COMPANY OVERVIEW (2017 10K)
Irving, CA based HABT operates and franchises restaurants in 11 states plus 2 in the United Arab Emirates and 1 in China and competes in the $44B fast casual sector. Of the 209 stores as the end of calendar ‘17, 193 are company stores and 16 franchised/licensed. Habit stores are heavily concentrated in CA and spreading in adjacent states (except Oregon) and recently to the East Coast.
HABT’s financial record in the past 8 years (including the pre-IPO years) reflects its early growth stage, with rapid percentage growth in the early years, still growing but slowing more recently, as shown in the table above. Sales have grown from $28.1M in 2009 to $331.7M in 2017. The overall sales progress has been complemented by a positive string of comps for the entire period until finally interrupted, but just barely. Adjusted EBITDA grew from $1.9M to $32.4M, with store level EBITDA consistently above 20% until this past year. AUVs grew during the same period from $1.2M in 2009 to the current level, but also have come down from their highest level. While the overall strategy remains the same, the company (rightly) is targeting about half the historical unit growth rate in the near future.
While still admirable, many of the operating parameters have moderated from their peak levels. Comp sales, positive for over 50 quarters, finally showed a very small recent decline. Part of the slow-down is surely caused by the industry-wide malaise, but still, traffic declines in recent quarters evidence the company’s transition and the challenges of the company’s “more of the same” strategy. This is a particular concern as it plants its flag in all new markets on the other side of the country. We are encouraged by our own limited observations of New Jersey stores and we are also encouraged that the company has beefed up its real estate staff, which will be crucial in penetrating these new and unfamiliar markets. Undoubtedly the company’s new emphasis on drive-thru locations is a positive move, in combination with the above noted real estate approach.
MENU, DEMOGRAHICS, AND DAYPARTS
Habit Restaurants specializes in made-to-order entrées char-grilled over an open flame. It is centered on its signature burgers (60% of entrée sales), but its menu includes tri tip (bottom sirloin) steak, albacore tuna filet, and chicken sandwiches (26%). Habit also offers fresh, hand cut, made-to-order salads with char-grilled chicken, tuna and tri tip steak options (14%). The dessert menu consists of handmade frozen, shakes, soft serve cones, malts and sundaes. The daypart mix is split evenly between lunch and dinner, and over 60% of the customer base is in the age range of 25 to 54. The company prides itself on providing exceptional quality at a great value. In a recent comparison between a cheeseburger, fries and drink combo with peer fast casual burger competitors, only In-N-Out burger’s $5.95 price point bettered HABT’s range from $7.23 to $8.77 in 2017. Other competitors included Smashburger ($9.97), Shake Shack ($11.39) and Five Guys ($11.47). Mobile and on line ordering is processed through a call center, and tablets are used in selected restaurants to expedite drive-thru service and faster delivery times during peak hours.
UNIT LEVEL ECONOMICS
HABT stores, which are all leased, average about 2,000-2,800 square feet. It seeks locations with co-tenants such as Walmart, Costco and Target, grocery stores, theaters and drug stores. Surprising perhaps to some, it also locates stores in proximity to Chipotle, Starbucks and Panera, pleased to “throw their line in the water where the fish are biting”, or as Willie Sutton said, “hit the banks because that’s where the money is”.
For the 52 weeks of 2017, restaurants open 12 months or more had an AUV of $1.9M and generated a cash on cash return over 40%. In the TTM through Q4’17 the average unit volume (AUV) of company locations was $1,885k, while the company store-level EBITDA margin dropped 250 bp YTY to 18.5%. Store level EBITDA averaged 21.9% in the 7 years prior to ’17, holding steadily in the 21-22% range until the recent margin slippage.
New stores require an average cash investment of $850K, which is net of landlord allowances for non-drive-through locations and $1,250k for drive-through units, which “blends” to an average cash investment of $1,050k. On a blended basis, by their third year the company targets an AUV of $1.85M and a cash-on-cash return of at least 30%, implying store-level EBITDA margins of about 17%.These “targets”, especially the margins, are no doubt designed to be conservative. Still, using management guidance, we estimate volumes of the most mature stores (i.e. open > 3 years,) seem to be have peaked at about $2,200k, probably running somewhat less lately. Similarly, we estimate the most mature stores (open 3+ years) generated store level EBITDA margins of closer to 25% if those open less than 3 years average 17% or less, with all categories doing less lately with the reported margin pressure.
Since its 11/19/14 IPO at $18.00, HABT shares traded just over $40.00, then declined steadily to the current level, near its low. Candidly, the stock traded at a very high valuation, as we have noted in our earlier writings, so the correction in price was to be expected, even without the moderation in some of the operating parameters. There is no dividend and the Company has not been a buyer of its own shares.
CURRENT DEVELOPMENTS (Per ’17 Yearend Report and 2/28/18 Conf.Call)
Highlights for Q4’17 included a comp sale decrease of 1.0% (with transactions down 3.0%), adjusted pro forma net loss of a nominal $44,000. Adjusted EBITDA declined from $8.4M to $7.3M. There were 13 new company operated locations opened (four with drive-thrus) and one franchised (in Shangai, China). Reported GAAP earnings were of course affected by adjustments related to the new Tax Act. In their formal guidance for ‘18, the company is looking for comp sales of flat to slightly positive with store level margin of 16.0-17.0% (vs. 18.5% in ’17), G&A of $37.5-$38.0M (up 15.9% from ’17, at the midpoint), D&A of about $24M (up 28.3% from ’17), Capex of $43-46M and an effective tax rate of 29-30%. Expansion plans for ’18 include 30 new company operated locations (15 with drive-thrus, and 5-6 on the East Coast) and 6-8 franchised units.
On the conference call, the company reiterated their reluctance to get drawn into the price wars taking place in the QSR burger business, they are selectively offering (new to HABT) lower priced items (as a test) solely in digital channels. Delivery is being tested in two markets, using two different third party provider, and cover 20 locations. The business generated appears to be mostly incremental, and enthusiasm (so far) was expressed. A proprietary mobile app is being developed, as well as a self ordering kiosk, both to be launched in 2H’18. As indicated, greater emphasis is being put on new drive thru locations. A national ad agency has been hired and new products continue to be developed, including an expansion of breakfast offerings. Labor efficiencies are a continued objective, especially since so many locations are in California. Looking toward 2019, company new store growth will slow to 10% on the base, allowing more operational focus on existing locations.
Operating details for Q4 included an increase of 100bp in CGS to 30.4% and an increase of 120 bp in labor expenses to 34.6%. The average hourly rate was up over 6%, some of which was offset by productivity gains. Occupancy and other expenses were up about 100bp to 18.1%, due to higher rent at new units, higher advertising, utilities and CAM charges. G&A was down 30bp to 9.6% of revenues. D&A was up 60 bp to 6.2%, no doubt due to higher investment in new stores. Pre-opening expenses was $1.1 milllion, up from $813k in ’16, expected to range between 90-100k in ’18. CGS expense is expected to be up about 2%, and the average wage rate will rise 6-7%, as in ’17. The Company confirmed on the call that it was the labor and occupancy expense lines that were the most problematic.
An analyst, predictably, asked whether Q1 sales were running in “the flat to slightly positive” range as the year’s guidance would imply, and the response was “Quarter to date, we’re within that guidance that we laid out”, possibly helped by slightly better weather (which hurt last year by about 1%). There was also a comment by management indicating that the slightly better trend would be back weighted to H2, considering the new product initiatives. Our interpretation would be that, if comp sales were running positive as of the 2/28 call, it was only “barely”. Pricing is running about 2.9% in Q1 and more price may be taken in the middle of ’18.