This post is part of the Reporter’s Notebook blog.
Investors have been pouring money into fast-casual chains in recent years. Private equity groups and even a few strategic acquirers have been buying up fast-casual growth chains of late, some with as few as three locations.
On Wall Street, meanwhile, fast-casual growth chains have been receiving sky-high multiples, as investors all look for the next concept that will turn early investments into riches.
This has led to concerns that the sector is in bubble territory. The current environment has even drawn comparisons to the late 1990s dot-com boom, as investors pump money into chains like The Habit Restaurants and Shake Shack Inc.
But as we’ve noted recently, the stock prices of two notably high-priced stocks have come down. And so too, has the fast-casual sector in general.
Even after a recent increase, Chipotle Mexican Grill’s shares remain more than 12 percent off their 52-week high from February.
Shake Shack, meanwhile, which at one point was trading at a price more than four times its IPO price from January, is off 46 percent off of its all-time high back in May.
In addition, the entire sector outside of Shake Shack and newly public chicken wing chain Wingstop dropped slightly in the first half of the year — an unheard of decline for a sector accustomed to growth in all its forms.
Meanwhile, IPO valuations for fast casual and QSR chains seem to have waned in the post-Shake Shack market. The 60 percent first-day pop for Wingstop in June is still a really good day, but remarkably it’s still below average among restaurant IPOs these past three years.
Investors might be tempering their expectations of some of these early chains, while concern over valuations has taken over.
When Shake Shack’s valuation soared past $90 a share back in May, its market cap started to rival that of Wendy’s — the nation’s third largest QSR burger chain, one that is 12 times its size in terms of revenue. That generated a lot of warnings that its price was overheated.
In many cases, the chains’ sales have simply not performed investors’ lofty expectations. This is clearly the case with Noodles & Company, whose stock is the poorest performer among restaurant chains so far this year, down more than 40 percent. Investors have pulled back sharply, and the chain’s stock is now below its initial IPO price.
Unmet expectations were also the problem with Chipotle’s stock. That chain’s high valuation was more than understandable, given that it’s already the 14th largest chain in the country and is still boasting strong unit growth and double-digit same-store sales. But when you’re trading at north of $700 share and have a price-to-earnings ratio of more than 41, investors want that sales and unit growth to continue forever.
Regardless, it seems, perhaps the fast-casual bubble is starting to burst. Or maybe it’s just deflating a little bit.