CHUY’S: A COMPELLING OPPORTUNITY OR A “VALUE TRAP”?
We wrote recently that restaurant stocks are very inexpensive, compared to the historical range of valuations, and perhaps the worst of the trends in traffic, commodity prices and labor are adequately discounted. In the course of bringing the numbers within our “Corporate Descriptions” up to date we were a bit surprised that CHUY’s has become as inexpensive as it is. (Our readers should check out “Corporate Descriptions”. It’s a lot of work for us but a great tool.)
As of 3/31/22, CHUY had $90M of cash on the balance sheet relative to an equity market cap of about $400M and an Enterprise Value of a little over $300M. Moreover, EBITDA has grown from $35M in 2018 to $64M in 2021, an obviously very impressive improvement and the Enterprise Value (w/o lease obligations) now is only about 4.75x TTM EBITDA. With that as a starting point, we take a further look.
Large Cuts in Staffing Drive the Large Increase in EBTIDA from 2018 to 20
In spite of revenue in 2021 being relatively the same compared to 2018 ($396M in FY21 vs. $398M in FY18), the EBITDA rose from $35.2M to 64.4M. The EBITDA margin rose 750bps from 8.8% to 16.3%, a remarkable increase in such a short period of time. The obvious next question: “Are current EBITDA margins sustainable?”.
A closer look at the income statement shows that the $30.7M decline in labor costs drove the entire increase in EBITDA. As a percentage of revenue, the company was able to lower labor costs from 36.2% to 28.7%. The company has stated that they are operating at about 80-85% staffing levels compared to where they believe will maintain quality customer service.
CHUY 10Ks provide a significant amount of useful historical information to help investors understand the drivers of the company’s business. Since 2014, the company has made significant cuts to the number of managers and hourly employees in each store. Remarkably, the company employs approximately the same number of managers and hourly employees today that it did in 2014, with 37 FEWER stores. This nearly 40% reduction in staffing is very unusual in the industry and we believe it is unsustainable. In this regard: On the Q1 FY22 conference call, management stated that it believed that staffing would return to 90-95% of 2019 levels, implying that 10-12 more employees per store are needed.
The significant reduction in employees per store (some of which management attributes to more efficient use of technology, especially at the manager level), reduced labor costs as a percentage of revenue from 36.2% to 28.7%. This reduction is in stark contrast to the trend experienced by many of its peers over the same period of time. As shown in the table below, most peers showed an increase in labor as a percentage of sales of 80-100bps. Darden has been able to lower its labor costs slightly over that period of time. Since 2015, labor costs as a percentage of revenue have averaged 33.5% at CHUY. We believe that this percentage is a more reasonable level of future costs than the current run rate and there was, in fact, a 140 bp increase in labor costs in Q1’22 on revenue up by 14.6%. While management suggested that the labor situation is starting to normalize and “help is on the way”, the table below shows that other full-service operators are not showing the same degree of abnormality.
“NORMALIZED” EBITDA POTENTIAL COULD BE AS LOW AS $44M
We continue to focus on the labor situation at Chuy’s because long term macro trends suggest that other costs, such as operating, occupancy, marketing and G&A will probably not decrease in the foreseeable future. It is important to note that, in spite of closing 18 locations (16% of the 114 there would have been) in the last six years, AUVs have declined from $4.87M in 2014 to $4.20M in 2021. At the same time, net cash investment per new store has increased from $1.8M to $2.5M, which has lowered the AUV/Net Investment ratio from 2.71X to 1.68X. More worrisome is the decline in customers per location per year from 36K in 2014 to 24K in 2021. Since CHUY can only raise prices so much to offset this steady decline in traffic (3.3% long-term trend), we believe that the other costs of running the business will stay close to current percentages of revenue, highlighting the importance of labor costs.
Wall Street is estimating $425M of revenue and $51M in EBITDA for FY22 and $475M in revenue and $58M in EBITDA in FY23. Simply taking the recent percentage of revenues of all costs except labor and increasing labor a modest 130bps to 30% of sales (and exclude pre-opening costs) our EBITDA estimates come close to analysts estimates. However, considering the factors we discussed above, we feel that 30% labor costs as a percentage of revenue could be too low. If labor costs rise to 32% of revenue, which would still be 150bps below the long-term average and many of its peers, EBITDA drops to $44M-$49M or almost 30% below the current run rate.
(1) Officers and Directors own less than 2% of the outstanding shares.
(2) Margins were shrinking for several years prior to COVID, “adjustments” were in process.
(3 ) Company sold 3.04M shares at $15.86/sh (19% dilution) in ’20, after purchasing 90K shs at $15.57. In ’21 repurchased 462k shs at $31.45/share. In retrospect…..sad.
(4) Non-operating Impairment Charges – $53.3M from ’18, ’19 and ’20.
The above discussion provides more questions than answers. We have no visibility as to what will provide a predictable, sustainable growth trajectory. Our conservative view is that EBITDA in 2022 will more likely approximate $44M than $65M and we are concerned that the Chuy’s basic dining experience may continue to lose traffic. On that basis, we would rather bet on restaurant companies that are in a stronger competitive position.