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Restaurant Stocks: “David vs Goliath”

It’s been a rough year thus far for the restaurant industry, with a pullback in traffic, higher costs due to commodity/wage inflation, and a challenging environment for some companies from a traffic standpoint.
The result is that much of the group has become un-investable, and some names are looking worse by the month, including Red Robin (RRGB), which will post its third straight year of heavy net losses in FY2022.
Given this backdrop, the best strategy is to focus on the industry leaders and those with proven business models enjoying unit growth and still enjoying strong restaurant-level margins.
However, in a sector where there are still several names with these attributes, it’s tough to decipher which are the best to own. In this update, we’ll compare newly public restaurant operator First Watch (FWRG) with long-time franchiser Dominos Pizza (DPZ) and see which is the better name to own in the current environment.
Scale & Business Model
Dominos and First Watch are akin to David and Goliath from a scale standpoint, with Dominos being the largest pizza company globally with ~19,300 restaurants and First Watch being an emerging breakfast chain with ~450 restaurants.
The differences in the business model are also night and day, with Dominos being a 98% franchised model with a significant international footprint and First Watch being a primarily company-owned company model, with just 22% of its restaurants being franchised currently.

While Dominos’ operators have seen some headwinds due to elevated cheese prices and difficulty securing drivers from a margin standpoint, Dominos is more inflation-resistant than First Watch, given its franchised model where operators bear the brunt of higher costs.
The good news is that First Watch still has very respectable restaurant-level margins, even if they dipped 440 basis points in the most recent quarter. Besides, this margin erosion was largely due to a conservative pricing approach to maintain its value proposition. Plus, as its alcohol mix grows and it’s rolled out to 100% of the system, we could see some additional benefit from a margin standpoint.
That said, Dominos is the clear winner from strictly a margin standpoint, with 30% plus gross margins and double-digit operating margins vs. First Watch at 21% and 4%, respectively, on a trailing-twelve-month basis.
Domino’s Pizza – 1 / First Watch – 0
Unit Growth & Positioning In A Recessionary Environment
Moving to unit growth, First Watch is the leader by a wide margin, with considerable white space (~450 restaurants in 28 states vs. ambitions of up to 2,500 restaurants) and consistent double-digit unit growth rates. Meanwhile, Dominos has continued to grow at an impressive pace given its scale but will be lucky to grow at 5% this year and 4% next year.
However, from a positioning standpoint, pizza tends to hold up better than casual dining occasions, given its relatively low average check to feed the family, the ability to skip tips to keep checks low when picking up, and convenience. In fact, Dominos started paying guests for picking up earlier this year with a $3 tip in the form of online credit.
That said, First Watch’s traffic is clearly suggesting a different story, with it being one of the only brands industry-wide to see positive but high single-digit traffic growth in Q2 (8.1%). This suggests that First Watch’s differentiated menu might make it more recession-resistant than some of its casual dining breakfast peers.
It’s also possible that its breakfast daypart might be stickier, with it being a tradition for many families to go out for breakfast on weekends without breaking the bank vs. a higher check dinner occasion.
So, with better unit growth and what appears to be similar positioning in a recessionary environment due to recent traffic trends, First Watch wins in this category.
Domino’s Pizza – 1 / First Watch – 1
Valuation
Finally, from a valuation standpoint, Dominos is not cheap at first glance, trading at ~22x FY2023 earnings estimates in a recessionary environment with some margin compression. That said, Dominos has historically traded at 27.8x earnings (15-year average), and even using a 5% discount to this multiple (26.4 x 27.8) places a fair value on the stock of $393.40.
Meanwhile, First Watch trades at 47x FY2023 earnings estimates, and while a premium valuation is justified, this is not cheap when the S&P-500 (SPY) is in a cyclical bear market, and growth stocks are being taken down due to multiple compression.
So, while I think there is some upside for FWRG long-term as its earnings play catch-up, DPZ is the more attractive bet from a valuation standpoint.

Domino’s Pizza – 2 / First Watch – 1
Final Verdict
Dominos and First Watch both make excellent buy-the-dip candidates, but neither are in low-risk buy zones just yet, even if Dominos is the better restaurant stock to own on the above criteria, slightly edging out the newly listed and high-growth breakfast concept, FWRG.
However, if we were to see DPZ decline below $292.00, or FWRG below $14.20, I would view pullbacks to these levels as buying opportunities.
For now, I see safer bets elsewhere in Retail, such as Capri Holdings (CPRI), which trades at less than 6.5x FY2023 earnings estimates.
Disclosure: I am long CPRI
Taylor DartINO.com Contributor
Disclaimer: This article is the opinion of the contributor themselves. Taylor Dart is not a Registered Investment Advisor or Financial Planner. This writing is for informational purposes only. It does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Taylor Dart expressly disclaims all liability in respect to actions taken based on any or all of the information in this writing.

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An Auto Parts Winner in a Greener Future

The global auto industry is in an all-out drive toward a cleaner and greener future.However, for some suppliers to the auto industry, it has not been a pleasurable joyride.

Instead, current conditions are more like driving on a icy, treacherous mountain road in the middle of a blizzard. Only the most skilled drivers will make it to the bottom of the metaphorical mountain intact.

Tough Sledding for Auto Suppliers

Most auto suppliers are already feeling a squeeze due to rising energy prices and rampant inflation in other parts of the supply chain. They have little choice but to shoulder most of the extra costs of making their components sustainable to help the automakers meet their environmental targets.

And make no mistake: the carmakers are pushing their suppliers hard. For example, Reuters reports that BMW expects all of its battery and many of its steel and aluminum providers to produce materials made using renewable energy, while Volvo Car is targeting 25% recyclable plastic in its cars by 2025.

Consequently, many suppliers to the automobile industry are making large investments to “green” their companies, doing everything from developing recyclable parts to using renewable energy.

Simultaneously, many of these same firms have little leeway to raise the prices they’re charging automakers, which are themselves focused on reducing costs. Automakers are spending tens of billions of dollars to shift their focus to producing electric vehicles.

This difficult situation faced by the auto parts industry was summed up nicely by Joe McCabe, CEO of the research firm AutoForecast Solutions, who told Reuters: “We use the term disruptive all the time, but it’s much more than just disruptive. We’re going to see a real big shakeout the next five, 10 years in the auto supply chain.”

In other words, the auto industry’s move to a greener future, alongside the supply-chain problems that began during the pandemic and soaring costs, has killed the profit margins for auto parts suppliers and created a perfect storm for the industry.

It is likely that only the strongest and shrewdest companies will survive this extinction event in the sector. The rest will go the way of the dinosaur.

One company that I believe will survive is TE Connectivity (TEL). It is able to pass along price increases to its customers, and it pays a dividend, too.

TE Connectivity

TE Connectivity is an American-Swiss technology company that designs and manufactures connectors and sensors able to withstand harsh environments for a number of industries. These industries include automotive, industrial equipment, communications, aerospace and defense, medical, energy, and consumer electronics.

Going green is costly for even the biggest suppliers, and TE Connectivity certainly isn’t immune. But it is a bit ahead of the curve, having launched its own sustainability drive in 2020. The company is presently working on recyclable products with automakers including Volkswagen, Volvo and BMW.

Of course, TE Connectivity continues to face supply chain challenges—but it seems to be navigating the headwinds well, as indicated by its continued price increases to customers that aid the company in offsetting inflationary pressures.

And the long-term thesis of growth that stems from increased vehicle electrification is holding up well, as management reaffirmed in its latest quarterly earnings results. Management expects electric vehicle production to be up more than 30% for the year, while the total automotive production environment is expected to remain flat.

The company’s third-quarter sales grew 7% year over year, and 2% sequentially, to $4.1 billion. Organic growth could be seen across all business segments.

Some of TE Connectivity’s other businesses, outside of automotive, did extremely well. Two of the largest growth areas were in the industrial equipment and data and devices end markets. Both grew at 27% on a year-over-year basis.

The industrial equipment segment saw continued benefits from increased factory automation applications, while the data and devices segment achieved its outperformance thanks to market share gains in artificial intelligence applications and high-speed cloud content growth.

TE Connects to the Future

The company’s balance sheet is sound, with very low net debt to EBITDA. That allows it to return an appropriate amount of capital to shareholders.

Management’s goal is to return two-thirds of free cash flow to shareholders, of which one third will fund the firm’s dividend (current yield is 2%) and the other third will be used for opportunistic share repurchases. However, this goal is often exceeded when management doesn’t find value-accretive deals for its cash.

TE Connectivity has raised its cash dividend every year since 2010. Over the past five years, the company has returned an average of more than 80% of its free cash flow to shareholders.

TE Connectivity has maintained a leading share of the global connector market for the last decade,

thanks to its dominance in the automotive connector market, from which it derives nearly 50% of its revenue. I do not expect the company to lose its dominant position. Morningstar reports: “While the firm’s entire business benefits from trends toward efficiency and connectivity, these are especially notable in cars, where shifts toward electric and autonomous vehicles provide lucrative opportunities.”

Just like other tech-related stocks this year, current market conditions have hit TE Connectivity, with a drop of 29%. It is a buy anywhere up to $120 per share.
It’s raised its dividend 37.5% on average, could be acquired, benefits from rising interest rates, trading at massive discount, and pays an 8% yield. This is my top pick for income during a rough market.Click here for details.

Inflation Continues To Spiral Higher

Key reports released last week in both the United States and the Eurozone revealed what global citizens have been acutely aware of. Inflation continues to spiral higher and at a staggering level.
This prompted Credit Suisse to issue a dire global economic outlook, saying that the “worst is yet to come”.

The Commerce Department released the latest inflation numbers vis-à-vis the PCE that revealed that the Core PCE jumped 0.6% in August. It shows that inflation is still intense and increasing.
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The preferred gauge used by the Federal Reserve, the PCE (Personal Consumption Expenditures Price Index) revealed that inflation accelerated even more than expected in August. On a year-over-year basis, the core PCE which omits food and energy costs increased 4.9%, above projections of 4.7%.

It was reported by Dow Jones newswires that inflation in the eurozone hit a new record high of 10% in September.

Dow Jones reported, “The consumer price index–a measure of what consumers pay for goods and services–increased 10.0% in September compared with the same month a year earlier after climbing 9.1% in August, according to preliminary data from Eurostat, the European Union’s statistics agency.”
The CPI for the Eurozone differs from the United States in that it was higher energy prices up 40.8% year-on-year in September after a 38.6% increase in August. The latest numbers for the CPI in the United States showed a slight downtick in August from 8.5% to 8.3%.
After five consecutive interest rate hikes including three consecutive 75 basis point rate hikes at the last three FOMC meetings, the Federal Reserve has raised interest from 0 to ¼% in March 2022 to its current range of 3% to 3 ¼% since March.
However, Friday’s report suggests that the Fed’s extremely aggressive rate hikes have yet to lower inflation.
Vice-chair Lael Brainard spoke at a research conference organized by the Board of Governors of the Federal Reserve System and the Federal Reserve Bank of New York, saying, “Inflation is very high in the United States and abroad, and the risk of additional inflationary shocks cannot be ruled out.
She later added that policymakers were “committed to avoiding pulling back prematurely saying that, “Monetary policy will need to be restrictive for some time to have confidence that inflation is moving back to target,”

Last week gold futures basis the most active December contract traded to a low of $1621, a high of $1684.40 and as of 5 PM, EDT is currently fixed at $1668.30 after factoring in Friday’s net decline of 0.02% or $0.30.
Until December gold can effectively close above $1680 per ounce there is still an extreme danger that gold could drift lower if severe dollar strength as witnessed recently continues.

Chart 4 is a daily chart of the dollar index in Heikin-Ashi format. It differs from a standard candlestick chart in that the open is fixed from the prior candle’s midpoint. It clearly illustrates a potential pivot looking at the third candle from the right which is green and has an extremely small real body and long upper and lower wicks. This is followed by the two green candles.

Chart 5 is also a daily Japanese chart in Heikin-Ashi format. It shows the opposite pivot with a series of red candles up until three days ago when the candle color changed from red to green with a small green real body with long upper and lower wicks.
Both of these charts are indicating that on a technical basis we could see a short-term pivot with the dollar moving from extremely bullish to bearish, and gold moving from extremely bearish to bullish.
For those who would like more information simply use this link.
Wishing you, as always good trading,Gary S. WagnerThe Gold Forecast

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pexels-photo-164527.jpeg

The Dollar Has Hit The First Target

The king currency has finally hit the first long-term target of $114 that was set in the summer of a distant 2019 when it traded around $96.
That aim wasn’t clear then as the dollar index (DX) looked weak in the chart. The short-term structure was similar to a pullback after a heavy drop.
The majority of readers did not believe the DX would ever raise its head as you can see in the 2019 ballot results below.

However, I had found a bullish hint in a very big map, and I warned you “Don’t Get Trapped By Recent Dollar Weakness”.

Back in August, you had already been more bullish on the dollar as you voted the most for the target of $121.3 in the earlier post. This confidence is due to the certain position of the Fed, which resolutely fights the inflation, lifting the rate aggressively round by round.
Let me update the visualization of the real interest rate comparison below to see if the dollar still has fuel to keep unstoppable.
Source: TradingView
The real interest rate differentials are shown on the scale B: blue line for U.S. – Eurozone, orange line for U.S. – U.K. and the red line for U.S. – Japan.
As you can see in the chart above the dollar’s buffer only grows over time as the trend gets even sharper. In August, the blue line was at +2.4%, the orange line was at +2.35% and the red line was at -3.3%. The change is huge in favor of the U.S. compared to its rivals.
Currently, the DX is lagging behind two differentials: U.S. – Eurozone (the largest component of the DX) and U.S. – U.K. (3rd largest component of DX). We can clearly observe the potential of the dollar to close that gap, rallying at least in the area of $120-$123, where the next target of the distant 2001-year top is located.
Let me refresh the technical chart below for more details.
Source: TradingView
This chart above represents the right part of a Giant Double bottom pattern (purple). It emerges accurately as planned as the price is approaching the main barrier of the Neckline.
There is another crucial element in the chart, the uptrend channel (blue dotted). Recently, the price has pierced the upside of it above $114. However, the DX couldn’t consolidate the success and dropped back below the barrier to close the month’s candle underneath.

The price could take two paths from here. The continuation to the upside based on the aggressive tightening is the first option. Another option could put the market on the pause within a consolidation (red down arrow). The former is needed to let the market take a break and reflect on the consequences of the Fed’s actions. This path is not bearish as it is just one of the natural stages of the market to let the latter accumulate enough power for further growth.
The bearish scenario is not considered as the next target of $121 is closer than the first support at $100. That area has been shown in my earlier post. It consists of the simple moving average for the past one year and the large volume profile zone.

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Intelligent trades!
Aibek BurabayevINO.com Contributor
Disclosure: This contributor has no positions in any stocks mentioned in this article. This article is the opinion of the contributor themselves. The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. This contributor is not receiving compensation (other than from INO.com) for their opinion.

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