RBC's 3 Restaurant Picks For 2017

In a note released on Thursday, RBC Capital Markets, said McDonald's Corporation MCD, Panera Bread Co PNRA and Starbucks Corporation SBUX are its top Outperform rated names heading into 2017.

Co-Specific Initiatives, Industry Trends, Tax And Valuation

Analyst Zachary Schwartzman attributed his view to the combination of company-specific initiatives in the areas of food renovation, digital and value that should drive improving sales by mid-2017, potential benefit of improving retail/restaurant industry, reasonable valuation levels and potential benefits from corporate tax changes.

That said, RBC Capital Markets believes there may be better potential upside in names such as Chipotle Mexican Grill, Inc. CMG and Texas Roadhouse Inc TXRH, if tax changes approach the levels of its upside scenario.

The firm noted that its upside scenarios include significant earnings and price target increases for two reasons, namely a roughly 2-point boost to industry demand by 2018 from income tax reduction and further earnings per share increase due to corporate tax reductions. RBC referred to the 2.5-basis-point-consumption boost, its U.S. economist Tom Porcelli foresees from the positive impact of estimated tax changes to disposable personal income.

According to the firm, adjustments to the U.S. federal tax rate to 20 percent from 35 percent, offsetting removal of deductions such as interest cost and FICA tip credits and addition of a capital expenditure deduction were used to calculate the estimated tax changes. The firm expects the tax changes and stronger industry demand to boost earnings per share by an average of 20 basis points by 2018 and create an average stock upside of 30 percent from current levels.

5 Predictions

RBC also made five predictions for investors in restaurant stocks:

1. Significant upside remains if the bull case for Trump tax changes occurs, with Chipotle, Panera and Texas Roadhouse being the biggest winners.
2. Food deflation drag would significantly reduce in the second half of 2017, boosting fast food same store sales growth. McDonald's, Wendys Co WEN, Yum! Brands, Inc. YUM and Restaurant Brands International Inc QSR are to benefit the most from the development.
3. Fiscal stimulus should help restaurant industry trends, although secular trends could still weigh on casual dining.
4. McDonald's and other quick service chains will respond to the twin pressures of convenience stores and fast casual with a combination of value, premium renovation and digital enablers. McDonald's, Yum! Brands, Restaurant Brands and Wendy's are potential winners on this count, while Dunkin Brands Group Inc DNKN could be a potential loser.
5. Although wage pressure will remain in 2017, the firm noted that long term outlook has improved. Chipotle and Texas Roadhouse are winners in this aspect.

The firm also raised its price targets and valuation multiples on those companies in its coverage universe that are most likely to be impacted by corporate tax reform and fiscal policy.

Ratings/Price Targets

• McDonald's: Outperform/$145 price target.
• Panera Bread: Outperform/$250 price target.
• Starbucks: Outperform/$66 price target.