2023-04-13 13:02:19 ET
Summary
- Revenue should benefit from price increases, improving mix shifts, and a focus on enhancing guest satisfaction.
- An inflationary environment and increased advertising investments should pressure margin growth over the coming few quarters.
- Valuation is a slight discount to historical averages.
Investment Thesis
Brinker International, Inc.'s ( EAT ) revenue is expected to benefit from price increases and improving mix shifts, which should help offset the impact of declining guest traffic in an inflationary environment. Moreover, the company's focus on improving guest satisfaction and new restaurant developments should support revenue growth in the long term. However, margins should be under pressure due to inflationary costs and the company’s increased advertising and repair and maintenance spending in the coming quarters. The current valuation is a slight discount to historical levels but is not enough for me given the mixed outlook with good revenue growth but poor margin prospects. Hence, I have a neutral rating on EAT stock.
Revenue Analysis and Outlook
The company has seen good momentum in its off-premise sales post-pandemic. The surge in dine-in sales post-reopening also added to the growth and the company has seen healthy revenue growth in recent years.
In the second quarter of the fiscal year 2023, the off-premise business continued to drive sales growth for EAT. Additionally, price increases and a positive mix shift also contributed to sales growth, more than compensating for the negative impact of declining guest traffic. This resulted in a 10.1% year-over-year increase in sales growth, reaching $1.02 billion. On a comparable same-restaurant basis, total company-owned sales increased by 9.7% year-over-year, reflecting a 9.7 percentage point benefit from price increases and a 5.5 percentage point benefit from mix shift, offset by a 5.5 percentage point headwind from the decline in guest traffic.
EAT’s Historical Revenue (Company Data, GS Analytics Research)
Looking forward, I believe EAT should be able to deliver sales growth with the help of price increases, menu improvements, new unit openings, and improvements in the guest experience.
Like many in the industry, EAT has also taken menu price increases to cover inflationary input costs. However, the company took pricing actions a little late compared to its peers, leading to price gaps. This gives the company some more leeway to increase its menu prices further. So, I expect the carryover impact of price increases from late last year, and further price increases should help the company's sales growth moving forward.
While there are near-term concerns regarding declining guest traffic in an inflationary environment, I believe the company's efforts to provide value by introducing an attractive opening price point should help offset some of the decline in guest traffic. In a recessionary environment, customers become more value-oriented. So, EAT has introduced a '3 for me' platter at the opening price point of $10.99. The platter includes a complete meal with unlimited chips and salsa, a full-size entrée, and a bottle of soft drink. Moreover, the company is also increasing advertising and bringing back its on-TV ad commercials. The on-air advertisement of the new '3 for me' platter should help the company in increasing top-of-mind awareness and offset the impact of the macroeconomic slowdown on guest traffic.
In addition, EAT is also focused on improving its overall menu. In the first quarter, EAT introduced a new bar menu, resulting in significant increases in alcohol sales, guest check, and mix in the second quarter. The company is further expanding its bar menu to include more premium drink options. It has also added more dipping sauce options, which are popular on its off-premise menu. So, I believe price increases, new opening price point items, overall menu improvements, and increased advertising should help the company offset the headwinds from the slowing economy in the coming quarters.
For longer-term sales growth, the company is trying to enhance the guest experience. It is bringing in bussers and additional bartenders so that servers have fewer tables to serve and can focus on improving guest engagement. This should help increase guest satisfaction at EAT's restaurants. Furthermore, new unit growth, which is a long-term sales growth driver, has also helped EAT in increasing its sales. Since FY2019, the company has increased its total company-owned restaurants by ~18% to 1181. The company has a target of opening a total of 19 new restaurants in FY23. While delayed construction is resulting in fewer new restaurant openings in FY23 compared to previous fiscal years, I believe the company should be able to accelerate new restaurant openings in FY24. So, in the medium to longer term, improvements in guest satisfaction and new restaurant openings should help drive sales growth.
Margin Analysis and Outlook
Since the start of fiscal 2022, EAT has been facing adverse impacts on its restaurant operating margins due to inflationary food and beverage costs, as well as high labor costs.
Inflationary pressures continued to affect EAT in the second quarter of fiscal 2023, with commodity inflation at approximately 19% Y/Y and wage inflation at around 5% Y/Y. Additionally, higher repair and maintenance costs as a percentage of sales also impacted margin growth. However, the company's pricing actions partially offset these elevated costs, resulting in a 50 basis points year-over-year decline in the restaurant operating margin to 11.6%.
EAT’s Historical Restaurant Operating Margin (Company Data, GS Analytics Research)
Looking ahead, while inflation is moderating, it is still meaningfully up Y/Y, and inflationary pressures are expected to remain a concern for the next few quarters and have a negative impact on the company's restaurant operating margins. Additionally, advertising spending and repair and maintenance costs as a percentage of sales are expected to increase as the company invests in acquiring customers and improving customer experience to drive longer-term growth, further impacting margins for the remainder of FY23. Further, as discussed in the revenue section, the company plans to increase bussers and bartenders to improve guest satisfaction. This may help in the long run but, in the near term, this should increase expenses. While price increases should help offset some of these elevated costs, margins are still expected to decline year-over-year for the full fiscal year 2023.
Valuation and conclusion
EAT's current forward P/E ratio of 13.26x FY23 consensus EPS estimate of $2.71 is a slight discount versus its historical 5-year average of 13.82x. While I like the steps management is taking to improve revenues, Brinker's margin outlook remains negative. The company’s history of generating shareholder returns is also somewhat unimpressive and the stock has meaningfully underperformed S&P 500 ( SPY ) as well as many well-run restaurant peers over the last decade. Therefore the chances of its P/E multiple re-rating upwards in the near term are also minimal. So, it would be wise to wait for margins to bottom and revenue growth initiatives to gain more traction over the next few quarters before turning positive. As of now, I have a neutral rating on the stock.
For further details see:
Brinker International: Mixed Prospects