Chuy’s Holdings, Inc. (CHUY) – No Place to Hide

CHUY reported earnings for Q4’16 two days ago, missing Street estimates of revenues, earnings, and earnings per share. The details below are not intended to criticize the management of CHUY, which can be commended for an excellent record of growth, maintenance of a strong balance sheet, and continued opportunities for unit expansion and earnings growth. This is more a commentary on the current headwinds affecting even the better managed restaurant companies, likely to reduce the rate of corporate progress at least for the foreseeable future.

Fourth Quarter Report

Chuy’s reported  a comp sales  decrease of 1.1% in Q4’16 which, combined with an increase of 1.3% in average check, demonstrated a traffic decline of 2.4%. The Company pointed out that weather and the calendar shift of Xmas from Friday to Sunday cost about 120 bp, and new stores that entered the comp base but were still in their honeymoon period cost about 40 bp. Notwithstanding these explanations, this was the worst traffic trend at least since 2010. It should be noted that comps have steadily declined over the last six quarters, finally going negative recently.

Earnings per share were reported at $0.14 per share, versus an estimate of $0.17 and compared to $0.01 per share a year earlier. There were “non-recurring” expenses in both years, so “adjusted” earnings per share were reported as “increasing” to $3.1M ($0.18) versus $3.0M ($0.18) year to year in Q4. “Impairment and closure costs” were $1.1M in Q4’16 vs. $4.4M in Q4’15 which affected the GAAP numbers, obviously reducing the year earlier earnings to only $0.01 per share. It is noteworthy that Q4’16 was charged a tax rate of only 15.6% versus 28.9% for all of ’16 and an expected effective tax rate of 29-31% in ’17. Above the tax rate line, adding back the impairment charges to before tax income provides operating earnings of $3.9M for the quarter, down about 9% from $4.3M. Adding back D&A, we get $8.0M, down from $8.7M. It is important to note that the largest change in operating expenses was the labor line, with was up 180 basis points in the quarter.

Relative to Q1’17 to date, analysts predictably posed the question on the Q4 conference call. Management responded…”we’re basically flat to a little down as we’ve rolled into the year right now”.

Yearly Report

Earnings per share for the year were reported at $1.02 versus $0.77. Comps were up 0.8% for the year, no doubt reflecting a modest traffic decline, which accelerated through the year. The tax rate helped in ’16, 28.9% versus 30.8% in ’15. Income before taxes was up 30.3% but when we add back the lower impairment charges this year, the gain (before impairment) was only 12.1%.

While there are other fourth quarter operating details we could describe, including cannibalization of a couple of stores, intensified efforts relative to takeout and delivery sales, and expanded G&A needs, investors are most concerned with prospects going forward. The Company guided to $1.11 to $1.19 for ’17, but pointed out that ’17 is a 53 week year, which will contribute about $.05. Cannibalization in two Austin, TX locations will likely cost about $.03 per share. Larger office space will cost $400,000 per year, or about $.015 after taxes. The Company says that the $1.11 to $1.19 compares against “diluted adjusted net income per share of $1.08. If we add the $0.05 per share from the extra week to $1.08, we get essentially flat earnings per share just below the middle of the range provided. That is understandable, and appropriately conservative since there are no expense lines that are expected to decline materially. “We would expect labor pressure to continue in ‘17”, “the expected year over year growth in G&A dollars is greater than our historical run rate…2017 guidance includes…office space expansion, senior level personnel and several technology upgrades”…additional professional fees associated with becoming SOX compliant”….”pre-opening…looks to be a little bit higher on a per restaurant basis for 2017”….”flat to slightly up from a commodity inflation standpoint”. Bottom line: the bottom line on a percentage basis is unlikely to improve, and could likely suffer from here.

The last important ingredient is the performance of new stores. The Company provides us with full year revenues from comping stores, at $330.6M, spread over 3879 operating weeks, calculating to $4.43M annualized per store. 22 new restaurants opened during and subsequent to fiscal 2015, with 596 operating weeks, contributed $47.0M, annualizing at $4.1M. While the Company has expressed satisfaction, though lower than described a year earlier. The Company pointed out that $4.1M is down only 4.8% from 2014, still generating “targeted” 30% cash on cash returns. The Company said further: “that AUV is still over $4M and we expect it to settle in that $3.7M range”. Among the 12-14 locations planned in 2017, new markets will include Denver, Chicago and Miami, in our mind a bit riskier than existing successful markets. It seems safe to say that, for the moment at least, revenues at the newest stores are not accelerating.

Our conclusion: As stated at the outset, almost all of the variable described above are typical of many, if not most, operators in the restaurant industry. Sluggish traffic trends (especially for dine-in locations), higher labor costs, commodity costs that have probably seen their best levels, competitive pressures, and occupancy expenses that continue to edge higher are not a happy combination. If the headwinds are substantial enough long enough, even better companies are finally affected.