source: MarketWatch)

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