A great deal of progress has been made over the last year or so in terms of stabilizing traffic and sales. This is a result of the improved service, simplification of the menu, accompanied by their focus on value. The 3 for $10 meal (a starter, entrée, and non-alcoholic beverage) has apparently been a major contributor to Chili’s effort to “differentiate” their offerings. Their other efforts have been typical of virtually every chain, build on Loyalty Programs, enhance To-Go efforts, try to “break the code” on Delivery. (that means, satisfy the customer without undermining your brand or your margins). Putting it all together, though, store level margins are materially lower (necessary as the changes have been) so the progress has come at a cost. EPS is basically flat over the last four years to end 6/30/19, and that holding pattern is due to fewer shares outstanding and lower taxes. It is all Chili’s, and many others in the industry, can do to hold market share, let alone build profits. EAT has improved their position versus a year or so ago but basic store level economics do not allow them to build new stores today with attractive store level economics. With a 5% yield a year ago, at a decade long low stock price, in a ridiculously low interest rate environment, EAT has since proven to be an excellent investment. Today, with a 3% yield, when investors can earn 2.8-2.9% in 2 year US Treasury securities, Brinker stock, without above average predictable organic growth in operating earnings, is not a compelling value.
EAT: COMPANY OVERVIEW
Company Background and Long-Term Strategy Brinker International operates two restaurant brands, Chili’s Gill & Bar and Maggiano’s Little Italy. Chili’s is one of the largest casual dining brands in the country and accounts for more than 85% of the Company’s revenues. As of the end of Q3’18 (Q1’fiscal’19), there were 1,634 Chili’s (up 12 in the last 15 months) operating in 31 countries and two US territories. Domestically, there were 1,250 Chili’s (down by 2), 945 (up 5) of which were Company-operated. Of the 384 international Chili’s (up 14), 5 (down 9) were Company-operated. Acquired in 1995, there were 52 Maggiano’s in operation (no change in 15 months), all by the Company and located in the US, as of the end of Sept.’18. Overall, in the last 15 months, the 1686 restaurant count increased by the 12 Chili’s locations. Clearly, the modest growth is coming from the international side, while the Company invests capital to improve the productivity of the domestic fleet.
During the late 1980s and 1990s, the Company pursued a multi-concept growth strategy and teamed up with Phil Romano, a restaurant entrepreneur, to develop new brands. Macaroni Grill, Cozymel, Spageddies, and Eatzie’s were concepts developed in conjunction with Mr. Romano. Acquisitions included Regas Grill (renamed Grady’s), On the Border, Corner Bakery and Maggiano’s, the latter two brands having been developed by Lettuce Entertain You.
Founded by Larry Levine, the first Chili’s opened in Dallas, Texas in 1975. Norman Brinker, one of the most highly regarded restaurant executives, bought the chain in 1983 and the Company, then named Chili’s, went public in January, 1984. The original Chili’s menu was limited and consisted of burgers, chili, and tacos, along with fries. Under Mr. Brinker’s leadership, the menu was broadened, with one of the first additions being fajitas, a highly successful offering that is a staple on the current menu. In the fall of ‘17 the Company announced it was reducing the items on the menu by some 30-40% in order to focus more on quality and improve speed of service.
For both brands, management is committed to strategies that produce long-term sales and profit growth, enhance guest experience, and enhance team member engagement. Objectives include brand differentiation, operating cost reductions, and strong brand presence in key markets. Current market conditions have obviously been challenging and the Company has developed both short and long-term strategies to address those challenges, including:
Simplifying the menu and back of house complexity by reducing the number of menu of items by 30-40%. This has resulted in reduced ticket times and more consistent food quality. This strategy also resulted in increasing the quality of the chicken crispers offering, implementing a new “smash” burger cooking process for burgers, adding a “smokehouse” menu platform, and a new line of craft beers.
Providing “every day value” through the core menu. Bundled offerings could continue to be part of this strategy, but the Company is unlikely to have limited time only offerings.
Leveraging technology to engage guests. A new on-line ordering system has been implemented, and the Chili’s app has been upgraded to enable curbside service where guests can order, pay, and notify the restaurant of their arrival, never having to leave their car. Table top technology is being further leveraged to power loyalty programs that are likely to be a significant part of the future marketing strategy.
New prototype for Maggiano’s. A smaller restaurant with a flexible dining area that can be used for banquet space will enable development of markets that were not appropriate for the prior prototypes.
Unit Growth. While 6 company operated Chili’s and 1 Maggiano’s opened in fiscal ’18, only 2-4 company Chili’s are planned in fiscal ’19, and no Maggiano’s. A total of 39 franchised Chili’s opened in ’18 (34 int’l and 5 domestic) . For ’19, a total of 37-42 franchised Chili’s are planned (33-38 int’l and 4 domestic). One franchised Maggiano’s is expected to open.
Sources of Revenue Total revenues were $3.14 billion in fiscal 2018 (ending June), with Company sales accounting for 97% of the total and Franchise and other revenues the remainder. Chili’s accounted for about 87% of Company sales; average unit volumes were $2.8 million, 14.1% of which was contributed by alcoholic beverages and take-out accounted for 11.5% of sales. The average check was $15.70 (up 2.8% YTY) per person. Maggiano’s average unit sales were $8.3 million, 15.4% of which was contributed by alcoholic beverages; banquet sales were 17.8%. Maggiano’s offers carryout and delivery services, but the percentage of sales was not disclosed. The average check at Maggiano’s was $28.40 in fiscal ‘18 (up 1.8% YTY).
Menu The Chili’s menu (Chili’s Menu) consists of hamburgers, fajitas, ribs, Fresh Mex, Tex Mex and other items. Maggiano’s menu (Maggiano’s Menu) offers chef prepared classic Italian-American items. Guests can order either family style of individually.
Unit Economics A typical existing Chili’s restaurant is between 4,500 and 6,000 square feet with 150-252 seats. According to the most recent franchise disclosure document, the current 6,028 square foot prototype seats 246 and is estimated to cost between $2,815,000 and $4,397,000 to develop excluding land but including preopening costs. Assuming the mid-point of that range ($3,606,000) and Chili’s restaurant operating margin in fiscal 2018 (14.9%) on average restaurant sales of $2.8 million, the cash return on investment is 11.6%. Current unit economics for Maggiano’s are not disclosed. There has not been a disclosure (that we have found) since 2010, relative to the investment in a new Maggiano’s, which was $7.5M per unit at that point.
Operating Metrics In 2010, the Company initiated a program to return excess cash flow to shareholders. Since then, more than $3 billion has been paid to shareholders in the form of dividends and share repurchases. The share repurchases have resulted in Brinker having negative Stockholders’ Equity so Return on Equity is not a meaningful measure. The Company’s Return on Assets over the last twelve months has been 10.9%. Despite the significant share repurchases, Brinker’s total leverage remains manageable, with a lease adjusted debt to EBITDAR ratio of 4.3 times in fiscal 2017, coming down to 3.6x at 9/30/18, expected to be 3.9-4.0% as a result of the sale/leaseback in Q1’19 of 141 Chili’s for $456M.
Shareholder Returns Brinker’s stock has rebounded nicely in the last twelve months, from a low of about $30/share, as sales and traffic stabilized and most recently moved up. It is still down from a high of about $62/share in early calendar ’15. The Company continues to repurchase stock, having bought $105M worth in Q1’19 after buying $303M in fiscal’18. The dividend yield is 3.1% currently and the board has an objective to pay out 40% of earnings.
Recent Developments – Per Q1’19 report and Conference Call
The GAAP reported results were distorted (positively) by the large gain from the sale/leaseback of 141 properties. Earnings per share, excluding special items were up 11.9%. Chili’s company operated comp sales were up 2.0%, with franchised Chili’s up 1.5%. Maggiano’s comp sales were flat. Company operated restaurant margin was down 150 bp to 11.1%. The earnings release indicated that Maggiano’s store level margin increased, with a lower cost of sales, so the margin decline at Chili’s was a little worse than the indicated 150 bp.
For Company operated restaurants as a whole, Cost of Sales was up 10 bp to 26.3%. Labor was up 20 bp to 35.2%. Other Restaurant Expenses (including occupancy, but not D&A) were up 110 bp to 27.3%. Operating Income, before Interest, and Taxes, was $46.9M, up sharply from $28.6M, However, This year “Other Gains and Losses”, almost all of which was the S/L transaction was $13.3M which normalized this year’s Other Income to $35.8M. This compares to a normalized $42.0M a year ago, down 14.8%, more in line with the lower store level margin at Chili’s.
As expected, only a handful of locations opened, 5 Chili’s in total, of which 4 were international. Without question, the biggest financial event was the sale/leaseback,, generating $456M of liquidity, enhancing the Company’s ability to renovate stores, repurchase stock and pay dividends.
The operational focus, including the various operating initiatives, is steadily, if slowly, gaining traction.Same Store comps at Chili’s have improved in each of the five most recent quarters, from negative 3.4% in Q1’18 to positive 2.0% (with +4% traffic) in Q1’19. We must point out that traffic was down 8% a year earlier, a very easy comparison, but still encouraging that that the tide has turned. Maggiano’s has similarly improved comps each quarter from negative 2.6% in Q1’18 to flat in Q1’19.
Guidance for all of fiscal ’19 included a comp sales increase of 0.75-1.75% (presumably conservative, considering Q1), restaurant operating margin down 160-180bp, a touch worse than the 150bp decline of Q1, a tax rate of 14-15%, and EPS of $3.70-$3.90.
Conclusion: Provided at the beginning of this article.