Look Who's Coming To Dinner: The Restaurant ETF

The consumer discretionary sector is off to a rocky start this year. For example, the Consumer Discretionary SPDR (ETF) XLY, last year's top performer among the nine legacy sector SPDR exchange-traded funds, is off 1.8 percent year to date.

Quiet as it has been kept, restaurant stocks have been a source of strength for the discretionary sector this year. Just look at The Restaurant ETF BITE. BITE, which debuted in October, has surged more than 6 percent this year.

BITE is an equal-weight ETF, a methodology that is proving advantageous at a time when McDonald's Corporation MCD and Starbucks Corporation SBUX have traded slightly lower on a year-to-date basis. If BITE used market cap weighting, it is likely McDonald's and Starbucks would be the ETF's two largest holdings, meaning the fund would probably be in the red this year.

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With restaurants being a source of strength for the often richly valued discretionary sector, it is not surprising that some BITE holdings trade at lofty valuations. As Morningstar noted, McDonald's trades at 30 times earnings, while Shake Shack Inc SHAK trades at 100 times earnings.

Fast Casual Restaurants

Fast casual concepts such as Chipotle Mexican Grill, Inc. CMG and Panera Bread Co PNRA have been drivers of growth for the restaurant industry and should retain that status going forward.

“It's easier and cheaper to operate these restaurants than it is casual dining. You don't need as much space and you don't have wait staff. Consumers are still ordering at the counter, but they are willing to pay up for it,” said Morningstar. “That's been the fastest-growing category within the restaurant industry, and I think they'll continue to grow. This group has done a great job catering to what consumers are looking for, whether it is new taste profiles, better-quality products, the ability to customize, or ordering through a mobile app. These firms are ahead of the curve on that end.”

Of the aforementioned stocks, only Panera is a top 10 holding in BITE. The ETF's largest holding, as of March 4, was Domino's Pizza, Inc. DPZ.

BITE “tracks The BITE Index, an equal-weighted index of all restaurants that are publicly traded in the United States with a market cap of $200 million or greater and $1 million of daily average turnover. It is rebalanced semi-annually in June and December and is currently comprised of 50 companies,” according to a statement.

“Valuations have come down a bit. But you have to take each restaurant chain in isolation. A lot of the quick-service guys – and some of the fast-casual players – have reached a point of being much more attractive. It still looks like a lofty multiple on strictly a P/E basis. You are still talking about a group that's trading at 24 times earnings, which is above what we've seen across the broader consumer space,” added Morningstar.