The turn of the decade featured the creation of the fast casual sector that fuses the speed and efficiency of fast food with quality of casual dining. Chipotle is typically credited with starting this trend and also its most recent struggles. In late 2015 the first of many health scares broke out at a Chipotle restaurant in the United States causing a freefall in sales and the stock. While other operators haven’t had it as bad, there is still an evident slowdown occurring throughout the space. Popular names like Shake Shack and Noodles & Co have been hammered this year for consistently delivering decelerating growth. Early signs appear as if these trends will continue as we head into third quarter earnings season.

Chipotle (CMG) Consumer Discretionary – Hotels, restaurants & Leisure

Chipotle is still having trouble getting out from under the numerous health outbreaks starting in late 2015. The burrito chain which was once heavily praised as revolutionizing the fast casual sector is now largely an afterthought to a catalogue of other food chains, one being Shake Shack. Amidst the turmoil, earnings and traffic trends have taken a dramatic downturn. Last quarter comparable restaurant sales decreased a 3.6% on a 16.6% decline in total revenue. In an effort to regain customers, Chipotle has hit the ground running with new promotional campaigns and marketing initiatives. Some of these include Chiptopia which rewards customers for frequent visits throughout the summer. More recently, the company launched free kid’s meals on Sundays and complimentary beverages for students. While Chipotle continues to win back the hearts of its once loyal customers, investors have hammered the stock. Shares are down 14% year-to-date and 36% in the past 12 months.

Shake Shack (SHAK) Consumer Discretionary – Hotels, restaurants & Leisure

In its early days on the market, many investors were convinced that Shake Shack was well on its well to replacing Chipotle as the new fast of fast casual. Thanks to a string of slower than expected quarters those notions have receded. The burger chain has struggled to sustain high growth and rapid expansion as it goes through the maturation process. These growing pains are likely to continue for the near future until revenue and margins are commensurate with its value. At the moment the stock is considered well overvalued given what they deliver quarter after quarter. Shake Shack shares have fallen 17% year to date and nearly 27% in the past 12 months.  

Panera (PNRA) Consumer Discretionary – Hotels, restaurants & Leisure

Panera has been the most resilient across the fast casual sector. The bread maker remains dedicated to improving efficiency and quality to better meet its customers needs. This includes the recent move to only serve “Clean” bacon as opposed to what is found at McDonald’s. “Clean” simply insists that food doesn’t contain artificial ingredients while also shedding some light on the standards that Panera holds themselves too. Meanwhile the continued rollout of Panera 2.0 is expected to enhance in store productivity. Still expectations are slightly muted heading into its third quarter earnings report. Analysts at Estimize are calling for earnings per share of $1.37 on $685.84 million in revenue. Compared to a year earlier this represents a 9% increase on the bottom line and 4% on the top.

How do you think these names will report this week? Be included in the Estimize consensus by contributing your estimates here!

Investors who stuffed themselves on fast casual stocks are paying for it now.

Shake Shack, like GoPro and Fitbit, was once a high-flying, wildly valued cult stock whose shareholders loved the company’s products. Yesterday, that affair ended abruptly, with SHAK falling $5 to $37 on disappointing guidance for 2016. The former fast casual darling is now down 60 percent from its $97 peak last May. Investors who look at price, and not valuations, might think this is a good entry point.

They will likely be wrong.

Like many cult stocks, Shake Shack zoomed higher on its first trading day, more than doubling its IPO price of $21 and closing at nearly $46 in January of last year. Since cresting close to $100 five months later, the stock has been on a steady downswing. Yet Shack’s valuation remains quite bloated. A favorite metric for naysayers is the fact that SHAK trades at roughly $15M per restaurant, an unheard of amount for a fast food chain, and one that the company doesn’t look likely to live up to. The ten Street analysts covering SHAK predict 2016 earnings per share will be $0.39, vs. $0.32 in 2015, with projected revenues of $243M, vs. $191M in 2015. Even after its post-earnings tumble yesterday, that still puts Shake Shack ‘s stock at an obese 97x forward earnings and 5.5x revenues.

What really spooked investors yesterday was SHAK’s comp store sales guidance. After growing at 13 percent in 2015 the company is guiding 2016 comps at a much slower 2.5-3 percent rate. If this occurs, it is likely SHAK shares will continue to slide lower, possibly much lower, for the remainder of the year. How much could it fall? At a still generous 30x eps, SHAK would be an $11 stock.  

Shake Shack is not the only fast casual stock facing a potentially prolonged decline. Other restaurants that came public in recent years have also cratered, and could easily continue to shrink. Denver-based Noodles and Chicago-based Pot Belly are down 76 percent and 60 percent, respectively from their all time highs. Yet both remain pricey, as well. Noodles sells at over 100x its 2016 earnings projection of 8 to 12 cents per share, while Pot Belly sells at 37x its 2016 estimates. As with Shake Shack, both are more likely to trade lower as each company keeps losing its cult stock status and investors begin to demand some steak with their sizzle.

This pattern is not unusual. Companies often come public with excessive growth expectations, which are easy to achieve initially given their relative small size vs. industry leaders. In the restaurant space McDonald’s is still the QSR (quick service restaurant) leader. After some much publicized stumbles, it has quietly outperformed the industry, rising over 20 percent in the last twelve months. Even with that increase, however, Mickey-D’s still sells for “only” 21x 2016 earnings.

Though the fast casual boom might be fading, the restaurant industry, as a whole, remains attractive, as chains continue to take market share vs. mom-and-pop operators. Not only is chain food more consistent, chains hire better employees, train them well, and provide superior value for customers because their food costs are usually lower than independent players. That might explain why the valuation of nonpublic restaurants is markedly lower than public chains. I am a 50 percent owner of a popular Berkeley restaurant that has been open for nine years. Our operating profits are a healthy 20 percent of revenues. Yet, if we wanted to sell (which we do not), we would likely get 5-6x earnings, at best.

Finally, despite their recent struggles, I am confident that Shake Shack, Noodles, Potbelly, and the other newly public fast casual chains are here to stay. Their stock prices may drop further, but none of them are facing bankruptcy or catastrophic challenges to their business. Most importantly, unlike in the retail space, there is no category killer like Amazon out there crushing profits and devouring market share. As I wrote recently, the same cannot be said for GoPro, Fitbit and other fallen angel stocks in the technology space. Tech is an entirely different kettle of fish than fast casual dining, and those companies could very well disappear in the coming years.

The fast casual dining industry has been one of the most talked about segments of the market over the past year. The following chart of sales and earnings growth helps to explain this phenomena. F2024-F2015 growth is measured as the estimated growth between fiscal year 2015 and fiscal year 2014.

This article compares multiples for five of the most popular fast casual restaurants: Chipotle, Panera, Noodles, Potbelly and El Pollo Loco. Because the segment is growing very quickly, multiples are based on Wall Street’s estimates one year in the future.

To get a quick sense of relative value, each company was ranked from one to five on forward PE, EV/Sales and EV/EBIT. The three ranks were then averaged for a composite score. Some may argue that multiples without growth in the denominator aren’t useful, however I do not believe this is the case here because the growth looks to have normalized by 2015 (with the exception of Panera).

Panera Bread Co

Composite multiple rank: 4.7/5.0

As noted above, Panera has significantly less projected growth than the comparable group, so it makes sense for Panera to have lower multiples. A primary reason for lower growth is that Panera is closer to its target number of restaurants than other fast casual restaurants, so growth will be more dependent on increasing same store sales.

Forward PE and EV/EBIT multiples are the lowest at 26.33 and 16.7. EV/Sales is the fourth lowest at 0.87.

El Pollo Loco

Composite multiple rank: 3.3/5.0

El Pollo Loco started its life as a publicly traded company at the end of July. Shares initially skyrocketed as pundits compared the company to Chipotle (which is ~27 times larger by market cap), but are now trading just a few percent higher than they opened. Note that TTM figures were not included in the chart above because old data is unaudited and it may be non comparable due to accounting nuances.

Shares of El Pollo Loco are trading at a forward PE of 38.5 and forward EV/EBIT of 22.3, fourth highest of the peer group. EV/Sales is currently second highest at 3.08.

Potbelly

Composite multiple rank: 3.0/5.0

According to the chart above, Potbelly’s earnings fell 99.3 percent in the most recent twelve months. While this is technically correct, much of the decrease is due to a one time $16 million tax credit. Excluding the tax credit, earnings are down 84.5 percent. The drop in earnings can be largely attributed to a 14.2 percent increase in SG&A expenses.

Potbelly has the lowest EV/Sales multiple at 0.87, but the second highest PE and EV/EBIT multiples of 60.6 and 29.6.

Chipotle Mexican Grill

Composite multiple rank: 2.3/5.0

Chipotle is arguably the most talked about fast casual restaurant on Wall Street. This is probably a function of the company’s double digit growth and $20.9 billion market cap. A combination of retail investor attention and liquidity likely play a role in boosting the stock’s price, compared to its peers.

The company has the highest EV/Sales multiple at 4.9 and median PE and EV/EBIT multiples of 47.9 and 28.1.

Noodles & Co

Composite multiple rank: 1.7/5.0

With the goal of opening 2,500 noodle dish restaurants across the country, the company currently has just over 400 restaurants. 2014-2015 growth is projected to be the highest among the peer group at 17.3 percent sales growth and 26.7 percent earnings growth, however it also has the PE at 65 and EV/EBIT of 38. EV/Sales ranks in the middle at 1.95.

The following table summarizes these finding.