Something to Chew On: First Watch Restaurant Group’s Stock

Action Alerts PLUS Portfolio manager Chris Versace had breakfast over the weekend at one of First Watch Restaurant Group’s (FWRG)  474 locations. It was a warm, lively place and being the weekend, it was rather busy, and the food was first-rate. Should you find yourself in a First Watch location, Chris highly recommends the Cauli-Rizo breakfast tacos. They are simply delicious.

Putting our dining cap to the side, and donning our investor hat, restaurant stocks are an interesting bunch. They have to balance labor costs and food inflation, while not only driving same store sales growth. Consumers are a fickle lot, something we have observed more than few times with apparel companies, and yes there are fads here too as well. The real key, however, as evidenced by the likes of Starbucks (SBUX) , McDonald’s (MCD)  and others, is footprint expansion. For more established restaurant companies like those two, it means international growth and menu reinvention to keep bringing folks back.

For others, like portfolio resident Chipotle Mexican Grill (CMG)  and non-portfolio name, Dunkin Brands (DNKN) , there is domestic expansion as well as menu innovation. In some cases, as those maturing restaurant companies expand their reach, they can be takeout candidates either by private equity or other restaurant groups. Back when Chris was co-managing the Stocks Under $10 portfolio, he was very bullish on the shares of Habit Restaurant as the burger, fries and shake vendor expanded west to east. Habit was acquired by Yum Brands! (YUM)  in early 2020, and that acquisition led the Stocks Under $10 portfolio to book at 51% gain on its remaining shares of Habit.

So, what about First Watch shares?

To warrant a closer look by the AAP portfolio, a stock must clear some basic hurdles, one of which is trading volume. If a stock doesn’t trade enough shares on average, it could making getting into it or trading out of it problematic. Lower volume stocks can have wide swings in when there is sudden interest, and that can cost us both on the way in and the way out.

Based on our current holdings in the portfolio, the lowest average daily trading volume over the last 30 days is around 300,000 shares, and that’s for Chipotle. The next lowest at just over 575,000 shares per day is Axon Enterprises (AXON) , and the bulk of the portfolio’s shares trade more than a million shares a day. Our preference for the portfolio is to stick with an average daily trading volume floor of 500,000.

While First Watch serves us quite a meal, its average daily trading volume is around 266,000 shares, so that is going to be a strike against the shares.

Another strike, at least for now, is First Watch is a casual dining restaurant, and the data we’ve shared with members is consumers are shifting to fast casual and quick service given the rise in food prices. Recently First Watch shared its December quarter same-restaurant sales growth was 7.7%, more than a few points below the 12.9% year-over-year jump in Food Service & Drinking Places retail sales found for the December quarter found in the December retail sales report.

The third item that gives us pause is the company’s business model, which focuses on breakfast, brunch, and lunch. While it may be jam packed on the weekends, the company’s assets are unproductive during the dinner rush, which typically carries a heftier average check than breakfast. We also have to question how busy its footprint is for breakfast most days of the workweek. Consider the ease of popping into a Starbucks or a McDonald’s or hitting the drive thru….