A Restaurant Pair Trade: Jack In The Box Vs. Bloomin Brands

The restaurant sector, especially in the domestic market, is likely to benefit from multiple tailwinds, including tax reform and strong demand, according to Goldman Sachs. But some names will perform better than others. 

The Analyst

Goldman Sachs' Karen Holthouse upgraded Jack in the Box Inc. JACK from Neutral to Buy with an unchanged $109 price target. The analyst downgraded Bloomin' Brands Inc BLMN from Neutral to Sell with a price target cut from $18.25 to $17.

Jack In The Box: Valuation Support

Despite holding a "muted view" of Jack in the Box's comp trends, the case for buying the fast food restaurant's stock can be made, Holthouse said in the upgrade note. (See the analyst's track record here.) 

Investor expectations have been "reset" and the proceeds from the recent sale of Qdoba provide a valuation floor for the stock, the analyst said. And domestic quick service restaurant operators are likely to outperform casual diners in the early days of tax reform, Holthouse said.

The restaurant chain likely saw a boost from extremely cold weather across various regions, which could result in better near-term trends, the analyst said. 

Jack in the Box's stock is also attractive on a free cash flow yield basis, Holthouse said: The company's free cash flow yield experiences limited volatility, as the company boasts a 95-percent franchised concept. In fact, every one point in the JTIB restaurant system comps equates to 20 basis points in free cash yield, which makes it Goldman Sachs' "preferred exposure to a potential sub-sector rotation."

Related Link: Argus: Darden Restaurants Among 'Best-Managed' Dining Names

Bloomin' Brands: Unwarranted Gains In Stock

Casual dining stocks have justifiably moved higher on anticipation of tax reform benefits, but the 26-percent gain in Bloomin' Brands' stock is "unwarranted," Holthouse said in the downgrade note. The parent company of Outback Steakhouse and other brands continues to face "deteriorating perception and trends based on the fact the company hasn't established a consistent trajectory on a one-year, two-year or three-year comp," she said. 

Bloomin' Brands' P/E multiple is now trading at an 8-percent premium to its historical average and at a 16-percent premium to casual diner peers, the analyst said. Not only is there no top-line argument to be made in support of a premium valuation, but the opposite holds true, as the argument for a discounted valuation can be made, according to Goldman Sachs.

Price Action

Jack in the Box shares were up 1.91 percent at the close Friday, while shares of Bloomin' Brands were down 0.27 percent. 

Related Link:

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Photo courtesy of Jack in the Box.