2023-11-19 08:32:52 ET
Summary
- Brinker International faces challenges in labor, margins, and traffic trends, leading to a hold rating.
- Q1 2024 revenue grew 5.9%, with improvements in food and beverage costs and effective marketing.
- EAT plans to decrease the price of new menu items, indicating expected demand weakness, but stable wage inflation benefits bottom-line results.
Overview
Note that I previously rated hold rating for Brinker International ( EAT ) as challenges arising from labor, margins and traffic trends have created hurdles for them. In this post, I am reiterating my hold rating as management’s revenue guidance for 2024 of mid-single digit growth is clearly lower than the previous years’ growth and its decision to reduce pricing for new menu item is a clear sign that demand is expected to weaken. However, on the other end, stable wage inflation and turnover benefit its bottom-line results.
Recent results & updates
EAT reported first quarter 2024 total revenue of $1.01 billion. When compared with the 2023 first quarter of $955 million, total revenue grew 5.9% year over year. Its operating margin increased to 2.4% from a negative 2.1% operating loss in the first quarter of 2023. This resulted in a net income of $7.2 million, compared to a negative $30.2 million in the first quarter of 2023. Thus, it reported EPS of $0.16 vs. the 2023 first quarter’s negative $0.69. These improvements were driven by improvements in food and beverage costs and effective marketing, which improved comp sales. Comp sales across all three categories—Brinker, Chili's, and Maggiano's—all improved 5.8%, 6.1%, and 2.6%, respectively, when compared against the 2023 first quarter.
The restaurant's strong pricing level for the first quarter of 2024 contributed positively to EAT. However, it stated that as it moves through the rest of the year, it will decrease the price of its new menu items. This could likely be its strategy to attract more customers or retain existing ones and it is a sign that management is expecting demand weakness for the upcoming quarters. Apart from pricing, foot traffic is another key factor to consider. For the quarter, traffic was modestly weaker, as evident in Chili’s demand weakness. As the price is expected to decrease in the upcoming quarters, I anticipate its marketing effort to step down in order to protect margins. Thus, I expect its foot traffic will likely decrease due to lesser marketing campaigns.
On EBITDA, it reported $72 million as opposed to $27.1 million in the first quarter of last year driven by an increase in restaurant-level margin to 10.4%, a favorable mix, a deflationary commodity basket, and lower delivery fees and to-go as virtual brands taper off. In July, Uber Eats took down a significant number of virtual brands in a bid to clean up its apps, as the to-go market is currently plagued with ghost menus. As major brands start to clamp down, the to-go virtual brands are expected to continue to taper off, further giving a boost to EAT.
Another key factor is wage inflation, which is stable in the mid-single-digit range. The stabilization of wages can be attributed to the inflation recovery. In addition, the wage growth tracker has shown that since July 2022, wage growth has steadily declined over the months, and this is moving in line with inflation, which has also started to decline since July 2022. Moving ahead, I expect wages to remain stable and continue to support its margins. In addition to wages, improving hourly and manager turnover points to easier operations and more effective retention strategies. Strong staff retention is important, as stable leadership in restaurants is paramount for effective and efficient operations. Sales typically perform better when operations are efficient and run by knowledgeable managers and staffs.
Valuation and risk
According to my model, EAT is valued at $37 in FY25, representing a modest 2% increase. This target price is based on my growth forecast for the mid-single digits over the next two years. The rationale for my assumption is based on management's 2024 guidance, where they expect total revenue in the range of $4.27 to $4.35 billion. This represents a growth rate of 5%, which is lower than the 2022 and 2023 growth rates, and it is a clear sign that growth is decelerating. As a result of growth deceleration, it explains management’s decision to decrease the price of new menu items for the rest of the year as they are losing customers. By reducing prices, they are hoping it will attract new customers and retain existing ones. With stable wage inflation and turnover, I expect margins to remain stable for the next 2 years.
As of now, EAT's forward Price/Earnings stands at 10.12x, lower than its peers’ median of 14.18x. This lower multiple can be attributed to EAT's lower gross margins in comparison to its peers. EAT has a gross margin of 8.22%, which is lower than the peer median of 13.45%. However, its net margins of 3% is in line with peers. Although 1-year growth expectations are in line at 5%, given EAT’s current growth outlook for next year, it is expected to decelerate while peers are expected to improve. This is the main difference between them, which explains EAT’s lower forward Price/Earnings. With a low upside of 2%, I am maintaining my hold rating.
If EAT’s new pricing strategy works and is able to attract or retain customers, it might lead to a performance beat for the next quarter. This will lead to a change in its current negative growth outlook. With an in-line net margin and a better growth outlook, its forward Price/Earnings will move up and towards peers’ medians.
Summary
Although revenue grew in the quarter, its 2024 full-year revenue growth outlook, based on management’s guidance, is expected to be around 5%. When compared with the last two years, it is showing signs of deceleration. In order to improve its business, EAT’s is planning to reduce pricing for its new menu item in order to attract customers. However, the effectiveness of this new pricing strategy can only be gauged based on the next few quarters' results. Hence, with the weakness in mind, I am maintaining my hold rating for EAT.
For further details see:
Brinker International: Showing Signs Of Slowing Growth