A Growing QSR Royalty With A 9% Shareholder Yield

Jim Cramer likes to say, “There’s always a bull market somewhere.” Which is great if you’re a momentum investor, but we’re value guys. Fortunately the inverse – there’s always a bear market somewhere – is also true.

Today there is a bear market in restaurant stocks. Actually, there’s a bear market in almost anything heavily exposed to low-income consumers. We’ve written about this in regard to Dollar General. DG primarily serves low income, rural consumers. Years of high inflation have left them strapped for cash, so they’re buying only what they absolutely need and waiting until they need it. DG’s mix has shifted from discretionary to consumables, which has hurt their margins. Investors have published the stock.

It’s tricky to tease out the root cause of lackluster performance: is it a weak macro environment, or a weak competitive position? DG says it continues to take share from mom-and-pop operators, even as Walmart takes share faster. I personally don’t mind if someone is growing a little faster than me, so long as my competitive position is solid. The market seems to disagree., Walmart trades for 38x P/E while DG trades for 12x.

The market thinks Walmart is outcompeting DG and is willing to pay a big premium for the winner (and very little for the loser). I suspect both are winning, to different degrees, and that the data is being obfuscated by a weak low-income consumer. The huge difference in valuation looks like a mis-pricing. Retail is not a winner-take all market, so there should not be such a wide valuation gap between the top two players. These things always look obvious in retrospect, so time will tell if DG is actual losing its competitive position.

There’s a similar dynamic in restaurants right now. The winners are catching a bid and trading at full valuations (but not as rich as Walmart’s) while the losers are being priced for bankruptcy or at least a dilutive equity raise. Dine Brands and Jack In The Box are statistically cheap, but that’s mostly because of their debt and refinancing risk.