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One analyst has an ‘outperform’ rating on shares of Recipe Unlimited Corp., whose banners include Swiss Chalet, St-Hubert, Harvey’s, and The Keg, among others. The company should benefit from its high weighting in quick-service and casual/family concepts as these segments should be the first to rebound. THE CANADIAN PRESS/Nathan DenetteNathan Denette/The Canadian Press

Restaurant stocks are looking appetizing to investors as people become more eager to dine out amid the rapidly increasing COVID-19 vaccine rollouts and the lifting of lockdowns.

Although the industry has been hit hard by the pandemic, many restaurant operators have survived by using or adding alternative channels such as digital ordering, delivery, curbside pickups, and drive-throughs.

Given the potential for future growth, investors can play this sector by betting on stocks of individual restaurant chains or their suppliers, or through an industry-focused thematic exchange-traded fund (ETF).

Currently, the only ETF focusing on this sector is the actively managed U.S.-listed AdvisorShares Restaurant ETF EATZ-A, which launched in April. It holds mainly U.S. restaurant chains and Canadian-based Restaurant Brands International Inc. QSR-T and QSR-N.

“It’s obviously a COVID-19-rebound play … but we are also bullish on this area for the very long term,” says Dan Ahrens, chief operating officer and portfolio manager at Dallas-based AdvisorShares Investments LLC.

The U.S. economy has started to reopen, but the pace varies by state and city, Mr. Ahrens says. “Even though some [restaurants stocks] have rebounded already, there is a great deal of growth left as things continue to reopen.”

Restaurant chains can benefit as many independent eateries closed permanently during the pandemic, he says. “Many of the larger chains, frankly, had more of a corporate cushion and a better opportunity to survive.”

AdvisorShares Restaurant ETF is now more focused on U.S. fast-casual and fast-food restaurants because they’re valued more attractively and will draw more business given that they offer more affordable meals, Mr. Ahrens says.

Its top 10 holdings include Chuy’s Holdings Inc. CHUY-Q, Ruth’s Hospitality Group Inc. RUTH-Q, Jack In The Box Inc. JACK-Q, Texas Roadhouse Inc. TXRH-Q, and Dine Brands Global Inc. DIN-N, franchisor of Applebee’s and IHOP.

RCI Hospitality Holdings Inc. RICK-Q, the operator of adult entertainment or strip clubs and the Bombshell restaurant chain, is a top holding, but more of a special situation, he says. “A lot of [club] locations shut down completely and did not operate during COVID-19. They serve food, but have extremely high alcohol sales.”

Some U.S. firms are also global plays, Mr. Ahrens adds. For example, Wingstop Inc. WING-Q is expanding in the British market and will open its first Canadian outlet in 2022 as part of a 100-store expansion over 10 years. And Yum China Holdings Inc. YUMC-N has the right to licence the KFC, Pizza Hut, and Taco Bell brands in China.

AdvisorShares Restaurant ETF also has smaller weightings in food-delivery stocks, such as Doordash Inc. DASH-N and Just Eat Takeway.com NV, which owns Grubhub Inc. They rallied during the pandemic but “may be tailing off as things return to normal,” he says.

A risk to restaurant stocks is a labour shortage, which could mean wage increases and other hiring incentives, he says. Canadian restaurants, though, have been slower to reopen, “so that recovery and revenue growth is still in front of us.”

Peter Sklar, an analyst at BMO Nesbitt Burns Inc., says in a recent report that he expects the first half of this year to be the trough for the Canadian industry.

“That recovery could be swift with estimated 2022 sales at almost pre-pandemic 2019 levels,” he says. “There will be pent-up demand for dine-in restaurant experiences from lockdown fatigue,” albeit with initial capacity restrictions.

In a five-year forecast released in March, Restaurants Canada, an industry association, said it expects fast-food restaurants to rebound the quickest, with 2022 sales expected to grow 2.3 per cent from 2019 levels, while 2022 sales at full-service restaurants are expected to be 5.7 per cent below 2019 levels.

Among Canadian stocks, Mr. Sklar has an “outperform” rating with a $31-target price on shares of Recipe Unlimited Corp. RECP-T, formerly Cara Operations Ltd., whose banners include Swiss Chalet, St-Hubert, Harvey’s, and The Keg, among others. It’s currently trading at around $22 a share.

“Recipe’s high weighting in quick-service and casual/family concepts [at almost 85 per cent combined] should benefit as these segments should be the first to rebound,” he wrote in the report.

Mr. Sklar also has an “outperform” rating on Restaurant Brands International, which trades in both Canada and the U.S. and whose banners include Tim Hortons, Burger King, and Popeyes. He has a target of US$75 on this stock. It’s currently trading at around US$65 a share.

Tim Hortons’ digital sales rose to more than 30 per cent of revenue in the first quarter of this year from 23 per cent in the fourth quarter of 2020. That was helped by moving its popular annual “Roll Up the Rim to Win” contest to all digital from March 9 to April 4.

“This a positive development for Tim Hortons as, out of the three banners, it has struggled the most during the pandemic with Canada’s strict lockdowns,” Mr. Sklar wrote in a report on the company. “The contest and the banner’s popularity … bode well for [its] future as vaccinations are deployed.”

Another way to get exposure to the restaurant industry is by taking a “pick-and-shovel” approach and investing in suppliers. (This investment strategy stems from the days of the 1848 California Gold Rush, during which few prospectors struck it rich, but miners who sold tools and supplies made money.)

Restaurants can be tough businesses because it’s hard to sustain a competitive advantage as “the barriers to entry are very low,” says Sharon Wang, senior investment analyst at Vancouver-based Penderfund Capital Management Ltd.

However, Pender Small Cap Opportunities Fund holds U.S.-listed Par Technology Corp. PAR-N, a provider of point-of-sale (POS) hardware and software to the restaurant industry. “We are playing the digitization of the restaurant sector – it’s a big macro trend,” Ms. Wang says.

Restaurant chains need POS software to streamline daily operations and deal with everything from online ordering to inventory management, accounting, payroll, loyalty programs, and catering, she says. “It’s a challenge for restaurants to integrate everything and make the experience seamless to the customer.”

Par Technology’s main focus is selling its cloud-based Brink POS software to restaurants. That business is attractive because of the high-margin, recurring revenue from a monthly subscription fee, she says. “We also like the management team.”

The company’s niche market is enterprise-grade software aimed at restaurants with multiple locations, she says. Clients include names such as Five Guys, Subway, Taco Bell, Pizza Hut and Jack In The Box.

Although Montreal-based Lightspeed POS Inc. LPSD-T also sells POS software to restaurants, it typically sells to smaller operators and differs from PAR Technology in that it also has a big focus on retailers too, Ms. Wang sayss.

The restaurant industry is a huge market, and “digitization is still in the early innings,” she says. “A business such as PAR Technology has a long runway ahead of it.”

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