Why Restaurant Stocks Have Gone Bad

0:04Travis Hoium:Why have restaurant stocks gone south in 2025? Motley Fool Money starts now.

0:20Travis Hoium:Restaurant stocks like Chipotle, Darden and Starbucks have been some of the biggest winners for investors over decades, but are consumer tastes changing? I'm joined by Lou Whiteman and Rachel Warren to try to answer that question. Let's get to the news of the day. That's Kava. There's been some really strange trends in a lot of the restaurant industry over the past few months. Companies that were growing like crazy suddenly reporting negative numbers. Kava reported after the market closed yesterday as we're recording and the stock's down 23 % early in trading. Lou, what did we learn from Kava and why is this such a huge reaction from investors?

1:00Lou Whiteman:The headline numbers were fine, but if you dig a little deeper, the traffic was flat, margins are down. They did warn of comp sales guidance. Comp sales, because these restaurant chains are growing so fast, you want to compare apples to apples, like how many stores did you have last year, how many stores you have this year. Obviously, just getting more throughput through those stores. This is such a scale business. That's so important. They lowered their comp sale guidance by 200 basis points to 4 % to 6 % growth. That's a bad sign. Now, some of this, I think, is the big macro. CFO Tricia Tolliver said, we're operating in a fluid macroeconomic environment, and that one that creates fog for consumers with things changing constantly.

1:44Lou Whiteman:If there's fog for consumers, it's translated into fog for the business, which is fog for investors and investors are heading for the exits? I don't think we can really take a single quarter of Kava earnings and really make a holistic determination about the business. I think this is obviously one of those stocks that we look at as investors. The valuation is very high and expectations accordingly are also quite high. The company has had one of the best financial performances recently across all comps leading up to this point. In Q1, that was definitely the case compared to other quick service competitors.

2:17But Q2 was more mixed. Kava's same restaurant sales growth decelerated to 2.1%. That was quite a bit behind what analysts were expecting. They had been targeting more of the 6 % range. But I will note, this follows the first quarter where Kava's same restaurant sales growth was 10.8 % up year over year. So, I think that there are some positive points to note. They also grew revenue by more than 20%. And restaurant-level profits grew about 20 % as well in Q2. So it's not all bad news. Yeah.

2:49Travis Hoium:Those same store sales numbers have been absolutely crazy at Kava. They've been over 20 % for a lot of the last couple of years, which is almost unheard of in the restaurant industry. That's why this is a stock that was trading. I think right now it's about 70 times trailing earnings. But this is also, as you're scaling your business, you're growing, entering new markets. Lou, do they have the right menu for the American eater right now? I mean, burritos is something that kind of translates to everybody. Is Kava going to be able to do the same thing?

3:20Lou Whiteman:I think that is a great question, and it has to be baked into the kind of the growth estimates. Full disclosure, Kava is my go-to. I love Mediterranean food, but we are a culture of pizza and burritos. And I wonder, they're only at 400 locations now. They have big plans to get, I think, to 1 ,000 by 2032. Will they have success selling the Mediterranean diet versus pizza and burritos nationally. I think there's still a growth story here, but I don't know if the long-term trajectory, if we compare it to some of these other big names, I don't know if it's going to turn out that way with their menu versus what you can do with a burrito place or a pizza place.

4:03Travis Hoium:It's easy to put a huge growth multiple when you have those same store sales. We still don't have Cava where I live, so this is one I I would like to.

4:11Lou Whiteman:The American Heartland is a huge question, I think.

4:14Travis Hoium:Yeah. Pizza, burgers definitely translates here. Don't know if necessarily Cava does. Rachel, what's the growth thesis? I mean, the stock has taken a beating down over 50 % just from its highs earlier this year, much less as high as last year. What are you looking for for this to be a buy? Yeah. I mean, I don't think the story is nearly as bleak as the market's reaction might have you think. And I agree. The valuation is high. And I think one could even argue that a drop down in shares have been warranted. But here's the value proposition you really need to be thinking about if this is a business that you're looking to invest in.

4:49This is a company with extensive growth plans. They're looking to reach 1 ,000 locations by 2032. That's up from 398 locations currently. And historically, this is a business that has boasted really strong unit-level economics, including high profit margins and average sales per restaurant. and that's enabled them to fund that expansion with internally generated cash. Even if you look at the first half of Cava's fiscal 2025, you've got year-to-date free cash flow of about$22 million on about$612 million in revenue and$44 million in profits. Those top and bottom line figures were up 24 % and 31 % from one year ago.

5:27It's still a business with a really robust, addressable market, and they are still bucking that trend of same-store sales declines that we've seen from a lot of their competitors. So I think that there's still a lot to like about Kava.

5:40Travis Hoium:Speaking of same store sales declines, we're going to talk about Chipotle next and see why there are so many struggles there. We will get to that when we come back. You're listening to Motley Fool Money.

5:51Lou Whiteman:Support for the show comes from Fundrise. For the past 70 years, there's been a room in finance most people couldn't enter. A room where you could have invested in some of the biggest names in tech, companies like Airbnb and Uber before their multi-billion dollar IPOs. I'm talking about venture capital. Fundrise recently took a sledgehammer to those closed doors by launching a venture capital product that's available to anyone. Their mission is to give everyone the chance to invest in the best tech and AI companies before they go public. You can visit fundrise.com slash fool to check out Fundrise's venture portfolio and get in early today.

6:26Lou Whiteman:All investments involve risk, including the potential loss of principle. Past performance is not indicative of future results. This is a paid advertisement.

6:34Travis Hoium:Chipotle has been fascinating over the past couple of years. The stock's actually in its biggest drawdown, down 38 % from its high in 2024. That's the biggest drop in shares since 2017. The big news over the past few weeks is that same store sales, this number and concept that we keep talking about, so important for restaurants, down 4 % in the second quarter. The big change at Chipotle is that CEO Brian Nichol left for Starbucks. Is he a reason that same-store sales are down, or is there something else going on?

7:07Lou Whiteman:I don't think he's the reason that same-store sales are going down. I do wonder, though, about where you go from here. I'll be honest, I'm probably more bullish on this company as far as remaining a growth story than I am Kava, although I'd prefer to eat at Kava. But bottom line, Brian, I think there is a CEO question here. It's probably unfair to Scott Boatwright, Brian Nichols' replacement, because he seems to have the credentials. But Brian Nichols is special. That is what we've been told to believe. He did an amazing job here. He's well thought of what he's done at Starbucks. If he is special, then I think you do have to ask questions when someone new comes in.

7:49Lou Whiteman:It's no guarantee that the next person will be as good. And it's no guarantee that you can get this performance with average if you had someone special. I think there's just a lot of question marks around the company because of that. It might turn out to be unfair. It might turn out that everything's fine, and I do probably think so. But I do think, given the leadership change in a tough macro environment, I think it sort of makes sense for investors to have questions here. Yeah. I mean, we know the market hates uncertainty, right? And that's certainly been, I think, a trend that's been reflected across a lot of stocks, including restaurant stocks.

8:25With Chipotle specifically, I don't think that one can fairly attribute Chipotle's recent troubles to Brian Nichols' departure. I mean, Scott Boatwright is a veteran in the quick service restaurant space long before Chipotle. I do think the ship is in good hands overall. Chipotle's performance within the fast casual segment is lagging peers right now. If you look at Q2, they had a roughly 6 % drop in per location trap. and that was compared to flat performance for the segment overall. They had a 4 % decline, as you noted, Travis, in comparable restaurant sales. And that decline in comps was primarily driven by an almost 5 % decrease in transactions.

9:02But ultimately, I do think that this is a consumer spending issue, not a fundamental weakness with the business. And it's operating in a cyclical space. And I think investors should not be surprised that the business is being impacted by the downtrend of that cycle right now.

9:17Travis Hoium:Yeah, this has been one of the companies that's grown their same-store sales almost like clockwork. Really, since they had that E. coli outbreak, the stock obviously cratered when that happened. But this is another example of a stock that was priced for perfection, still has a$57 billion market cap. We got a 30 PE multiple on a forward basis. So, is the growth story over? I think that's the big question for investors right now. You start to have negative same-store sales comps, and you're paying a pretty high price still for Chipotle. Can they get that magic back, or has something fundamentally changed for Chipotle, Rachel?

9:57I do not think that the growth story for Chipotle is over. And I want to take a step back for a minute. I mean, if you look back to last year, Chipotle essentially outpaced the growth of the restaurant industry, where a lot of key names were already experiencing sales and traffic to clients. And that trend only really started to affect Chipotle's business at the end of December. I mean, if you go back to their Q1 earnings call, Boatwright said that diners' concerns about the economy had led them to skip restaurant visits and maybe save their money instead. You fast-forward to Q2, May was a tough month for Chipotle.

10:30But by June, same-store sales began increasing again. And Boatwright said that by exiting the quarter, they had begun to return to positive comp and transaction trends, which continued into July. So, I do think that it is important to take a more nuanced view here. There could be some bumpy quarters ahead, but a solid market and leadership position, I think, still gives this company a long-term advantage.

10:52Lou Whiteman:So, they're at under 4 ,000 stores. They hope to get to 7 ,000. As I said, kind of the style of food. I'm more confident that they can get there. I think I am, then the Cava gets to$1 ,000. Maybe not$7 ,000, but at least big growth from here. I think it's easier to expand once you have that scaling and critical mass, too. It is an easier ramp. I think there's also that lever of breakfast, which we've been joking about forever, but that makes more sense here as far as just expanding the comp sales.

11:21Travis Hoium:Yeah, where are we going to get some breakfast burritos? McDonald's has that. I'd be down for that.

11:26Lou Whiteman:That seems a lot easier here than it is for Cava again. And again, I don't want to be too hard on Boatwright. I think he's the right person for the job. But I do think sort of the wild card here, you're getting a much better valuation than Kava. Kava, before trading this morning, was, I think, 4X, the forward valuation. So, you're getting a better valuation. But if you buy into the fact that they had a best-of-class CEO before, will there be some sort of drop-off? And if so, how does that affect the business? I don't think that that is a bear case, but it is at least a question for the bulls that only time will answer.

12:01Travis Hoium:We're going to take a bit more of a macro view of the restaurant industry and talk about a tech company you may be interested in. We'll get to that next. You're listening to Motley Fool Money.

12:10Lou Whiteman:You just found out that your sales team is at risk of missing quota. Don't panic. Just ask Rippling AI. Since it's built on your real-time people and business data, Rippling AI can pull metrics from Rippling and Salesforce into a meeting-ready dashboard showing quota attainment, headcount plan, and monthly revenue to quota by region. In seconds, you'll see exactly what's behind your quota risk and fix it before it's missed. Question answered, action taken, crisis averted. When you have critical business questions that need answers, don't just file a ticket and wait weeks for an outdated report.

12:44Lou Whiteman:Describe what you need and have Rippling AI build it instantly from your live people and business data. Whether it's a dashboard with detailed charts or automated workflows with the right triggers, conditions, and approvals. Ready to rule your business? Head to rippling.ai slash fool to get the only AI built to give you full visibility and take complex actions across your entire organization. That's r-i-p-p-l-i-n-g dot a-i slash f-o-o-l. Sign up for exclusive access today, rippling.ai slash fool.

13:15Travis Hoium:Given that operating leverage, restaurants have been phenomenal winners for investors who have been able to buy at the right price and hold for a long time. Chipotle, McDonald's going back decades, even Starbucks, if you want to add kind of coffee into this. But we're seeing a huge pullback in a lot of restaurant stocks. We haven't even talked about Sweetgreen. That's down 70 % this year. So Lou, is there something specific with restaurant stocks? Is this a macro story? What do we need to take away? Because we've been hearing multiple things from different companies, and these consistent growers just aren't growing anymore.

13:49Travis Hoium:It seems like some sort of canary in a coal mine.

13:52Lou Whiteman:Yeah, I think there's two related macro trends going on here. The first is, I keep calling it the boiling frog economy. I think things seem better than they are, because it's just slowly, slowly inflation is creeping up, And so I think it is affecting consumer habits.

14:09Travis Hoium:And by the way, inflation is one of these things that comes up on every one of these conference calls. Absolutely. Prices are up. It gets very specific for restaurants.

14:17Lou Whiteman:It hits on both sides because it hits on their costs. And it also, I think, does influence consumer behavior and maybe bring down traffic. Also, I think it's interesting, and maybe this is related. If you look at this quarter, full-service restaurants have outperformed fast food and fast casual in a big way. Talking about comp sales, Chili's is out this morning, up 22%. Olive Garden comp sales, up almost 7%. Same with Longhorn. Texas Roadhouse, up 6%. You compare that, you mentioned Sweet Greens, which is fast casual, down almost 8%. Wendy's down 4%. Jack in the Box, down 7%. I don't know exactly what is going on here.

14:57Lou Whiteman:I suspect that maybe if people are eating out less, they are just one atmosphere, and They're like, all right, instead of it's just that incremental stop three times a day that's going away and special occasions are holding on. But I do think that there is that the restaurants are telling us something about just the state of the consumer. And Travis, you're right. It's not something we're hearing universally. So I do wonder if this is a canary. I do think it's a really interesting dynamic we're seeing right now. I mean, we know and we're witnessing the ways in which the macro environment is giving consumers pause.

15:31We're seeing consumer sentiment numbers that come out. We are seeing consumers shifting their spending behaviors, but they're not curtailing all discretionary purchases. I mean, obviously, there's been a shift towards essential items like groceries, but then there's discretionary areas that have shown significant resilience, like spending on leisure travel and other big ticket items. But it's been really interesting to see the ways in which some of those trends have and have not trickled down to restaurant spending. There seems to be a lot more nuance. And I do think Lou's right. Consumers are becoming increasingly picky about where they want to put their money to work.

16:07I think that's a reality that a growing number of restaurants are contending with. And I see a lot of consumers prioritizing value. Maybe if they're going to spend money to go out to eat, they'd rather have that sit-down experience than a quick grab-and-go. And at least right now, I think that that is a common through line that we are seeing in restaurant earnings.

16:26Travis Hoium:It's so interesting that value has become the sit-down experience. I mean, even going back to 2008, 2009, you would see pretty good numbers from McDonald's because people stopped going to sit down restaurants and traded down to McDonald's. Now it seems like prices have gone up at a lot of those fast, casual, fast food places. And you're right. If I'm going to go and take the family out to eat, do I want to spend$40,$50 at McDonald's? Or do I want to spend$60 or$70 to actually sit down and have full service? It seems like a lot more people are doing the full service choice, but we'll see how this plays out.

17:03Travis Hoium:This is going to be fascinating because, you know, Lou, restaurants really tell us a lot about what consumers are choosing.

17:11Lou Whiteman:Yeah. And to me, I think it's you're still going out with the family to celebrate a birthday or something. That's why you're still seeing it. But if you're racing home, you could either make a PB &J at home or grab a Big Mac. I think that's where the maybe the little bit of cost creep and the pressure on the household budget, maybe that's where it's showing through.