Chain Leader

David Farkas

The Downfall of Hot Restaurant Stocks
January 8, 2008

Is Chipotle Mexican Grill the new Starbucks? Sorry, I hate those kinds of questions, too.

To give that query perspective, consider the sad fortunes of recent “hot” concepts.

 Anyone recall Boston Chicken--after 1995, it was called Boston Market--the rotisserie chicken chain notorious for coddling restaurant analysts with ski packages and lavish conferences? It peddled a pretty good tasting product, then deemed “healthful,” which in turn created the home meal replacement category. Today it’s known as carryout.

Most people know it filed for bankruptcy in the late ‘90s and was picked up for a song in 2000 by McDonald’s, which paid a paltry $700 million. The burger giant sold it last August to voracious Sun Capital Partners.

Yet a few still recall how smitten Wall Street and restaurant executives were with the company’s “area developer” (read: franchisee) strategy, which managed to get open 1,000-plus units in a few years. Many observers, alas, overlooked the enormous amounts of capital the company was loaning its franchisees to do so. Then came inklings that franchisees were experiencing dismal sales and piling up operating losses, which by 1995 totaled $200 million.

Some may also recall that management, led by a 38-year-old CEO named Scott Beck, wasn’t particularly helpful when it came to divulging such financials. 

Next up: Krispy Kreme Doughnuts, where management couldn’t hide the fact that its sputtering empire was about to collapse after one of the most successful stock prices run-ups in history. The clue: It promised to restate earnings.

Still, who doesn’t remember shares of KKD changing hands at nearly $50 in 2003, an awesome 235 percent premium from its 2000 IPO price of $21? Those were heady days, with lines around the block at new store openings. For doughnuts?

And yet by 2004 the company was falling apart. Among many other things, management was accused of padding quarterly reports, corporate greed and mismanaging the business. The Securities and Exchange Commission stepped in to investigate; longtime and once widely admired CEO Scott Livengood, who blamed the company’s tumbling sales and profits on the Atkins Diet, stepped down.

The slings and arrows of outrageous fortune are now pointed toward Starbucks. The Jan. 7 issue of the Wall Street Journal, for example, outlined how McDonald’s (registration required) is poised to steal market share from the Seattle-based specialty-coffee chain with McCafe, a lineup that includes cappuccinos, lattes and cold mochas at lower prices. McCafes are in some 800 units, according to the paper.

The article’s headline alone, “McDonald’s Takes on a Weakened Starbucks,” was ominous. To be sure, the coffee chain’s stock price and sales have turned negative for the first time, and McDonald’s means serious business when it comes to new beverages. But any notion that the army of Mac-toting 20- and 30-somethings who visit Starbucks as many as 20 times a month will switch allegiances is laughable.

Finally, Chipotle, which has been adding units rapidly while racking up admirable comparable sales in a beleaguered economy. The fast-casual concept is the Street’s new darling, at least for the time being, with a stock price of $118 per share and an earnings multiple of 60 times. The industry hasn’t seen this kind of faith since, er, Boston Market and Krispy Kreme were doing their thing.

Of course, blood may spill yet should Chipotle’s sales slip. Jeffrey Bernstein, a prominent restaurant analyst with Lehman Brothers, whom I talked to last week, predicted even a “modest slowdown” could crater the stock.

Discussion question: Who takes on a weakened burrito chain?

Posted by David Farkas on January 8, 2008 | Comments (0)