Why investors shouldn't abandon casual dining stocks

Trevir Nath, director of content

Over the past 10 years, the fast-casual sector has taken the restaurant industry by storm. Since Chipotle went public in 2006, we have seen a number of fast-casual names follow suit, including Bojangles, El Pollo Loco and Shake Shack. As a result, it has been thought that casual dining has lost its way, not only for consumers but for investors as well. However, after a strong report from Darden Restaurants, the divide between fast casual and casual dining might be smaller than initially expected.

On Tuesday, Darden Restaurants posted better than expected third-quarter earnings. The casual-dining operator reported earnings per share of $1.21 on $1.85 billion in revenue, beating the Estimize forecast of $1.84 billion. Total same-store sales grew 6.2 percent, highlighted by a 6.8 percent increase from Olive Garden and a resounding 9.9 percent increase for Bahama Breeze. Additionally, the hospitality group returned over $200 million to shareholders through dividends and buyback programs while also retiring $750 million in debt.

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Still, investors were not pleased. In the moments following its report, Chairman Jeffrey Smith stepped down from his role with Darden. Starboard's Smith played an integral role in Darden's turnaround; in his time with the company shares rose more than 50 percent. Following the news, the stock fell 3.5 percent to $64.99. Even without Smith, Darden expects sales at established restaurants to grow between 3 and 3.5 percent for the remainder of the year.

Like Darden, Shake Shack topped expectations in its fourth-quarter earnings but left investors wanting more. The company's weak guidance sent shares plummeting, which are now down 14 percent since its March report. The NYC-based burger chain expects same-store sales at existing restaurants to rise between 2.5 percent and 3 percent in 2016, slightly worse than what Wall Street had been anticipating. Investors have been concerned that Shake Shack won't be able to justify its staggering valuation of 100 times earnings.

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Nevertheless, Shake Shack beat Wall Street by 1 cent on the bottom line and $1 million on the top line, yet fell short of the crowdsourced consensus. Earnings per share of 8 cents were up from a net loss in Q4 2014, while $51 million in revenue rose 46.8 percent on a year-over-year basis. Same-Shack sales grew a resounding 11 percent, thanks to the launch of the well received Chick'n Shack sandwich and the openings of nine new locations around the world.

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While consumers and investors have praised the fast-casual model for years now, they shouldn't be too quick to abandon the casual-dining space. Darden has been a prime example, as they have topped earnings in each of the past six quarters. That said, strong earnings, no matter what the industry, will have a tough time attracting investors if future guidance is weak.

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