Chipotle Mexican Grill, Inc. (CMG), Darden Restaurants, Inc. (DRI): BlackRock Says Avoid Restaurants

In a recent weekly market commentary, Russ Koesterich, chief investment strategist at BlackRock, is calling for continued stock gains, but warns that consumer stocks look overpriced. He singles out restaurants as an area of concern.

“A combination of slow growth, low inflation, and relatively low interest rates should allow for stocks to move higher over the next 12 months,” says Koesterich. However, he notes that consumers continue to struggle with weak income growth, which is a notable restraint on spending.

For example, income growth over the past 50 years has averaged about 3%, but was just 1.7% over the past three years. With that as a backdrop, it’s easy to understand why he isn’t expecting much from companies that offer discretionary products, like food away from home.

Chipotle Mexican Grill, Inc. (NYSE:CMG)

Hot Concepts

If you want to find an expensive restaurant stock, you don’t need to look much further than the current hot trend–fast casual. Although Noodles & Company doubling on its debut has made headlines, the euphoria overshadows Chipotle Mexican Grill, Inc. (NYSE:CMG)’s price to earnings ratio of over 40.

Although these concept restaurants are very popular with customers today, consumers are notoriously fickle. And so, too, are investors. For example, in the first four months or so of 2012, Chipotle Mexican Grill, Inc. (NYSE:CMG) shares ran up to over $425 a share. By the end of the year, though, the stock had fallen nearly $200, touching a low around $240.

The drop was precipitated by the company’s sales stagnating at around $700 million in each of the second, third, and fourth quarters of 2012. However, if that’s enough to knock over 40% from the stock’s market cap, it was probably overpriced at $425.

Revenues headed higher again in the first and second quarters of 2013. The shares have responded by heading right back up to $400 a share. Revenues, though, haven’t improved enough to support an over 60% price advance. Investors should tread carefully with Chipotle Mexican Grill, Inc. (NYSE:CMG).

The New Kid

Noodles & Co. is another one to watch carefully. It has benefited from being one of just a few publicly traded fast casual restaurant. While the shares have come down some from their post-IPO heights, Noodles is still a hot concept in a hot sector. It has very little publicly available information for investors to go on and even less trading history.

The restaurant makes noodle dishes from Pad Thai to mac and cheese. It has around 350 stores in 26 states, so there’s room for growth. In fact, pro-forma numbers show that it has been growing earnings and sales nicely over the last three years. The bottom line, for example, jumped from just nine cents to over $0.20 cents a share in that time period.