2 Restaurant Stocks to Buy, 1 to Avoid

By Markets Fool.com

The business of dining out is on the upswing. As U.S. consumer confidence marches higher, food service operators are posting higher sales and customer traffic. In fact, February marked the fourth straight month of industry gains in those key metrics, according to the National Restaurant Association.

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Investors have their choice of restaurant stocks that runs the gamut from blue-chip dividend payers to newly public growth companies. But which ones are worth considering as long-term investments? We asked three Motley Fool contributors to weigh in on two restaurant stocks to buy -- and one to skip.

Andrs Cardenal:Chipotle Mexican Grill is the poster child for the fast-casual revolution, which describes restaurants that provide a similar experience to that of traditional fast-food chains, but with higher-quality products and healthier ingredients for a few extra bucks. Fast-casual concepts are outperforming the industry, and Chipotle is a growth leader in this promising segment.

Source: The Motley Fool.

The company has increased sales by more than 22% annually through the last five years, and the latest financial report confirms the business is as hot as ever. Revenue in the fourth quarter of 2014 jumped 26.7% year over year, while comparable-restaurant sales grew by 16.1% over the same quarter of the prior year.

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Considering demand strength, Chipotle still has significant room for growth in the U.S. Besides, the company has barely given its first steps in international markets. In addition, Chipotle is expanding into Asian cuisine and pizza with its ShopHouse and Pizzeria Locale concepts. If management can replicate with these new ventures at least a fraction of the success it has achieved with Chipotle, this could open the doors for massive growth opportunities.

The biggest risk when it comes to Chipotle is valuation. The stock trades at a forward P/E ratio of 38 times the earnings estimate for the coming year. This is more than double the average valuation for companies in the S&P 500 index. While Chipotle clearly deserves a premium due to its superior growth prospects, the stock is still vulnerable to any disappointment in the short term.

On a longer-term basis, however, Chipotle is a fantastic business to own for years to come. Any dips down the road should be considered an opportunity to buy an exceptional company at convenient prices.

Bob Ciura: Darden Restaurants is a restaurant stock to buy following a hugely successful turnaround in just the past year. In 2014, Darden was shrouded in uncertainty. The company was under pressure from shareholders for its declining same-restaurant sales, particularly in its core brands. Darden eventually bowed to this criticism and sold off Red Lobster for $2.1 billion. It also took investor demands to turn Olive Garden around seriously, and the results speak for themselves.

Last quarter, comparable sales at Olive Garden increased 2%. The Olive Garden is Darden's flagship, so finally returning to growth matters a great deal to the company. Separately, Darden's other core brand, LongHorn Steakhouse, grew comparable sales by 5%. Darden operates a number of smaller specialty brands that are putting up high growth, too. Eddie V's and The Capital Grille grew comparable sales by 9% and 6%, respectively. Overall, Darden grew comparable sales by 3% last quarter, which beat expectations. The company anticipates at least 2% comparable restaurant sales growth this year, which would cement its successful turnaround.

Because Darden has restored comparable-restaurant growth, and the company is effectively cutting costs, adjusted earnings grew by 39% last quarter. The company generated $325 million of free cash flow in the first three quarters of the fiscal year, which easily covers its cash dividend. With a modest valuation at 12 times earnings and a secure 3.4% dividend yield, Darden is an attractive restaurant stock to buy.

Demitrios Kalogeropoulos: As tempting as it is to get in early in the life of an expanding restaurant business, I'd steer clear of Noodles & Company right now. Sure, the international kitchen concept is a relative toddler with just 500 locations -- the same number Chipotle had when it went public in 2006. And we know how well an investment in that fast-casual upstart has worked out since then. Noodles' management aims to reach 2,500 stores eventually, which isn't far from the 1,800 Chipotle has now.

But that's where the favorable comparisons between the two restaurants stop and the unfavorable ones begin. Noodles & Company only managed 1.3% comparable-store sales gains last quarter, while Chipotle's was 16%.

Source: Noodles & Company.

Even more worrisome, though, customer traffic fell in the quarter and for the full year. Meanwhile, Noodles' profitability is on pace to shrink for the second year in a row to 19% of sales in 2015. (Chipotle's profit margin is closer to 28%.)

The main reason for the dip is that Noodles' is ramping up spending on a new advertising campaign intended to goose sales. But at the same point in Chipotle's life, the burrito slinger relied on word of mouth as its marketing. It isn't a good sign that Noodles & Company doesn't have the same ability, particularly as it expects to more than quadruple its store footprint over the long term.

Wall Street sees this fast-casual eatery expanding sales by 20% in 2015, mainly by adding 50 new locations to the store base. But I think restaurant stock investors can find better places to park their money, including the two companies listed above.

The article 2 Restaurant Stocks to Buy, 1 to Avoid originally appeared on Fool.com.

Andrs Cardenal has no position in any stocks mentioned. Bob Ciura has no position in any stocks mentioned. Demitrios Kalogeropoulos has no position in any stocks mentioned. The Motley Fool recommends Chipotle Mexican Grill. The Motley Fool owns shares of Chipotle Mexican Grill. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.