Fast food stock you should consider investing in

By Ken Shreve, Portfolio Manager

With the government looking to clamp down on the banking sector, mulling various taxes and legislation to boost its coffers, it can be difficult to find a sector that’s beyond the long arm of the legislature. And while restaurant stocks may be subject to the headwinds of a rocky unemployment situation, the administration is unlikely to go after the consumer while he’s down. For that reason, investors should consider the following stocks as relatively government-proof investments.

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In recent quarters, Buffalo Wild Wings , Chipotle Mexican Grill and Panera Bread have delivered robust bottom-line and top-line growth despite the tough economy. The common bond among all three? Great food, fast growth, strong management and cheap eats. All three firms continue to grow despite economic — and political — headwinds.

Panera had its initial public offering in 2000, Buffalo Wild Wings went public in 2003 and Chipotle went public in 2006. All three sell at a premium to their peers, but it’s justified because they’re flat-out growing faster than their competitors. Earnings growth is the main driver of a stock’s price, so it’s important to pay attention to the fast-growers in the early stages of their business — they may be more volatile, but they can crush the market in the early stages of growth.

I also like the mutual fund sponsorship trends in all three names, and there’s plenty of room for more. A stock can get “over-owned” by institutional investors, and it’s tough for a stock to outperform the market when its story is already known by the institutional crowd. Buffalo Wild Wings, Chipotle and Panera are still getting discovered by the big guns.

 

Buffalo Wild Wings

Buffalo Wild Wings’ strong price performance since its IPO hasn’t been an accident. The company operates 633 restaurants in 41 states, about 65% of which are franchised.

The company reported robust growth in the third quarter back in late October. Earnings growth accelerated for the second quarter in a row, rising 52% from the year-ago quarter. Sales rose 25% to $132.7 million.

In its third-quarter earnings release, CEO Sally Smith was optimistic about the future: “Based on our current development pipeline, we believe we can achieve 13% to 15% unit growth in 2010, which, along with strong restaurant-level performance and leveraging our infrastructure, should translate into net earnings growth of 20%.”

Short interest remains high in Buffalo Wild Wing, but it is declining. As of Dec. 31, 3.69 million shares were held short compared to its average daily volume of about 350,000 shares. This means it would take about 12 days to cover the current short position. I never let a high short position dissuade me from a stock. In many cases, high short interest can result in future price strength, especially if the company continues to deliver strong earnings. Remember, a short position is ultimately closed by buying back shares of the stock. Short squeezes tend to occur when a company reports good news.

Buffalo Wild Wings will report earnings on Feb. 11. According to Thomson Reuters, analysts on average expect profit of 51 cents a share, a 19% increase from a year ago.

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Chipotle Mexican Grill

Chipotle made a smashing debut on Jan. 26, 2006, when it doubled from its offering price of $22 — the best one-day performance for an IPO in more than five years. But the company hasn’t been a flash in the pan — it has posted consistent growth in recent quarters. In the past three quarters, Chipotle has delivered earnings growth from 49% to 83%. Sales growth has ranged from 14% to 16%. The company’s “fast-casual” approach seems to be clicking with consumers.

Chipotle’s strategy was simple after it was spun off from McDonald’s : Serve gourmet Mexican food quickly in a casual environment. The first time I visited a Chipotle restaurant, the line was about 25 deep and I almost walked away. I stuck it out and I had my food 10-15 minutes later — pretty impressive. Low prices, quick service and great food never gets old.

The company is still growing within the quick-service market. At the end of the third quarter, the company operated 911 restaurants, and it plans to open 120-130 restaurants in 2010. At the end of 2004, total sales were $470.7 million. Through the 12 months ended Sept. 30, 2009, total sales came in at $1.48 billion.

Chipotle’s earnings due date is Feb. 11. Analysts expect quarterly profit to rise 52% to 97 cents a share.

 

Panera Bread

Panera Bread is another well-run restaurant stock. As of Sept. 29, the company owned and franchised 1,362 locations under the brands Panera Bread, St. Louis Bread Company and Paradise Bakery & Cafe.

Last week, Panera said same-store sales in December rose 9.6% from a year ago; this solid result follows 6.1% year-over-year growth in November and 6.8% growth in October. The company also said sales were up 9.4% in the first 21 days of the January 2010 fiscal month. As a result of strong sales trends, Panera raised its earnings guidance for the fourth quarter ended Dec. 29 to 94-95 cents a share from its prior forecast of 85-87 cents. Like Buffalo Wild Wings and Chipotle, Panera reports earnings on Feb. 11 as well — a busy day for restaurant stocks.

In November, Panera announced a three-year, $600-million share repurchase program — yet another upside catalyst for this fast-grower.

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The Broad Market

A quick word about the health of the broad market: Institutional selling has the upper hand over buying, which makes for a difficult environment to make money in stocks.

Despite the strong fundamental and technical pictures of Buffalo Wild Wings, Chipotle and Panera Bread, taking new positions in any of them is riskier now because of the weak technical picture of the Dow, S&P 500 and the Nasdaq. A bad market tends to take everything down with it. The fact that all three are trading near highs means there’s good news priced into them, but I think there’s more potential for good news down the line.

Keep in mind that a 10% market pullback can bring corrections of 20% to 25% in leading growth stocks. Once the correction runs its course, it’ll be the high-quality, well-sponsored names with great fundamentals that will have best chance to outperform. In the restaurant space, Buffalo Wild Wings, Chipotle and Panera will offer plenty of upside. The fact that they’ve been able to execute in a tough economy means they should be able to execute even better in an improving economy.

So do some homework, look over the menu, and circle Feb. 11 on your calendar. These three stocks could add sizzle to your portfolio.

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