IPOs are a hot market right now.
In 2014, there were 292 initial public offering, which raised a total of $96 billion. That marked the best year for IPOs since 2000.
There are expected to be 32 IPOs for the month of June, just one shy of last year’s mark.
However, what’s not so hot is the fast-casual dining sector, which has seen a slew of IPOs in 2014 and 2015. Investing in fast-casual stocks is akin to dumpster diving right now. But are there a few out there worth owning now that the euphoria has worn off?
The big issue is that most of these names still trade at outsized valuations. That’s right, even with the steep selloff in major fast-casual IPOs, many are still trading on the rich side. For example, Chipotle (NYSE: CMG) trades at a forward price-earnings ratio (based on next year’s earnings estimates) of around 30.
The biggest culprit of expensive valuations is Shake Shack (NYSE: SHAK). Shares are down more than 20% from their all-time high, but it trades at a forward P/E ratio of 410 and a price-to-sales ratio of 17.5.
Another recent burger-joint IPO that’s very expensive is Habit Restaurants (NASDAQ: HABT). Its stock has also fallen close to 20% from its all-time high. Its price-to-sales ratio is 4.6 and its forward P/E is 120.
Zoe’s Kitchen (NYSE: ZOES) is one of the few bright spots. Its shares are near all-time highs, and last quarter its same-store sales blew through estimates with strong traffic and pricing. Yet it’s trading at a price-to-sales ratio of over 4 and its forward P/E ratio is nearly 250. So it still has a lot of growing to do in order to make that valuation more reasonable.
Don’t forget about Potbelly Corp. (NASDAQ: PBPB), which is down close to 60% from its all-time high. The problem with Potbelly is that it’s struggling to generate a decent return. Its operating margin is on the low end of all the fast-casual players at 3.3%, and its return on invested capital is a mere 3%.
What about Noodles & Co. (NASDAQ: NDLS)? Its stock has fallen 66% from its all-time high, its valuation is mediocre and its operating margins just aren’t that great. Last quarter the fast-casual company reported same-store sales that declined and missed forecasts.
Chicken is hot right now, with Wingstop (NASDAQ: WING) soaring 60% on its debut earlier this month. However, it’s trading at a price-to-sales ratio of over 11.
Bojangles (NASDAQ: BOJA) also had a strong first day, popping 25% on day one, but it’s down more than 10% from the peak. Its valuation is reasonable, with a forward P/E ratio of 31 and a strong return on invested capital and margins.
However, there might be a better play in the fast-casual chicken space. El Pollo Loco Holdings (NASDAQ: LOCO) has seen its shares fall close to 50% from their peak. However, the developer and franchiser of Mexican-focused chicken joints in California, Texas and Arizona is one of the cheapest players in the industry. And its return to invested capital is best in class at 27%, not to mention its 14% operating margin.
The fast-casual space is a tough one to own. Nonetheless, there’s also value to be found in beaten-down industries. The key is to make sure the stock is actually cheap on a valuation basis. El Pollo Loco is the cheapest among the major fast-casual players, and has the best returns.
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