All posts by Roger Lipton


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I just returned from John Hamburger’s RFDC, the must attend conference for restaurant industry professionals, in Las Vegas. Something approaching 3,0000 attendees spent two days networking, listening to panels focused on critical industry developments, and getting macro-economic updates from keynote speakers such as Arthur Laffer (Ronald Reagan’s economic guru) and Guy Adami  (daily CNBC stock market commentator).

Three major takeaways:

(1) There is still a huge amount of capital available to finance restaurant growth as well as renovation.  Valuations are high on a historical basis, but interest rates are still low, investors of all stripes are “reaching for yield” so institutions have money to invest in pizza, burgers, and tacos. All of this is cyclical. Those of us who have been around for a while have lived through several similar periods, and this too shall pass. From a macro standpoint, very low interest rates spawn “misallocation of capital” as investors (and institutions in turn) underestimate the risk side of the equation. The music is playing so the dance goes on. As Warren Buffet famously said: “When the tide goes out, we will find out who is swimming naked”.

As a corollary, the question is always asked at this conference and elsewhere: “How big does my operation have to be to raise capital from institutions?” And most private equity investors, will respond sagely with something like “We like to see upwards of $5 million of EBITDA at the store level”. To that I say: “Beauty is in the eye of the beholder”. It depends on “what you’ve got” and “who’s running it”. For example: If Danny Meyer, or Howard Schultz,  had one location,  in his mind, he could raise money from institutions and/or individuals. Away from the restaurant industry, look at the billions of dollars that Tesla and Uber have raised. They are losing billions, breakeven is years away, but they tell a good story. Bringing it back to home for us, it depends on the unit level economics (existing, or even planned) and the credentials of management. Size matters, but not always.

(2) By far the issue of the day for the industry is DELIVERY. The workshops and panels dealing with delivery were standing room only. Virtually everyone is evaluating it, testing it, trying to offset lower dine-in traffic by re-capturing the customer with delivery. The big names are pretty well known: Grubhub, DoorDash, Postmates, Uber Eats. Everyone knows by now that profit margins on the delivered food is lower than within the store, due to the commissions paid to the delivery agent. It’s also obvious to most of us that loss of control over “the last mile” provides an element of risk to the brand. However, the really big stumbling block as described by many of the conference speakers is that the delivery agents retain the customer information, therefore compromising the restaurant’s degree of exclusivity with the customer. Therefore: any restaurant chain of substance, who can afford the time and money to develop it, is intent on developing an in-house capability to control the process, at least to the degree of controlling the customer information. It will likely turn out that the most customers for the delivery companies will be independents and multi-unit operators too small to afford in-house delivery capabilities.

(3) Profit margins for restaurant operators, even the best of breed, are severely challenged, with labor costs (especially) rising as far as the eye can see. Traffic continues to be challenged, in spite of delivery, mobile apps, curbside pickup and the other operating initiatives. Franchisees are increasingly unhappy with franchisors marketing leadership that focuses on discounted deals. The traditional “conflict of interest” between franchisors, driven by royalty generation, and franchisees, who fight the daily battle for unit level profit, has been exacerbated by the current environment which gives every indication of continuing. Franchise associations at Tim Horton’s, Dunkin’ (forget the Donuts), Jack in the Box, and even McDonald’s are becoming “Activists”. This week, flying to Las Vegas, TV commercials came across my screen for “All you can eat fries for $1” at Wendy’s, and “Ten chicken nuggets for $1” at Burger King. A day later, the Burger King commercial for “Three pancakes for $0.89” hit my TV screen. So the key promotional price point has become ONE DOLLAR. So now, at Burger King you can get ten nuggets and three pancakes for $1.89. I personally wouldn’t want to make a habit of it, but it might get me through the lunch hour:) Seriously, while the franchisor will make the case that these deals are traffic builders, only one end of the barbell, etc., it’s hard to believe that profitability will be enhanced for the franchisees, and they are making their feelings known.

I would welcome input from any of you relative to other important issues, explored at the Conference, that could be worthy of discussion here.

Roger Lipton



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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.


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.




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More than eight restaurant companies have reported their third quarter results in the last week, and provide a reasonable picture of what is going on out there. The companies whose results we  have analyzed below are those of Habit (HABT), Pollo Loco (LOCO), BJ’s (BJRI), Cheesecake Factory (CAKE), Ruth’s Chris (RUTH), Denny’s (DENN), Texas Roadhouse (TXRH), and Shake Shack (SHAK). We will not detail here the many operating initiatives that virtually all are pursuing, such as delivery, curbside pickup, mobile apps and loyalty programs. Presented below is a summary of the key operating metrics, at the unit and corporate levels. Below the store operating line, you should know that the “general administrative” operating initiatives being pursued cost money, such as development of mobile apps and loyalty programs. The operating margins, at both the store and corporate level continued to be affected by much more than the prime costs, namely cost of goods and labor. All the numbers shown below are for the third quarter and nine months ending September.

Sales & Traffic

The first question every analyst asks relates to “the comps”. The follow-up question is about the “traffic”, adjusted for price and menu mix. Looking at the table below, BJ’s and Texas Roadhouse had materially positive comps, Habit and Ruth’s Chris a little less so. BJ’s is bouncing back from a down year and Texas Roadhouse continues to do an excellent job of driving traffic and comps. Habit’s 3.6% comp was driven entirely (and then some) by price, with traffic down 3.4%. RUTH managed a 1.5% traffic increase. In terms of traffic, HABT, LOCO, CAKE, DENN, and SHAK all showed (or implied) negative traffic. Going forward to Q4, based on formal guidance and conference call commentary, TXRH and BJRI are pretty safe bets to have positive traffic and RUTH is probably OK as well. Keep in mind that the traffic challenge is in spite of the progress that everyone is making with their loyalty programs, delivery initiatives, curbside pickup, mobile apps, etc. Most importantly, there was no indication from anyone that trends have firmed up in Q4. General expectations are for “more of the same”.

Prime Costs – Cost of Food & Paper, and Labor

You can see from Chart II below that the change in cost of goods through nine months was most often small, but Habit, Pollo, BJ’s, Ruth’s Chris, and Denny’s had some material benefit. Habit’s “progress” was a result of their 7% price increase, while RUTH benefited from lower beef prices. Overall, CGS did not hurt anyone and a few companies benefited. In terms of guidance for Q4 and calendar ’19, the general expectation was for flat to up commodity costs. Generally, the tailwind of a year or so ago is history, it’s getting a little tougher, and is planned that way for ’19 but hasn’t really shown up yet. Safe to say that CGS cannot be counted on to provide any relief.

The labor picture, on the other hand,  is clear, and not pretty. While HABT and BJ’s kept labor costs under control because of higher sales (including the price increase at HABT), most everybody had a higher labor percentage for nine months and are guiding to a continuation in Q4 and calendar ’19. Interestingly, TXRH, in spite of higher sales had higher labor by 194 bp. They have obviously chosen not to stint on service. Guidance for virtually everyone is for wage increases of about 5% in calendar ’19 and beyond, implying 150 bp penalty to the store P&L.

Occupancy and Other Store Expense

Companies report on this category in different ways, some breaking out occupancy and others including it within “other store expenses”. Generally, this category of expense has been increasing, and is expected to continue upward, especially with the expansion of delivery services. Allocation between this category and corporate G&A can be opaque, but we can assume no relief from this area.

The Bottom Line:  Q3 Store EBITDA and Adjusted Operating Income, Nine Mos. GAAP Pretax Earnings and Store Level EBITDA

The result of all of the above is shrinking margins, except in “special situations” such as HABT, LOCO and BJRI which are comparing against depressed results and RUTH which has lower beef costs. In Q3: at the store level EBITDA line, margins have shrunk from 30 bp at CAKE to 150 bp at Texas Roadhouse and 170 bp at Denny’s. In terms of guidance for store level EBITDA, virtually nobody is suggesting improvement. It is a similar story in Q3 for “Adjusted Corp. Operating Income”. HABT, LOCO, BJRI and RUTH compared well enough because of easy comparisons, but the others, CAKE, DENN, TXRH and SHAK suffered.

Most interesting to us, in terms of reported results, is the nine month change in pretax GAAP earnings, and GAAP EBITDA, because GAAP was the standard before “adjustments” became commonplace and nine months is a better indication than only one quarter. We are looking at pretax results because the after tax earnings and earnings per share are distorted this year with the much lower tax rates which will not be reduced further. Pretax GAAP earnings and EBITDA can therefore provide the most consistent guidepost to “organic” and sustainable growth trends. The result, for nine months of calendar ’18 is lackluster results. Nine months GAAP pretax earnings (as a % of revenues)  were up only at LOCO and BJRI versus depressed results in ’17. The absolute GAAP pretax earnings change was materially up only at LOCO (41%) and BJRI (57.6%). It was down materially at HABT (-81%) and CAKE (-25.7%). It was down 5.2% at DENN and up only 4.5%, 4.2%, and 2.6% at RUTH, TXRH and SHAK, respectively. Lastly, nine months’ store level restaurant EBITDA change was down everywhere but BJRI (up 90bp) and RUTH (up 130bp). Declines ran from -80bp at SHAK to -200 bp at DENN. 


The results as detailed above are not encouraging. Behind the generalized optimism by operators, the details show lackluster results for nine months of calendar ’18, by all indications to be continued in the fourth quarter. Moreover, there is little reason to expect better bottom line operating results in calendar 2019. Sales and traffic show no signs of meaningful improvement, cost of goods is not improving, labor expense is guaranteed to grow on an absolute basis and it is difficult to raise prices sufficiently to improve margins. The various operating initiatives all carry an incremental expense of  some sort, delivery in particular, so help is not on the way from this front. People have to eat, but they don’t have to increase spending sufficiently to allow higher profits for operators.

Roger Lipton

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November 1, 2018

The general equity market was volatile and weaker during October. Gold bullion, and the mining stocks were relatively quiet, all changes rather immaterial.  Gold bullion was up 2.2%; the mining stocks as represented by an average of the three mutual funds we track (Tocqueville, Oppenheimer and Van Eck) down an average of 1.8%, possibly weaker from the tail end of the Vanguard liquidation we have discussed. The two ETFs, GDX and GDXJ were up an average of 1%, so obviously their holdings did better than the broader mutual fund portfolios.  Though it’s our job to focus, and report, on small changes such as these, the longer term is obviously our major concern. The downside damage in the gold sector over the last several years obviously dwarfs a few points one way or another, and the upside when it comes will make our monthly reports seem immaterial.

The following bullet points summarize our current thoughts:

  • Gold, as a “safe haven” is not yet in great demand in “the West”, though major accumulation continues in China & India and all major Central Banks. North American investors will see the light sometime soon, especially if the equity market’s recent downside volatility persists.
  • The mining stocks continued to act a bit weaker than bullion in October, possibly representing the tail end of the Vanguard liquidation.
  • It is just a question of time until Jay Powell, Fed Chairman, backs off of his intention to keep raising rates, and reinstitutes an accommodative monetary policy (QE4, or whatever). This will happen when the stock market takes a more sustained tumble and the slowing worldwide economy becomes more apparent. Calendar ’19 will not have the tailwind of much lower tax rates, and the resumption of monetary stimulus should generate much more interest in gold related securities. The gun is loaded, the spring is coiled.
  • Central Banks, including Russia, Poland, Turkey, India, China, and others, are steadily increasing the gold bullion reserves within their foreign exchange holdings. Through September, the amount bought was the largest in six years, over 200 tons, and that doesn’t include China, who alone may be purchasing that much, or more.
  • Central Banks, on the other hand, are reducing their holdings of US Treasury securities, expressing dissatisfaction with our accelerating deficits.
  • China, allowing their currency to cheapen, has virtually offset the effect of the new tariffs. This demonstrates how major trading competitors can use their currency as an economic, and even political, weapon of sorts.
  • China, Russia, and Europe have set up alternate payment systems that do not require the use of US Dollars, undermining the credibility of the US Dollar as a reserve currency. The last time there was a major movement away from the US Dollar was 1971, when Richard Nixon ended the dollars convertibility into gold, inflation took off and gold went from $35 to $850/oz.
  • The recently announced merger of Barrick Gold and Randgold, both within our portfolio, is no doubt a reflection of what they perceive as a bargain price level, and their desire to be the very strongest participant in a dynamically evolving gold market. These kinds of transactions often occur at the bottom of a cycle.
  • Goldcorp, one of the premier gold mining companies, also in our portfolio, just announced a buyback of approximately $350M of their public shares, an obvious statement that their stock is considered substantially undervalued, and another possible indicator of an inflection point.
  • There have been hardly any major gold discoveries in recent years, as opposed to a decade ago. Since major new mines can take a decade or more before production commences, increased demand will not bring out more supply for many years, even at higher prices, and the upside price volatility will be that much greater.
  • Considering that the price of gold bullion, though down this year, has been fairly steady the last several months, even in the face of higher interest rates and a strong US Dollar, we believe the stage is set for a major rally in gold bullion and the mining stocks once the dollar weakens a bit (or more) and/or the stock market has its long overdue correction (or worse).

For the above reasons, and many others, we believe the stage is set for a major upward move in the most unloved asset class on earth.  Legendary investors like John Templeton are famous for saying that the time to buy is when there is “blood in the street”. It seemed that way to us a few years ago, but nobody can tell when the bottom will be put in. None of the concerns that we have been enumerating regularly have gone away. It’s not a question of “if”, just a question of “when?”.

Roger Lipton

P.S. As I finish this letter, at 10:18am on November 1, the dollar is weak, gold bullion is up 1.2% and the mining stocks are up about 3%. Every long trip has to start with a single step😊

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We wrote an article on October 11th, discussing the three major positions in Bill Ackman’s Pershing Square Capital portfolio, within our knowledge base, that comprise a massive 41% of his $8.3 billion portfolio.

At the close of business, October 11th, Restaurant Brands (QSR) was $56.26, Chipotle (CMG) was $434.06, and Starbucks (SBUX) was $54.87. Our conclusion on October 11th was that he should switch his QSR immediately into McDonald’s (then at $163.98), sell his CMG to take advantage of the huge move since new management has been installed, and hold his SBUX (which has moved up nicely).

We have no reason to think that he has made any moves in the last several weeks, but Restaurant Brands, McDonald’s and Chipotle have all reported third quarter results. Starbucks reports tonight.

From the close of business October 11th to last night’s closing price, Restaurant Brands, at 53.06 was down 5.7%, or $85M on the $1.5B position. McDonald’s, at $178.42 was up 8.8%, so would have made Ackman’s Pershing Square Capital a profit of $132M. Chipotle closed at $465 so Ackman would have foregone a profit of 7.1% or $63M on his $900M investment.

Our advice, less than three weeks ago, to Ackman can definitely be considered “theoretical” in terms of the practical ability to switch $1.5B positions instantly, or sell $900M worth of Chipotle on the spur of the moment, and Ackman’s positions are established on the basis of long term prospects. Acknowledging that three weeks doesn’t “make a season” or prove a thesis, Ackman’s portfolio would be ($132M+85M-$63M) a cool $154M better off, or 4.5% of the $3.4B in these three positions, especially costly when all hedge fund managers are fighting for every basis point in a difficult market environment.

Our points here are (1) too many multi-billion hedge funds, and other institutions are playing hunches rather than making well informed long term judgements. This is a function of not enough really attractive reward/risk investment propositions when trillions of dollars of capital are competing to generate “alpha” after nine years of a bull market (2) there is too much emphasis on short term performance, trying to “game” the monthly comps for example,  rather than evaluate long term strategic positioning (3) in too many cases, the self confidence of multi-billion dollar money managers is unjustified. They are very smart, hard working, in many cases have become very rich (which breeds inflated egos), and can’t be expected to know as much they should about every industry. Rather than make Bill Ackman an undeserved particular example: Eddie Lampert, still a billionaire, had no chance whatsoever to turn around Sears based on his strategies, and there were lots of highly experienced retailers that could have told him so. It has taken ten years to play out, but it was clear to many of us years ago that the brilliant and successful Lampert was wasting enormous time and money on Sears.

If we were speaking with Ackman today, we would suggest that it’s not too late to adjust the portfolio. The last three weeks are history.  Let’s see what happens over the longer term.

Roger Lipton

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Conclusion LAST DECEMBER 17th: @ 12/17/17

The recently announced purchase by Jana Partners of a total of 8.7% of the stock in BLMN leads us to evaluate the long term attractiveness, at or near this price, of this Company.  At about 16.5x ’18 EPS and 8x estimated ’17 EBITDA, the stock, while not bargain priced, is not expensive. On the other hand, other than adding further leverage to the balance sheet, we don’t see a lot of easy levers to pull to improve earnings by an order of magnitude.

The current $1.2B of debt is “only” 3x EBITDA, so that is considered “conservative” in this environment and more debt could be added. If the company were taken private at a 25% premium to the current price (with, for example, $1.0B of equity and $1.5B of debt) the total debt would be $2.7B, or about 6.7x EBITDA, pretty heavy leverage. (we used to think). Parenthetically, D&A is not “free cash flow”, as evident by the ongoing remodel program at Outback. If more equity were added, the resulting leverage would obviously be more acceptable.

The sale/leasebacks have been almost completed so that liquidity opportunity is in the past. We don’t think that a franchising program, going “asset light”, which private equity investors love, is easily applicable in this case. Though strange things can happen, and franchisees (especially overseas) might be seduced, the cash on cash returns, after royalties, would not be all that impressive to a franchisee unless the AUVs were much higher.

On balance, we consider BLMN stock to be “fairly valued”, with no visible special opportunity for a buyer at a premium to the current price, though anything can happen in an environment where capital is available, at interest rates that continue to be suppressed.


We describe below how management is bending every effort to build upon the long established base of each concept, and they deserve great credit for all of that.  However……the harsh reality is that these are all mature brands that are collectively generating less than fabulous store level EBITDA margins (11.9% in Q3 and 14.4% for nine months). Even if improved by 250 bp over the next year or so, for which management holds out hope, the unit level economics with today’s real estate burden (especially if interest rates continue to rise) will not be extraordinary. Depreciation is not “free cash flow”, and BLMN is demonstrating that “investments’ must be made to keep a concept current. If 5% is deducted for D&A (to be “reinvested” in stores), another 7% spent on G&A, 1% at least for interest on the debt, it leaves only 3-5% of revenues before taxes. High margin franchise and license revenues could be an additional positive, but that is hard to quantify. The Brazilian economy is volatile and the Chinese economic backdrop has its own set of macro issues.

Our view is that Bloomin’ Brands provides a good example of a highly competent management team using every tool at their disposal to improve results. BLMN is not statistically expensive, and “above average” earnings growth could be ahead, but we don’t think that industry peer “average growth” is going to be much, so “above average” may not be good enough. Operating margins are going to be hard to improve, interest rates will likely move higher over time, and corporate tax rates will not come down from here. BLMN doesn’t qualify as a growth stock, doesn’t provide a high enough dividend to make it a “yield” stock, and as a takeover candidate, activists don’t have a silver bullet which management is not already employing.  

Company Background and Long-Term Strategy

Bloomin’ Brands operates and franchises four restaurant brands domestically: Outback Steakhouse; Carrabba’s Italian Grill; Bonefish Grill; and Fleming’s Prime Steakhouse & Wine Bar.  The Company operates Outback Steakhouse restaurants and Abbraccio Cucina Italiana (essentially Carrabba’s) in Brazil and franchises Outback and other brands internationally. The following table shows the number of restaurants in operation by concept and geography as of the end of the third quarter of fiscal 2017.

The first Outback Steakhouse restaurant was opened in Tampa, FL in 1988 and the company went public in 1991.  Originally, the restaurants were open only for dinner and each was operated by a managing partner that was required to invest in his or her restaurant and sign a five-year employment contract.  In return, the managing partner received a percentage of his restaurant’s defined cash flow.  This progressive management structure (a version of which was used successfully by Sambo’s decades earlier) enabled the company to attract high-quality operators who supported rapid growth through most of the 1990s.

The company also sought to diversify and made acquisitions of several concepts, including Carrabba’s, Fleming’s, and Bonefish.  Other concepts that were acquired over the years, including Roy’s and Lee Roy Selmon’s, have been sold.

In the mid-2000s, the company’s growth slowed and, similar to many casual dining operators at the time, sales and profitability came under pressure.  Prodded by an activist investor, the company elected to go private in 2007.  Renamed Bloomin’ Brands, the Company went public again in 2012.  Since its second IPO, the Company has regularly divested itself of assets, including Roy’s in 2014, its South Korean Outback’s in 2016, and 54 Company-operated domestic Outback’s to franchisees in 2017; the Company has also sold and leased back approximately 250 restaurants since early 2012.

Long Term Strategy:

Continued focus on US sales and profitability.  The Company is in the latter stages of an exterior remodel program and the early stages of an interior reimage program designed to enhance visibility and improve guest appeal.  The Company also is making investment to improve the guest experience and increase off-premise sales.  A major component of these efforts relates to technology.  Additionally, management is always seeking to develop innovative new menu items.

Accelerate international growth.  International development, though relatively stagnant lately, is planned, with focus on South America, principally Brazil where the brand is already established, and Asia, with China being an important growth market.

Driving shareholder value.  Management continues to reinvest back in the business to maintain and enhance the brands’ competitive positions, improve the Company’s credit profile, and return excess cash to investors in the form of dividends and share repurchases.

Sources of Revenue  Total revenues were $4.2 billion in 2017, more than 99% of which was from sales of Company-operated restaurants.  The Company does not break out total sales by brand, but does disclose average Company-operated restaurant sales and operating weeks for each accounting period.  Based on that data, the following table presents a breakdown of Company sales:

Total sales in the above table differ from reported sales due to the impact of rounding average restaurant sales and operating weeks and the table does not include sales for Abbraccio (14 restaurants), the Outback Steakhouse restaurants operated in Hong Kong (9) and China (6), and the South Korean Outback’s that were sold in the middle of the 2016 to a franchisee and contributed $90 million to sales in 2016.

Menu The Outback Steakhouse menu (Outback Menu) offers seasoned and seared or wood-fire grilled steaks, chops, chicken, seafood, pasta, salads and seasonal specials. The menu also includes several specialty appetizers, including our signature Bloomin’ Onion, and desserts, together with full bar service including Australian wine and beer.

Carrabba’s Italian Grill menu (Carrabba’s Menu) includes a variety of Italian pasta, chicken, beef and seafood dishes, small plates, salads and wood-fired pizza.

Bonefish Grill’s menu (Bonefish Grill) specializes in market fresh fish from around the world, wood-grilled specialties and hand-crafted cocktails.  In addition, Bonefish Grill offers beef, pork and chicken entrées, as well as several specialty appetizers, including our signature Bang Bang Shrimp, and desserts.

Fleming’s menu (Fleming’s Menu) features prime cuts of beef, chops, fresh fish, seafood and poultry, salads and side dishes. The steak selection features USDA Prime corn-fed beef, both wet- and dry-aged for flavor and texture, in a variety of sizes and cuts. Fleming’s Prime Steakhouse & Wine Bar offers a large selection of domestic and imported wines, with 100 selections available by the glass.

Unit Economics Unit level economics are not disclosed. However, in the August 2012 IPO prospectus, the Company disclosed that it would seek to develop new domestic restaurants with an average pretax return on investment of 15%.  The prospectus also indicated that international restaurants were producing returns on investment greater than 30%.  At that time, the Company’s emphasis was on domestic growth, but new units developed internationally are currently more likely than domestically, where renovation and relocation are the emphasis.  The typical square footage and domestic average restaurant sales in 2017 of each restaurant brand are as follows:  Outback Steakhouse, 6,200 and $3.354M; Carrabba’s, 6,500 and $2,960M; Bonefish Grill, 5,500 and $3.079M; and Fleming’s, 7,100 and $4.436M.  Outback Steakhouse restaurants operating in Brazil averaged sales of $4.429M in 2017.

Management has expected to open 40-50 new restaurants a year, the bulk of which will be international, but that has stagnated in 2017. The first three quarters of ’18 have shown openings of  12, 8, and 5, with closings of 7, 12, and 7, for a net contraction of one unit.  The Company also is testing 5 “express” Outback restaurant for take-out only that, if successful, could be used to fill in domestic markets.

Operating Metrics Bloomin’ Brands has been highly leveraged since its 2012 IPO, having been subject to a leveraged buy-out in 2007.  The Company has consistently generated sufficient cash flow to both service its debt and return cash to shareholders.  Because of the substantial share repurchase program, as described below under: Shareholder Returns, the Company’s shareholder equity has declined to $60.1 million at the end of 2017s third quarter, from $556 million at the end of 2014.  Consequently, debt to equity and the return on equity are not meaningful measures of performance. Lease adjusted debt to earnings before interest, taxes, depreciation and amortization, and rent (EBITDAR) is the best measure of leverage and was 3.5x at the end of 2017, down from 3.9x in 2016 and 2015, 4.1x in 2014, and 4.3x in 2012.

Shareholder Returns Bloomin’ Brands’ stock had been under pressure fairly consistently since early 2015 largely reflecting the conditions of the casual dining sector, and the necessity to improve the “dining proposition” at most of Bloomin’s concepts.  In November 2017, a group formed by JANA Partners, an activist hedge fund, filed a 13-D indicating it “intends to have discussions with the Issuer’s board of directors and management regarding topics including a review of strategic alternatives including exploring a sale of the Issuer; portfolio composition; operating performance and cost management; capital allocation; board composition; and governance.”  A year ago, this was reminiscent of the actions in the mid-2000s of another activist investor, Pirate Capital, that ultimately led to the predecessor company going private in 2007. In this case, Jana exited their position in early to mid ’18, apparently with a small profit. Within the last month, a new “activist”, Barington Capital Group, has purchased a modest 0.6% of the common stock, and is expressing their dissatisfaction with the current leadership. The Board has supported the management team and the Company has so far refused to meet with Barington.

Bloomin’ has more than $830M of stock since early 2015, as well as paying out approximately $100M in dividends. Much of that capital was raised through the sale/leaseback of $650M worth of real estate. The current dividend yield is about 1.9%

Recent Developments: Per Q3’18 Earnings Release and Conference Call

The quarter was largely encouraging. Most of the operating initiatives are bearing fruit, and/or promising to do so in the near future. The most widely watched guidepost, comp sales, was up 2.9% overall, including 4.6% at Outback. The other concept US comps were -0.6% at Carabba’s, +1.8% at Bonefish, and +0.5% at Flemings.  It was the seventh consecutive quarter of SSS at Outback and the fifth quarter of positive traffic, +0.9% in Q3. Traffic is presumably still negative at the other concepts. Importantly, there has been a weaning of discount promotions, largely completed at Outback, almost completed at the others.

Guidance was raised for Q4, in terms of comp sales (up 50bp to 2.0-2.5%), adjusted earnings per share by .02-.03 to $1.41-$1.47. Management indicated, on the conference call, a high level of confidence that store operating margins would improve in Q4’18 and more in calendar ’19.It should be noted that the higher EPS guidance for ’18 is a result of a lower tax rate, as well as the ongoing expectation of operational improvement.

New units, domestically at least, are taking a back seat (the company didn’t put it quite that way) to the success of renovations (interior and exterior) and especially relocations where feasible. Interior remodels are driving 4-5% comp improvements, and relocations a dramatic 30-50%. They are spending from $300-500k on full remodels, including expanding the To-Go rooms. The opportunity is obvious, limited by individual real estate situations.

Delivery, as part of the “To-Go” effort, is another major focus, now 13% of sales, expected to grow to at least 25%. It is considered largely incremental, would prefer to control it internally rather than third parties like DoorDash, but will react market by market. Delivery was rolled out to 240 locations in Q3, 200 more in Q4 and company wide by the end of ’19. Not all domestic locations are “eligible”, perhaps 80%, the remainder being “rural”, presumably without the necessary consumer density.

Marketing continues to be redirected: to digital venues, social marketing, an emphasis on  “personalizing” the customer contact. The loyalty Rewards program is now at 7.2M members, up 600k in just the last quarter, and management is very high on the potential here. Predictably, management declined, for competitive reasons,  to discuss details such as frequency or average ticket from these customers.

In terms of store level operations, the EBITDA margin in Q3 was 11.9% vs. 11.8%. For nine months it was 14.4% bs. 14.6%. In Q3: cost of sales was down 10 bp to 32.4%, labor was up 10 bp to 30.4%, other operating expenses were down 50 bp to 24.6%. Management expects to improve operating margins in Q4 and ’19, even without help from commodity prices and carrying the predictably higher labor costs. The sharp reduction in discounting, working its way through all concepts, labor efficiencies, better (high quality) traffic at Bonefish and Flemings, the result of the renovations and relocations, an improvement in Brazil, less foreign exchange burden, each contribute to the success in “monetizing” the operational investments of the last several years.

Conclusion: Provided Above


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Back in July and August, when it was clear that US GDP growth was above 4% for the second quarter, many economists were predicting a continuation of that kind of growth. We reiterated that our experience, following the dining habits of US consumers over four decades, did not confirm the optimism of the PHD economists. (There are over 300 PHD economists working at the US Fed. How do 300 economists ever agree on anything?) Summarizing what some people would call our “anecdotal” observations: people have to eat just about every day, and dining habits are about the easiest thing to expand upon or cut back, long before hard earned dollars are spent on autos, vacations or home improvements. So: regarding the “meals prepared away from home” industry, which these days must include delivery and takeaway, Q2 and the beginning of Q3 showed that with just a few exceptions, same store sales at the publicly held restaurant companies were barely positive,  traffic trends were still negative, and that supported our doubt that the economy was about to take off.

However, we have to admit that we had a just a bit of concern that restaurant sales and traffic, as a tried and true leading indicator may have seen its best days. After all, we are living through some major long term cultural changes in consumer behavior, driven by Amazon, Netflix, Domino’s and social media giants such as Facebook and Google, all of which have  clearly changed the world. We are old enough to know that nothing is forever, not even restaurant sales as an indicator of the broader economy.

Our concern, at least for the moment, has been allayed. As we suspected back in the summer, the 4%+ GDP growth is now in the rear view mirror, Q3 will be closer to 3% than 4%, and growth in 2019 is expected (by the 300 PHDs) to be closer to 2% than 3%. The question now becomes: what is the restaurant industry showing us today. According to Miller Pulse, Restaurant Traffic, after PEAKING at a NEGATIVE 1% in August, FELL BACK to OVER 2% NEGATIVE in September. Also according to Miller Pulse, two year stacked same store sales, after peaking at plus 2% in June, has fallen steadily to be virtually flat in September. So this time the PHDs are on the right track, at least for the moment. A broader implication here is that Jay Powell, Chairman at the Fed, had best tread carefully with the continuous interest rate increases, lest the economy tip into recession, and the deficit really explode with higher interest rates on $21.5 trillion and lower tax revenues.

We will know even more about sales and traffic trends in the next ten days. McDonald’s reports Q3 tomorrow morning and there is no reason to think they will  lose (or gain) any large portion of their recent momentum. Noodles reports tomorrow evening and Chipotle Wednesday evening, both of which are in the middle of turnarounds. Dunkin’ Donuts reports Thursday morning, and their traffic will likely still be challenged .

Next week will provide many more data points. We will report again to you next Wednesday, 10/31, after Blooming Brands, Texas Roadhouse, Wingstop, Papa John’s, Cheesecake Factory, BJ’s, Habit, Denny’s, IHOP, Applebee’s, and Yum Brands, have all reported their most recent quarter. We should have a decent picture at that point how sales and traffic trends exited Q3 and began Q4.

Keep in mind that the lackluster sales and traffic trends are in spite of aggressive promotion, and an incremental contribution from delivery (with lower margins)  and takeaway. Since labor costs continue upward, commodity costs no longer help, nor do higher rents, construction costs, insurance, trash collection and other operating expenses. It will continue to be very difficult to maintain, let alone improve, current operating margins, considering the ongoing traffic challenges. This year’s often improved after tax earnings per share have been more a function of reduced shares outstanding and lower tax rates than operating progress.

Roger Lipton



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We recently (10/5) published our updated writeup on Domino’s, a fully copy of which is provided below. Our conclusion, with the most pertinent bullet points BOLDED, was as follows:

“We have no quarrel with the consensus that Domino’s is writing the book in the pizza delivery business, and there is no apparent reason that they will lose market share to Pizza Hut or Papa John’s. We can’t help but point out, however, that the recent rate of increase in Operating Earnings (rather than the more dramatic recent EPS growth), at roughly a “mid-teen” rate, should probably be the expectation. This still admirable growth rate would be driven by a 6-8% (more likely to be closer to 6 than 8 in the near term) rate of net new stores, a mid-single-digit comp (against very tough comparisons), a bit of SG&A leverage and/or fewer shares outstanding. This year’s tax impact won’t be duplicated. Relative to the share repurchases, if we were on the Board we would not be enthusiastic about (according to Bloomberg) share repurchases at 34x ’18 earnings, 24x trailing EBITDA, 33x trailing Cash Flow and 45.3x trailing Fee Cash Flow. Even when borrowing at still low interest rates, the EPS accretion at this valuation is modest. The regular dividend, yielding 0.7% currently, has been increased each year, but perhaps shareholders would better appreciate another special dividend (last paid in 2012 at $3.00 per share), or a substantial increase in the regular dividend, rather than spending hundreds of millions to buy back stock.

We wouldn’t want to be short this fine company’s stock, and DPZ has been a fantastic holding over the last decade, but we have a feeling that “the easy money has been made”.

With that background, recent developments by way of the third quarter results were as follows:

The Q3 earnings “beat” of $1.95 vs. Street expectations of $1.75 was driven by fewer shares outstanding (43.0M vs. 47.7M) and a low tax rate. The company continued its aggressive repurchase program by spending $109.1M in Q3 at an average of $274/share and an additional $10.0M in just the first 11 days of October at $273/share. The tax rate in Q3 was only 15.3% vs. 33.3% in ’17. Income from operations was up 13.1% in Q3, up 13.3% for the nine months, so the gain has been narrowing.

Same store sales were up 6.3% domestically, barely below the expectation of 6.5%. International comps were up a more modest 3.3%. Net new units were up 232 globally, 173 internationally and 59 in the US. This was just above the 217 net new units in Q3’17, 164 internationally and 53 domestic, so the trailing twelve month continues to be right at the 6% level versus the base, at the low end of the 6-8% range over 3-5 years to which the company has guided. It is a strong commentary on the health of the system that only 21 stores (out of over 15,000) have closed in the last twelve months, 19 internationally and 2 domestically.

It was interesting to us that the comp increases, both domestically and internationally were driven by transaction growth, as well as ticket growth in the US. The Piece of the Pie loyalty program was called out as a meaningful contributor to the traffic gains. It may be an important insight, provided by management in the course of the conference call that “it is transaction count growth over time that correlates not only with sales growth, but with profit growth……our Piece of the Pie rewards program….the foundation was built on driving frequency…points are earned based on the number of purchases as opposed to the amount of dollars spent”. While there are lots of contributing factors to transaction growth, or lack thereof, we can’t help but contrast the consistent growth in comps at DPZ with the now acknowledged traffic slowdown at Starbucks since they changed their loyalty program a couple of years ago to reward dollars spent rather than transactions. Seems worth thinking about.

Otherwise, there were few surprises. Higher labor expenses continue to be a burden, and the commodity basket has been up 3-4% year to date. No guidance relative to future commodity cost was given.  There is continuing capital spending to support supply chain distribution. The Hotspot initiative is promising, with more than 200,000 locations in the US, but no operating details were given. The bulk of the conference call was dedicated to a reiteration of the long term goals, described in our full writeup from 10/5 provided below.

Conclusion: Post Q3’18 Report

Very much the same as provided a couple of weeks ago, and reprinted above. The company is doing well, and there is no reason that they can’t continue their leadership position for the foreseeable future. However, in terms of the DPZ, the stock, there is no particular material positive catalyst on the horizon that would cause a “re-rating” on the upside. We think there could be at least modest risk from this price level, in the short run, from industry -wide concerns, a general market downturn, or a modest slowdown within the operating results at DPZ.

DOMINO’S PIZZA – Updated Write-Up And Conclusion

October 5, 2018


We have no quarrel with the consensus that Domino’s is writing the book in the pizza delivery business, and there is no apparent reason that they will lose market share to Pizza Hut or Papa John’s. We can’t help but point out, however, that the recent rate of increase in Operating Earnings (rather than the more dramatic recent EPS growth), at roughly a “mid-teen” rate, should probably be the expectation. This still admirable growth rate would be driven by a 6-8% (more likely to be closer to 6 than 8 in the near term) rate of net new stores, a mid-single-digit comp (against very tough comparisons), a bit of SG&A leverage and/or fewer shares outstanding. This year’s tax impact won’t be duplicated. Relative to the share repurchases, if we were on the Board we would not be enthusiastic about (according to Bloomberg) share repurchases at 34x ’18 earnings, 24x trailing EBITDA, 33x trailing Cash Flow and 45.3x trailing Fee Cash Flow. Even when borrowing at still low interest rates, the EPS accretion at this valuation is modest. The regular dividend, yielding 0.7% currently, has been increased each year, but perhaps shareholders would better appreciate another special dividend (last paid in 2012 at $3.00 per share), or a substantial increase in the regular dividend, rather than spending hundreds of millions to buy back stock.

We wouldn’t want to be short this fine company’s stock, and DPZ has been a fantastic holding over the last decade, but we have a feeling that “the easy money has been made”.

COMPANY OVERVIEW (2018 10-K; Analyst Day Slides January 2018)

Domino’s, with more than 14,856 locations in over 85 countries around the world, is the largest pizza company in the world based on global retail sales. Founded in 1960, Domino’s roots are in pizza delivery; however, in recent years a significant amount of sales have come from carryout. On average, Domino’s sells more than 2.5 million pizzas each day.

Domino’s business model is simple – they handcraft and serve quality food at a competitive price with easy ordering access and efficient service enhanced by their technological innovations.

Domino’s generates revenue and earnings by charging royalties and fees to their franchisees. The Company also generates revenue by selling food equipment and supplies to franchisees, primarily in the U.S. and Canada, and by operating a number of Company owned stores. In Domino’s international markets, they generally grant master franchises for a geographic area. These master franchises are charged with developing their geographical area and they may profit by sub-franchising and selling food and equipment to these sub-franchisees as well as by running their own stores.

Domino’s business model yields strong returns for their franchise owners and Company owned stores. Historically, Domino’s has returned cash to their shareholders through dividend payments and share repurchases.

Domino’s pioneered the pizza delivery business and has become one of the most widely recognized consumer brands in the world. Since 1998 the Company has been structured with a leveraged balance sheet and has completed a number of recapitalization events. The Company’s most recent recapitalization transaction (in 2017) primarily consisted of the issuance of $1.9 billion of fixed and floating rate notes and the repurchase and retirement of $910.2 million of previously outstanding fixed rate notes. Following this recapitalization, the Company has $3.15 billion in total debt. Excess proceeds were primarily used to repurchase shares of common stock.


Begun in 2009, Domino’s first priority was to reinvent their core pizza, and they relaunched the brand by introducing a new recipe for their signature product. Next, they improved existing products and/or introduced new items that complimented changes to the core pizza.

Secondly, in 2013 they launched the program to reimage the stores to be more attractive for carryout customers – creating the “Pizza Theater” design which allowed customers to see the process of pizza making. Market studies and current sales trends (from NPD/Crest) had revealed the take-out business was much bigger than delivery. In 2017, delivery business equaled slightly over 1 billion occasions whereas carryout was over 2.5 billion occasions. Since Domino’s carryout focus was launched in QTR-1 2011, Domino’s share of carryout has risen from 7.5% to 14.4%. Carryout necessitates Domino’s to be closer to the customers, therefore, the Pizza Theater helped address this but what was also needed was more locations to make carryout more convenient. In their 2018 Investor Day Presentation, Domino’s management discussed this plan in some detail. It is called Fortressed Markets and is based on realigning the franchise system with programs that encourage strong franchisees that wanted to grow multiple opportunities, both to open new locations and to buy out weaker franchisees in their market areas. Since 2016, Domino’s U.S. franchise base count has moved from 1,300 to 800. This new alignment continues to drive growth with those franchisees who share the Corporate vision. Another component of the Fortressed Market program has franchisees investing heavily by splitting their markets into smaller delivery/carryout areas. According to Domino’s Internal Data (Analyst Day slides) the majority of a location’s carryout business is within 6 minutes of the store. Seattle, WA was one of the first markets to engage in Fortressed Marketing and saw AWGS increase from $20.7K to $26.3K over a 3-quarter period in 2017.

Thirdly, priority was an aggressive investment in technology (which began in 2010) to be the leader in making connections with consumers through technology that exceeded their expectations. This became an aggressive investment in building digital platforms and eventually data analytics in-house. In 2016 Domino’s developed its own digital platform to manage internal operations and customer-facing actions all with the goal to simplify ordering and payment processing and enable order tracking on virtually any communication device. The system is called GOLO (Global Online Ordering). Together with a sophisticated loyalty program (launched in 2016), the platform provides a rich source of data for its robust marketing initiatives.

While Domino’s continues to innovate around the brand’s interactive experience with consumers, nothing has been, or presumably will be, embraced or created that can disrupt operations. Domino’s has preserved the integrity of their brand with an emphasis on continuity relative to their heritage.


As of its 2018 10-K Report, Domino’s operated and franchised 14,856 units globally generating more than $10,638 billion, making them the second largest pizza chain (after Pizza Hut) in sales and the number one pizza delivery company. Approximately one-half of the global sales are generated by 5,587 domestic stores (5,195 franchise and 392 Company). The remainder is produced by 9,269 franchised stores in over 80 markets around the world. Additionally, $1.7 billion is generated from Domino’s supply chain.

Domino’s revenue is generated from multiple sources: domestic franchise fees (5.5% of franchisee sales), international master franchise fees (3.0%), domestic and GOLO digital fees, and supply chain and Company-owned store segment.

UNIT LEVEL ECONOMICS (2018 10-K; 2018 Analyst Day Slides)

From the FDD and the above sources, we estimate AUV’s of Company units are slightly over $1.2M (or about $837/sq. ft. assuming the average store size of 1,500 sq. ft.) and domestic franchised units AUV’s are about $1.0M. Disclosed average store level EBIDTA of domestic franchisees is about $136K – up from $61K in 2009 or a store level margin of 13.6%. (These figures are presumably net of royalty fees and advertising fund contributions.) The cash investment for leasehold improvements, furniture, fixtures, equipment, signage for a new store (provided from Domino’s FDD) is about $410K. Accordingly, the $136K store level EBITDA would represent a store level cash on cash return of 33.1% for a domestic franchised unit.

The supply chain provides pricing and distribution scale and consistent uniform quality ingredients to participants. It operates 18 regional dough manufacturing and food supply chain centers in the U.S. It also operates centers in Canada and leases a fleet of more than 500 tractors & trailers.


Domino’s 1, 3 and 5-year stock performance has been 24.4%, 147.3% (35.2% CAGR) and 440.9% (40.1% CAGR) respectively. Including reinvestment of dividends, total return for the same periods have been 25.3%, 153.0% (36.2% CAGR) and 457.4% (41.0% CAGR).


Domino’s continued its outstanding performance in Q2, with domestic same store sales up 6.9%, international up 4.0%. It was the 98th consecutive quarter of int’l SSS growth, only the 29th domestically. Diluted EPS was up 34.8% on a GAAP basis and 39.4% “adjusted”. Impressive as the performance is, it should be noted that Income from operations (pretax) was up a more modest (and sustainable) 11.5%, with the higher percentage increases driven by 12.5% fewer shares outstanding and a tax rate of 15.1% versus 25.7% a year earlier. There were 156 net new stores added to the system, 113 internationally and 43 domestically.

The second quarter was highlighted by the innovate launch, late in Q2, of over 200,000 Domino’s Hotspots in the US. Financially speaking, the April recapitalization included $825 million borrowed, of which $490 million paid off previously issued notes. Also in Q2, 905,556 shares were repurchased for $219M and $0.55 per share was paid in dividends.  Remaining share purchase authorization amounted to $429.9M at the end of Q2. The operating numbers above are fairly consistent with the previous quarter, though lower, and the six month increase in operating income was 13.4%.

The Conference Call provided some additional operating details.

US franchisees’ SSS were up 7%, with company stores up 5.1%. The company continues to spend a substantial sum in technology related capital spending, now expected to be $115-120M in ’18, up from a previous estimate of $90-100M.  Supply chain investment is being accelerated, including additional distribution centers in the US, to support the double digit gross sales growth. Carryout business is viewed as a separate occasion from delivery, largely incremental, and advertising is targeted accordingly. Points of distribution, including Hotspots are also being designed with that in mind. The impact of Hotspots was not clear as of the end of Q2, including the incremental effect, but should be more apparent by the end of Q3. Management is guiding to 3-6% long term SSS growth internationally, slowing a bit from the more rapid growth recently.

On a trailing twelve month basis, 905 total net new stores were added, most of them internationally, as has been the case in recent years.  There was a modest slowdown in the rate of international openings in the first half of ‘18, but that is expected to be temporary, a consolidation of sorts after opening over 1,900 net new int’l stores in 2016-2017. The estimate continues to be 6-8% annual net new units on a global basis. The 905 net new stores opened (almost exactly 6% of the 15,122 base), of which 651 were international, including only 113 in Q2, so the Q2 pace is clearly below that.

CONCLUSION: Provided at the beginning of this article.






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What goes around comes around. It is inevitable that about the time that common wisdom indicates that this is the only way to go, the formula gets abused. (Golfers understand what I mean: just when you think you’ve “got it”, you lose it.)

In the world of pure franchising of restaurant concepts, almost all the major systems are experiencing hardly any net unit growth. Since franchisees vote with their bank accounts, you can bet that their return on investment is far from encouraging, and the challenges are clear.

Franchisee margins and cash flow have been squeezed by flat to negative traffic combined with materially higher wages, cost of tech upgrades, administrative costs to deal with increased regulation (now abating), higher construction costs which affect the cost of remodels and potential new locations. The saving grace the last several years was that commodity costs were modestly lower, but that is reversing to the upside. We all know that the world is “overstored” and company operated expansion has been slowed as well, but the overstored situation is unfortunately correcting itself at a very slow rate. The leases signed were ten to twenty years in duration and it can more expensive to walk away than to hang in as long as possible.

Franchisors have not been standing idly by in these challenging times. However, their natural inclination is to concentrate on sales, which translates to higher royalties, rather than franchisee profitability. Value Driven promotions have become the focus in an economic environment where middle class customers are still short of discretionary income, as evidenced by “Breakfast All Day”, “$1,$2,$3 Menu”,”2 for $6 Burgers”, “4 for 4”, “$5 Lunch Box”, “Buy One, Take One”, “Two Pizzas for $10” etc.etc.etc. Some chains like McDonald’s and Wendy’s have managed to maintain a “barbell” strategy, with traffic driven by the bargains, and the hope of upgrading at least some of the customers.

While the store level battle for market share continues, franchisors, especially those that are publicly traded, are encouraged by the “asset light” and “free cash flow” mantra of investors, who have accorded high valuations to pure franchisors. Companies are encouraged by investors to employ the presumably free cash flow in large stock buybacks, which keeps the earnings per share moving ahead, and the stock price, and obviously makes executive stock options more valuable. The table provided below this discussion provides the specifics, what we consider a shocking contrast to the financial health of the individual franchised operators. We’re not saying that all franchisees of these systems are on the verge of bankruptcy, but we are saying that it’s a real battle to maintain margins and cash flow. There’s a lot more time for leisure activities if you are the franchisor rather than the franchisee.

The question, apparently not obvious to many investors, especially in publicly held franchised restaurant companies, becomes:

To what extent is the franchisee system being short changed over the long term, enriching shareholders in the short run, by inadequate “reinvestment” of more of the franchisors’ cash flow. The system has “needs”, such as: product development, technology initiatives (including mobile apps), evaluation of the delivery trend, marketing support, remodel and technology upgrade financing, employee recruitment and training and retention approaches, field operations support, etc.etc. Some of this is being done, of course, but how much more could be, should be, perhaps even must be done?

Looking at the table below, we think it is no accident that Domino’s success the last ten years has followed upon the upgrading of their core products almost ten years ago. Combine that ongoing product focus with their focus and major capital investment in what has become their clear technological leadership. It’s been said that DPZ is a technology company that just so happens to sell pizza.

Franchisees at major chains are most often reluctant to go public with complaints. However, the disillusionment within the Tim Horton franchisee community has been well documented. Just in the last week, 20% of the domestic McDonald’s franchisees have publicized their request for a new Franchise Association,  Jack in the Box franchisees have asked for the ouster of JACK’s CEO, and we suspect that these situations are the tip of the iceberg. Popeye’s franchisees are surely looking over their collective shoulder, wondering whether the G&A “savings”, a key part of the play book implemented by Restaurant Brands (QSR) at Burger King and Horton’s will affect the support behind the Popeye’s franchise system.  Franchisees at Sonic, Wendy’s and Dunkin’ Donuts, as well as many others that are not “pure” franchisors, such as Pollo Tropical, Red Robin, Pollo Loco,  or Chili’s can’t be thrilled right now, or they would be building more stores.

A short story, and contrast, comes to mind, starting in 1992 when IHOP came public (and we made a lot of money for our clients and ourselves in the stock). Kim Herzer, now passed, was CEO. Our good friends ever since, Fred Silny and Steve Pettise, were CFO and Marketing VP, respectively. Herzer was a “simple man”, just wanted to be in the pancake business, never considered buying another brand. He and his organization bent every effort to make sure that every franchisee was as profitable as possible. He really understood , not just with lip service, that his franchisees were his partners, their success ensured his success, and he invested his capital and his organizational support accordingly. The company was unleveraged, and they used their “free cash flow” to build new stores and provide a turnkey fully equipped package for franchisees, who had adequate “skin in the game” by way of the $250k franchisee fee plus ongoing rent and royalties.  It was after Herzer was gone that Julia Stewart became CEO in 2002, borrowed $1.2B to buy Applebee’s in 2004, and the game changed. There were then two brands to oversee, debt to service, Wall Street expectations to meet, which included stock buybacks and dividends. For all kinds of reasons both brands have been challenged in the last decade, Applebee’s more than IHOP, and Julia Stewart has moved on. The billion dollars of debt is still largely in place, though refinanced at the lower rates available over the last decade.

In Conclusion: One can only imagine how much better all of the above mentioned brands might be doing if some portion of the hundreds of millions of dollars spent on stock buybacks and dividends had been directed toward operations.

Roger Lipton

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