Fast casual restaurants have been all the rage. Sitting above fast food on quality and below casual dining on price, they offer customers a desirable alternative to existing fare. Investors have driven up the shares of Chipotle Mexican Grill, Inc. (NYSE:CMG) and look set to do the same with the recent IPO of Noodles & Co (NASDAQ:NDLS).
Top, Bottom, Middle, and…
At the top of the restaurant industry are chains like Capital Grill, which sells expensive steaks. In the middle are companies like Olive Garden and Red Lobster, which are often described as casual. All three of these chains are owned by Darden Restaurants, Inc. (NYSE:DRI). While the high end of the company’s business, which includes more than just Capital Grill, has been doing fairly well recently, the casual dining segment has been a laggard.
Since Olive Garden and Red Lobster make up the vast majority of the company’s sales, that’s meant weak earnings and relatively poor stock performance. The shares yield around 4.4%, however, which might interest income investors looking for an out of favor industry giant. Still, the weakness of the company’s core brands speaks volumes about the middle layer of the restaurant industry.
The Wendy’s Co (NASDAQ:WEN) has always pitched itself as selling the best fare at the low end of the spectrum, otherwise known as fast food. Although some of the company’s problems have been self inflicted corporate actions, like the ill-fated merger with Arby’s, it has had an increasingly difficult time differentiating itself.
The Wendy’s Co (NASDAQ:WEN) has been barely profitable for the last four years as it tries to reinvent itself. Although there’s upside potential for aggressive turnaround investors, the risks are too large for most. The big problem is that The Wendy’s Co (NASDAQ:WEN) is stuck in the bottom of the industry when it wants to be something more.
The problem that both Wendy’s and Darden Restaurants, Inc. (NYSE:DRI) have faced is the emergence of the fast casual space. These restaurants use a fast-food like format to sell higher quality fare. That’s a combination that has captivated customers and investors. There’s opportunity, but only for the aggressive and fleet footed.
Chipotle Mexican Grill, Inc. (NYSE:CMG) is the best example and, up until recently, the only option investors had in the space. Although coming off of a small base, the company’s revenues and earnings have grown rapidly. That’s drawn in investors as quickly as the company’s high-quality Mexican fare has drawn in eaters, leading to a swift stock price advance.
What Goes Up…
However, in Chipotle Mexican Grill, Inc. (NYSE:CMG)’s swift ascent is also the warning. The shares ran up to over $400 by mid 2012 and then quickly fell to below $240 by late October of that same year. Hot stocks are great, but investors can sour on them quickly. That usually leads to drops that are even more rapid than the previous stock advance. Chipotle Mexican Grill, Inc. (NYSE:CMG) shares have since resumed their climb and now sit at around $375 or so.