Valuation multiples help investors decide on entry and exit points in securities. A company’s valuation multiple is affected by its perceived growth, risks and uncertainties, and investors’ willingness to pay.
Forward EV-to-sales ratio
Various multiples can be used to determine stocks’ valuations. We’ll use the EV-to-sales (enterprise value to sales) ratio because three of the eight companies under our review in this series are still in the growth phases of their life cycles. During the growth phase, a company’s operating costs will be higher, and its EPS (earnings per share) can’t be considered for valuation.
A company’s forward EV-to-sales ratio is calculated by dividing its current EV by its sales forecast for the next 12 months. Estimated future sales give us more visibility into a company’s growth prospects.
As of September 02, 2016, the eight fast casual restaurants under our review were trading at a median forward EV-to-sales multiple of 1.5x. Shake Shack (SHAK), which is still in its growth phase, has been trading at a higher valuation multiple of 4.2x. Since the beginning of 2Q16, the company’s valuation multiple has declined from 5.2x. The decline in SHAK’s share price has pulled down its enterprise value and EV-to-sales ratio.
SHAK is followed by Chipotle Mexican Grill (CMG) and Panera Bread (PNRA), which have valuation multiples of 2.6x, and 1.9x respectively. At the beginning of 2Q16, Chipotle was trading at 3x. But the recent fall in its share price has brought its PE multiple down.
Panera, however, has maintained its valuation multiple at 1.9x. The lowering of same-store sales growth and revenue guidance for fiscal 2016 led to the decline in Zoe’s Kitchen’s (ZOES) share price. This brought its EV-to-sales multiple down from 2.6x at the beginning of 2Q16 to 1.8x.
During the same period, Habit Grill (HABT), Fiesta Restaurant Group (FRGI), and Potbelly (PBPB) were trading at 1.3x, 1x, and 0.7x. The valuation multiple of all the three companies declined in 2Q16 due to declines in their share prices. Noodles & Company (NDLS), which posted a loss in 2Q16, was trading at the lowest valuation multiple of 0.5x.
In the next and final part, we’ll look at what analysts are expecting from fast casual restaurants.