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.
CONCLUSION NOW: 10/30/18 CURRENT
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