FRGI - Fiesta Restaurant Has A High Risk Of Downside

Summary

• That's an economic perspective that restaurants don't want.
• Among US restaurant operators, Fiesta Restaurant Group is struggling with the present while expectations for the future are no better.
• Fiesta Restaurant Group shares have unfairly risen. The price level can be used to sell shares profitably.

Current Economic Outlook Does Not Bode Well For Restaurants

In the US, the annual inflation rate fell another step, reaching 6.2% in January compared to 6.5% in December, which means that the disinflation process because of monetary tightening continues to deliver results. This, however, does not imply a turning point in monetary policy yet, as some policymakers signaled last week.

Although not as aggressive as in 2022, the Federal Reserve will continue to raise interest rates and the impact on the economy, which is expected to slow down this year, will match the cumulative effects of previous rate hikes.

Due to these factors, borrowing is becoming more and more expensive, which ultimately affects families' propensity to consume. Plus, inflation is still high, far from the Fed's 2% target which, combined with the perception of a less favorable outcome, is encouraging consumers to refrain from non-essential spending, including in pubs, cafés, or restaurants at night.

Restaurants are one of the industries hardest hit by the headwinds described earlier and furthermore a fall in real household income for Canadians, while stagnant in the United States, will not help the North American industry either.

Investors Should Review Their Investments in US-listed Restaurants Accordingly

Many restaurants whose businesses were already strained by the COVID-19 crisis are now at risk of closing due to rising energy costs in 2022 and the high cost of living due to record inflation impacting consumers. That said, investors should review their portfolio invested in US-listed stocks representing restaurants operating in North America. Possibly to lighten the weight of those who are not in sound financial circumstances and whose growth prospects are poor.

Maybe they want shares of Fiesta Restaurant Group, Inc. ( FRGI ) as this US restaurateur appears to be struggling with profitability and is at risk of financial bankruptcy amid weak financial conditions. And as far as the future is involved, expectations are no better. These issues could potentially weigh heavily on the share price going forward.

About Fiesta Restaurant Group, Inc. in the Restaurants Industry

Fiesta Restaurant Group, Inc., headquartered in Dallas, Texas, owns, operates, and franchises the Pollo Tropical brand of restaurants.

The company's Pollo Tropical restaurants offer fire-grilled and citrus-marinated chicken and other freshly prepared tropical-inspired dishes.

Until August 16, 2021, the company was also the owner, operator, and franchisor of the Taco Cabana restaurant brand.

How Is Fiesta Restaurant Group Performing and What Are The Expectations for Future Performance

For the third quarter of 2022, Fiesta Restaurant Group, Inc. reported an operating loss of $3.2 million compared to an operating loss of $3.8 million for the corresponding quarter of 2021.

The operating loss accounted for 3.4% of revenue in Q3 2022, compared to 4.4% in Q3 2021.

As a result of continuing operations in the third quarter of 2022, the company had total revenues of $95.6 million, an increase of nearly 8% year-over-year, and same-restaurant sales for the Pollo Tropical brand grew 9.3% year-over-year.

The company reported that higher sales helped reduce its operating loss year-over-year and noted that results probably would have been better had it not been for Hurricane Ian.

However, the operating loss wasn't just impacted by temporary factors like hurricane-related spending or higher energy bills.

Operating results were also impacted by factors such as sourcing more expensive inputs that the company needs on an ongoing basis for its restaurant operations.

In addition to higher raw material costs, the company could also have experienced employee salary increases, rent increases and additional advertising costs.

In fact, in the third quarter of 2022, all cost categories increased from year-to-year. Cost of sales increased 14.4%, restaurant wages and related expenses increased 1.3%, restaurant rental expenses increased 2% and advertising expenses increased 20%.

While inflation may still affect the purchase price of some of these inputs, like kitchen supplies or real estate rents, the need to retain enough employees when the high cost of living might tempt them to look for better-paying jobs could lead to higher labor costs for the company in the future.

Additional advertising may also be necessary to strengthen the company's brands and persuade people to visit Fiesta Restaurant Group restaurants, which would be done to offset the headwinds of the expected economic slowdown.

As shown, revenue for the third quarter of 2022 was higher year-on-year, but the company reported an adjusted net loss of $2.4 million (or -$0.10 per diluted share) and a net operating loss from continuing operations of $2.9 million (or -$0.12 per diluted share).

To significantly improve the company's profit line and create a powerful catalyst for higher stock prices, sales must increase sharply while keeping costs under control.

In terms of sales, the investor should be aware that people will dine out much less than before due to the higher price of goods and services. As such, there is a significant risk that also Fiesta Restaurant Group, Inc. could experience a decrease in the number of customers visiting its restaurants, impacting sales growth.

In terms of operating costs, these are in most cases influenced by factors over which the company has very limited control, as they relate to the adjustment of input prices for inflation and the availability of capital for operation and investment, but at a significantly higher cost.

Because of this, it seems unlikely that Fiesta Restaurant Group's stock price will benefit from any significant improvement in corporate earnings.

The Financial Condition

And while shareholders are hoping for a more favorable economic outlook for Fiesta Restaurant Group so it can improve profitability, its financial position isn't the healthiest right now.

As of October 1, 2022, the balance sheet was characterized by net debt of $124.44 million , implying a 12-month interest expense of $0.3 million , which the company couldn’t offset with 12-month operating income as this was a loss of $10.4 million .

This means that Fiesta Restaurant Group is not currently able to cover financial costs through profit, as would be the case if the company's operations were profitable.

Fiesta Restaurant Group is not currently creating value for its shareholders but destroying it. This negative dynamic can be seen in the following relationship, where the company's weighted average cost of capital is 8.91% , while the return on invested capital is -4.37% .

Essentially, this financial situation is in danger of failing, as evidenced by the Altman Z-Score of 1.62 . In assessing the likelihood of such an ominous event, the Altman Z-Score Fiesta Restaurant Group is in serious financial difficulties that carry a high risk of bankruptcy within a few years.

The Stock Valuation

Shares of Fiesta Restaurant Group were trading at $8.76 per unit for a market cap of $231.31 million as of this writing.

Buoyed by heightened investor optimism amid a general recovery in confidence in riskier assets rather than the company's virtues, shares of Fiesta Restaurant Group have soared well above 200- and 75- simple moving average lines so far this year.

This could be the right time to sell the shares and make a profit. Also, as the 14-day Relative Strength Indicator [RSI] curve appears to have taken a trajectory indicating the formation of a new downtrend phase. A 14-day RSI of 60.72 would suggest ample room for a bearish share price.

The chances of this stock being a winner this year are very slim. With the cost of living rising and the uncertainty posed by the expected recession, it's unlikely that more people will be visiting Fiesta Restaurant Group than before.

Conclusion

The market has formed very interesting price levels which can be used to profitably sell shares of Fiesta Restaurant Group.

Given the company's current profitability, financial condition and earnings outlook, FRGI stock most likely will not be a winner in 2023. This year is expected to be quite challenging for this restaurant operator.

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