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 Hereby provided, presented in the form of repeating our summary of 5/31/17. The prospects remain the same, from a higher number of stores, from a lower base of earnings. A case could be made that there is a lot of upside leverage here, and with other restaurant companies as well, when sales recover. We can all agree about the potential, the questions is when?

Back in May, ’17, after describing the results through Q1, we wrote the following:

“While the details of operating performance provided above (most lately, below) could be considered “sobering”, management of CHUY can be commended for an excellent record of growth, maintenance of a strong balance sheet, and continued opportunities for unit expansion and earnings growth. Almost all of the variables described above are typical of almost all operators in the restaurant industry. Sluggish traffic trends (especially for full service 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. This is more a commentary on the current headwinds affecting even the better managed restaurant companies.”

CHUY: The Company (2016 10-K) (Investor Slides Mar’17) (2017 Q3 Report)

Source of Revenues  Chuy’s Holdings, Inc. is a steadily growing Austin, Texas-based full-service restaurant chain featuring freshly-prepared Mexican and Tex-Mex fare.  As of 17Q3 it operated 88 stores in mostly suburban locations in 19 states, with 33 in its home state and the remainder throughout the southeastern states, Virginia suburbs of Washington DC, Ohio and Indiana.  The company has in the past targeted 20% annual growth, though slowing that growth lately, making the jump from a regional chain to a national one despite encountering challenges in entering some secondary markets in 2015.

Menu and Dayparts  The company’s menu offers endless taco chips and salsa and items with irreverent names, generous portions and value prices. Favorites include “Big as Yo’ Face” Burrito” ($8.69-$10.49) or “Chicka-Chicka Boom-Boom” ($10.69) are 2 of only 10 items priced over $10.  The other 40 items are less than $10 and the average ticket (including 18.3% alcohol) was $14.48 in 2016, which  is one of the lowest of its competitive set.  For example, a typical CHUY’s chicken burrito entree which includes a side of rice and beans and unlimited complimentary chips and salsa at $9.79 compares favorably with Chipotle’s $6.50 chicken burrito plus an order of chips and salsa for $1.95.

Operational Model & Unit Level Economics The company prides itself in the un-chainlike look of its stores with the slogan “If you’ve seen one Chuy’s, you’ve seen one Chuy’s.”  The flexible prototype is suitable for a wide range of sites including conversions. The only standard feature of the design is the kitchen which is strictly identical in every location.  Despite the variances in store design, the 61 comp stores at the end of 2016, averaged 8.8K square feet  in size generating AUV’s of $4.581K and unit-level EBITDA margins of 21.4%.  These historical results are materially higher than the conservative model  the company presents, which call for new stores to generate high single digit EBITDA margins in year one, low double digit in year two, and 15% to 16.5% by their third year, by which time the company model calls for AUV’s at $3.75M.  At this conservatively stated level of performance, targeted cash-on-cash return on the average new unit cash investment of $2.43M (leased location net of landlord allowance plus our estimate of pre-opening expense) would be 24.3%.  Currently, for the same cash investment, the actual cash-on-cash returns of the company’s comp stores at 2016 AUV’s and margins has averaged 40.3%. Obviously, if the future results move closer to the Company’s conservative targets, margins would contract materially. The difficult competitive environment is not helping at the moment, but we have sufficient respect for this management team that we viewed their model as “theoretical”, and expect results to exceed expectations in this regard when industry conditions improve.

Company Strategy  Until 16Q4 CHUY’s comps were positive for 25 consecutive  quarters.  During this stretch, it outperformed the industry by about 240bps on average as measured by Knapp-Track.  This was true even in 2014-2015 when the company struggled as it entered new secondary markets, and, importantly, the company’s comps averaged about 2.6% driven by a healthy balance of traffic and price, both positive in near equal portions.  Despite the relatively robust comps and store-level performance, operating margins have been uneven.  Similarly, the company’s ROIC has averaged only 10% in the last 5 years.  The variability is partly explained by poorly performing stores in newly penetrated secondary markets in 2014-2015. Management  addressed this challenge by temporarily slowing new store growth from a 20%+ pace to 12% and backfilling new markets to achieve area efficiencies.  Since then, TTM operating margins, which had fallen as low as 6.5%, recovered to 8.4% by 16Q1. However, in the subsequent 6 quarters, the company has finally succumbed to the restaurant industry malaise.  Comps steadily weakened before going negative 1.1% in 16Q4 (on – 2.4% traffic offset by +1.3% price) and that YTY decline in comps and traffic has continued through Q3’17.

The performance of new stores is an important analytical parameter. The Company provides us with revenues from all stores and the total operating store/weeks.  It also provides the store-weeks for non-comp stores, so analysts can track the annualized performance of the newest stores versus the chain average. At year end ’16 it appeared that the newest stores were annualizing at about $4.1 million, versus $4.58M for comp stores and $4.43 for all stores. The company has pointed out that the $4.1M is down only 4.8% from 2014, but this metric is worth watching.

Going forward, the company’s store development plan is the most detailed component of its strategy.  The company has slowed its unit growth from the  20% historical level, to 11 units on a base of 79, for a growth rate of 14%. As of the end of Q3, 8-12 new units are planned for 2018, which at the midpoint would be about 11% unit growth.  Management typically has been less clear on the trajectory of margins other than targeting G&A growth at half the rate of revenue growth, which, assuming revenue growth consistent with store growth, implied net earnings  growth of 25%-26% in the past, but these expectations have obviously been modified as well. We will detail the presumed new model within the Recent Development section below.

Operating Metrics  At the end of 17Q3 CHUY continued to have no debt and its $25M credit facility (expandable to $50M) remained untapped.  The ratio of lease-adjusted debt to EBITDAR is still manageable, under 3.0x, which is over a turn below the 3.9X average of casual dining peers (CAKE, ZOES, BJRI, CBRL, DRI and PLAY) with virtually no franchised units.  While  free cash flow will likely be sufficient to fund virtually all the new store development, and not require tapping the credit line, the new $30M stock purchase authorization, if exercised in the next twelve months, could require a modest amount of debt.

Shareholder Returns  In the nearly 5 years since its July 27, 2012 IPO at $17.17, CHUY’s stock has been as high as $43/share, in late 2013 and early 2014, but has retreated during the last twelve months from the mid-30s down to the present level, no doubt affected by the flattening of the previous growth in EPS. There is no dividend, and large stock purchase programs have not been part of the financial strategy, until the $30M recently announced.

CHUY:  Recent Developments

Per Q3’17 Corporate Release

Earnings Call Transcript

Reported results for Q3’17 were a continuation of the lackluster performance that has been typical of most casual dining chains. The comparisons at CHUY were made a bit more difficult by the effect of hurricanes Harvey and Irma, which accounted for about 90 bp of the negative 2.1% comp for the quarter. The decline in net income was affected by about $0.03 per share. Restaurant level “profit”, i.e.EBITDA, was $14.7M, down about 10% YTY. The transaction count was negative by an additional 160 bp from a rise in the average check. Two restaurants opened in Q3, , in Warrenville, ILL, and Jacksonville FLA.  Subsequent to the end of Q3, units opened in Pasadena, TX and Schaumburg, ILL.

Total restaurant operating costs increased by 310 bp to 84.1% of sales. All the important expense categories worsened. Labor was up 190 bp to 35.2%. Cost of goods increased 40 bp to 26.7%, from inflation in the price of produce and chicken, partially offset by lower beef prices. Other Restaurant Operating Costs increased 30 bp to 14.3% from insurance, credit card and delivery fees. Occupancy cost increased 30 bp to 7%, from higher rent at new locations and deleverage from the softer sales. G&A increased by 40 bp to 5.2%, management salaries, head count to support growth, office rent, maintenance and utility costs, and higher professional fees.

Going forward, expansion is being further moderated. Cost of sales in Q4 is expected to be up 40-50 bp YTY. Labor expense as a percent of sales is expected to continue upward, 50-60 bp in Q4,  not as much as in Q3,  since Q3 CHUY’s increase in labor was mostly non-recurring, with operating disruptions from the hurricanes as well as delays in store openings. Ongoing labor inflation, into 2018 is going to be in the range of 2%, which would imply about 70 bp with the labor percentage around 35%.

Management indicated that sales were a bit firmer in October, but cautioned that it was too early to assume that a better trend was in place. Guidance for all of ’17 was lowered by about $.08 per share, which had already been lowered earlier in the year. Recall that ’17 is a 53 week year, which will make 2018 a  tougher comparison. Other than a discussion of new openings for 2018, management offered very little guidance for ’18 either in terms of sales or operating margins. Obviously, most of the moving parts relating the sales trends are uncertain, and the expense lines don’t appear promising either. The most promising aspects of future guidance revolve around lapping the cannibalization of two Austin, TX locations that cost about $.03 of the YTY comparison in ’17. The G&A comparison will also not be so burdensome in ’18, with the office space expansion taking place in ’17, not to be repeated in ’18.

Conclusion: Stated at the beginning of this article, referring back to our summary of first quarter’s result, provided to our readers on 5/31/17. The more things change, the more they remain the same.

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