2023-06-28 04:39:10 ET
Summary
- Revenue should benefit from price increases, improving menu mix, and increasing guest satisfaction.
- Margins should benefit from price increases, a favorable cost environment, and improving efficiency.
- Valuation is lower than historical averages.
Investment Thesis
Brinker International, Inc. ( EAT ) is poised to experience revenue growth through price increases and mix improvement. Additionally, the company's sales should be bolstered by increased advertising and marketing efforts, as well as enhanced guest satisfaction. These factors should more than offset the challenges of declining guest traffic in an inflationary environment.
Regarding margins, although the full fiscal year 2023 is expected to witness a decline in growth due to weaker margins in the first half of the fiscal year, there are indications of a recovery in the fiscal year 2024. This recovery can be attributed to favourable comparisons with inflationary factors and improved productivity. In my previous article back in April, I provided a neutral rating for the stock. Since then, the stock has undergone a slight correction and is currently trading below its historical average forward P/E. Given the company's improving prospects, I am now moving to a buy rating.
Revenue Analysis and Outlook
In my previous article, I wrote about good revenue growth prospects for Brinker International. Since then, the company has reported its Q3FY23 results and has seen good growth. In the third quarter of fiscal 2023, sales growth benefited from good traction gained on the company's advertising campaign including returning to national TV. In addition, price increases and a positive mix shift, and good demand at Maggiano's restaurants also contributed to sales growth, which more than offset negative guest traffic. This resulted in a 10.5% Y/Y increase in sales growth to $1.08 billion. On a comparable same-restaurant basis, total company-owned sales increased by 10.8% Y/Y, reflecting a 9.6 percentage point benefit from price increases, and a 5.3 percentage benefit from mix shift, offset by a 4.1 percentage point headwind from guest traffic decline.
EAT's Historical Revenue (Company Data, GS Analytics Research)
Looking forward, the company should be able to continue delivering revenue growth as it benefits from price increases and lower promotions, increased advertising, and increasing guest satisfaction.
The company's pricing strategy has been instrumental in offsetting inflationary pressures and driving comparable sales growth. On its investor day earlier this month, management noted that Brinker still has room to close price gaps compared to its industry peers, and as a result, it anticipates implementing further price increases in the future. The company is also reducing promotional offers and focusing on improving the menu mix for long-term growth rather than trying to attract short-term customers with discounting/promotions. So, improving price/mix should continue to contribute positively to comparable sales growth in the upcoming quarters.
EAT's price increases (Company Data, GS Analytics Research) EAT's mix improvement (Company Data, GS Analytics Research)
Furthermore, the company has also increased its advertising and marketing initiatives. As I mentioned in my previous article , the company brought back its on-TV ad commercials. This on-air national advertising of the company's new menu items gained good traction and drove incremental traffic to the restaurants leading to sequential improvement in guest traffic count. Based on the success of this ad commercial, the company is planning for three additional on-TV ad campaigns in fiscal 2024, which should continue to help its sales growth in the coming year.
EAT is also focused on improving guest satisfaction and increasing customer loyalty to the brand for long-term growth. In the third quarter, the company brought back bussers, additional cooks, and table cleaners in order to reduce the burden of table servers. This resulted in increased customer engagement as table servers could focus on their assigned guest more effectively. This resulted in reduced customer complaints, order accuracy, and increased speed of table turns, all helping improve customer satisfaction. As these bussers and cleaners become more productive with their work, further reducing the burden of the table servers, guest satisfaction should continue to improve and help increase customer loyalty. Moreover, the company also simplified its menu by removing lower-performing and low-demanded menu items, which further resulted in increased speed of service, improved food quality, and guest satisfaction. So, I expect this improving guest satisfaction should help the company's sales growth in the coming year as well.
Hence, I remain optimistic about the revenue growth prospects of the company. EAT aims to achieve 3% to 5% annual top-line growth over the course of the next 3 years. Which I believe should be achievable given price increases, improving menu mix, and guest satisfaction.
Margin Analysis and Outlook
In the third quarter of fiscal 2023, Brinker International continued to face challenges arising from inflationary commodity costs, which increased by 9% year-over-year, and labor costs, which increased by 5% year-over-year. The company made the decision to reduce discounting and promotional offers during the quarter. This strategic move improved the menu mix by emphasizing more profitable items. Additionally, the company implemented price increases, which further contributed to margin growth and helped offset the impact of inflationary pressures. As a result, the company achieved a 30 basis points year-over-year increase in the restaurant-level operating margin for company-owned restaurants, reaching 13.4%. Moreover, the consolidated operating margin grew by 90 basis points year-over-year, reaching 5.9%.
EAT's Historical company-owned Restaurant Operating Margin and Consolidated Operating Margin (Company Data, GS Analytics Research)
Looking ahead, while the cost environment is turning favourable for the company in the coming quarters, the poor margin performance in 1HFY23 would likely lead to a YoY margin decline for the company for the full fiscal 2023. However, moving into fiscal 2024, margins should see recovery as they face easy inflationary comparisons due to moderating inflation.
Moreover, in the coming fiscal year, margins should also see benefits from price increases, and lower promotional and discounting expenses as the company continues to focus on increasing the profitability of the menu mix. Additionally, the company's restaurant-level managerial turnover has also come down below the pre-pandemic levels, which should help in improving productivity and reducing new hiring costs. This should also help support margin recovery in the coming fiscal year. The company has also made efforts in simplifying the operational performances by reducing complexities in the menu. For this purpose, the company has removed ~50 menu items and simplified the menu in order to drive productivity and efficiency. So, the company's medium to long-term outlook looks attractive.
Valuation and Conclusion
Brinker's International is trading at a 10.66x FY24 consensus EPS estimate of $3.36, which is at a discount to its historical 5-year average P/E ((FWD)) of 13.85x. So, the valuation looks attractive. Management is taking a lot of steps to position the company for long-term growth and some of these initiatives have already started gaining traction as is evident from the last quarter's earnings beat . The company's revenue and margin outlook is also positive supported by price increase, mix improvement, improving guest satisfaction, moderating inflation and productivity enhancements. This coupled with low valuations makes it a good buy.
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Brinker International: Low Valuations And Improving Prospects Make It A Buy