Highlights include Buffalo Wild Wings (BWLD), BJ's Restaurants Inc. (BJRI), California Pizza Kitchen, Inc. (CPKI) and Famous Dave's (DAVE).

Restaurant Growth Stocks Rising - But Will Earnings Follow?

Restaurant growth stocks have been sizzling lately. Shares of rapidly expanding restaurant chains have increased 91% since their November lows. Although the group's share prices remain 35% below their 52-week highs, there appears to be more downside risk than upside potential.

The growth stock dining group* is currently trading at 17.6x projected 2010 earnings, or 1.1x its projected growth rate of 15.7%, based on consensus estimates. On the surface, these multiples might seem reasonable, or even cheap if one assumes earnings will gain momentum into 2011.

However, these growth estimates incorporate both a strong rebound in same-store sales - driven by reinvigorated traffic -- and a return to double-digit unit development.

Clearly, same-store sales will likely begin to improve in the second half of 2009, as weak comparisons are anniversaried. But a resurgence in customer traffic in 2010 is anything but guaranteed, especially in the first half of the year.

When unemployment eases in 2010, consumers will face record levels of debt (currently totaling $2.6 trillion) and impaired home values, potentially dampening their discretionary spending. Feeling poorer, consumers may opt to pay down debt, save more and eat out less.

The rapid unit expansion incorporated in 2010 consensus estimates is also uncertain. New restaurant units take about 18 months from the initial planning to the opening. Almost every restaurant chain has scaled back -- if not completely halted -- new unit expansion. Comments from most management teams indicate they are in a wait-and-see mode with respect to expansion plans.

Restaurants with unique concepts that offer quality food at value prices are not only weathering the recession better, but will grow faster and more profitably when the economy recovers. And those with solid balance sheets will enjoy opportunities to grab "A" locations at reduced rents, as weaker tenants fold.

Buffalo Wild Wings (BWLD) fits this criteria, while offering investors the strongest growth (25% EPS growth expected in 2009) and same-store sales (+4.5 in 4Q08) in the industry. Vigorous growth, coupled with firm cost containment, has generated a history of superior ROE and ROIC. However, trading at 18.0x 2010 earnings, we think the shares are pricey and recommend waiting for a pullback in the stock.

The company is highly levered to the price of chicken wings (roughly 21% of sales), which has soared 39% since December, and any significant margin pressure in 1Q09 financial results could weaken share prices, providing a buying opportunity.

*Growth stock group includes BJ's Restaurants Inc. (BJRI), Buffalo Wild Wings, California Pizza Kitchen, Inc. (CPKI), Chipolte Mexican Grill, Famous Dave's (DAVE), Krispy Kreme Doughnuts, Panera Bread, PF Chang's China Bistro.