2023-09-26 05:24:25 ET
Summary
- The restaurant industry has seen slowing traffic since June according to some sources, putting a dent in the share prices of several restaurant brands.
- This is concerning when it comes to Chuy's H2 outlook, with the company already seeing lower traffic in a period of lower gas prices in Q2 and relatively easy comps.
- In this update, we'll look at industry-wide traffic, the outlook for H2 & whether CHUY stock is cheap enough given its plans to ramp up unit growth rates going forward.
It's been a tough couple of months for the restaurant industry, with the AdvisorShares Restaurant ETF ( EATZ ) down seven of the past nine weeks with a decline of 16%, doubling the decline of the S&P 500 ( SPY ). This can be attributed to the weaker traffic trends we've seen from Black Box Intelligence and OpenTable since July, in addition to rising gas prices which have reversed the tailwind that was present during the Q2 correction in gas prices. In fact, national gas prices are sitting nearly 7% above Q2 average levels ($3.87/gallon vs. ~$3.64/gallon) and when combined with a continued decline in consumer confidence, it's hard to be bullish on casual diners, and especially those that were already seeing a dip in traffic in their Q2 results. One name that has underperformed the industry is Chuy's Holdings ( CHUY ), and in this update we'll look at its recent results and its Q3 outlook.
Recent Results and Q3 Outlook
Chuy's released its Q2 results in early August, reporting quarterly revenue of $119.0 million, a 7% increase from the year-ago period. This was driven by a relatively 3.2% comp sales growth figure despite lapping easy comps from Q2 2022 (1.7%), and despite pricing of nearly ~7%, translating to a low single-digit decline in traffic in the period. The company noted in its prepared remarks that its Chuy's Knockouts [CKO's] helped to boost sales in the period, with its Tex-Mex Burrito, Grilled Grupo Tacos and Creamy Green Chicken Enchilada all performing well and providing a boost to incremental traffic relative and a higher mix than previous CKOs. Overall, traffic was still a little weaker than I would have hoped given the strong line-up of LTOs in the period, but we should see a continued boost in Q2 from this platform with the Hatch Green Chili Burger, Steak Burrito Bowl and Chicken Tinga Enchiladas released in July in the early portion of Q3.
Chuy's Holdings - Quarterly Revenue - Company Filings, Author's Chart
Looking at sales performance above, Chuy's revenue hit a new multi-year high at $119.0 million, an impressive feat given that it has seen no net unit growth since year-end 2019 (99 restaurants vs. 100 restaurants). However, the highest-quality growth is that which is driven by traffic, not above-average pricing, and while several restaurant brands have continued to grow sales, they have largely leaned on growing units and increasing prices, with the latter not being sustainable in a period of pinched wallets and lower consumer confidence. So, while brands have been able to take price over the past two years to combat inflationary pressures and drive sales, I'm not sure that this lever is available to the same degree from now on, especially with food-at-home getting even cheaper relatively to food-away-from-home (going out). The result is that down to flat traffic with a lower rate of pricing could make it more difficult to achieve mid single-digit same-store sales growth going forward. And as stated by General Mills ( GIS ) Chair & CEO, Jeff Harmening:
What I would say is, as consumers start to get squeezed, what generally happens is people move more at home. And now the cost of eating out is roughly four times what it is eating at home and so as consumers get more squeezed and as people get into their normal routines in the fall, we would think that at-home eating would probably pick up a little bit. We'll find out."
- General Mills, Q1 2024 Conference Call
Fortunately, while Chuy's sales came in a little below my expectations, especially given the weak gas prices which are often a tailwind for the industry, margins improved significantly, up from 19.1% in Q2 2022 to 21.6%, a 250 basis point jump year-over-year. This was driven by lower cost of sales as a percentage of revenue because of menu price increases and commodity deflation (4%) in the period, with the company calling out dairy, chicken, and produce, which were coming off major spikes last year. Unfortunately, this was partially offset by higher labor and operating costs (40 basis points and 10 basis points up, respectively), with hourly wage inflation, higher staffing levels, the addition of another delivery partner, and higher repair/maintenance costs. And given the margin improvement, adjusted earnings per share increased to $0.61 from $0.45 previously, placing year-to-date EPS at $1.08 (H1 2022: $0.78), and giving the company confidence to guide to $1.80 to $1.85 in FY2023.
Black Box Comp Sales/Traffic Growth & Open Table Seated Diners Statistics - OpenTable, Black Box Intelligence
That said, while the H1 results were solid and the company should benefit from continued commodity deflation in H2, the sales picture is less clear. This is because, as shown above, sales, traffic growth and seated diners by week trailed off substantially as Q3 progressed, with the brief up-tick in June erased, at least according to Black Box Intelligence and OpenTable data. In addition, Darden's ( DRI ) CEO Rick Cardenas noted in Darden's Q1 2024 Call that it saw a less favorable mix (some check management) and that the consumer is having a little less confidence and being more selective. This somewhat confirms the softness in traffic at casual dining restaurants, suggesting that Chuy's could see weaker than expected sales in H2 at the same time as it's rolling off the higher pricing in the first half of the year, which benefited its sales performance.
To summarize, I think it's difficult to be optimistic about restaurant brands beating in H2, except for some quick-service brands that have bucked the declining traffic trends that most brands have faced. And when it comes to meeting Q4 sales estimates of ~$119.0 million, I think there is a better chance of a miss than a beat, which makes it harder to justify paying up for the stock.
Recent Developments
Moving over to recent developments, there was some positive news on unit growth and catering, with the latter increasing 80 basis points year-over-year to 3.5% of Q2 sales. Meanwhile, regarding unit growth, no net new restaurants were added in Q2 as a closure in Illinois offset the new restaurant opening in Oklahoma City. However, the company added a new restaurant after quarter-end in Texas and the company expects to finish the year with 102 restaurants, and is confident that it can return to a 10% unit growth rate post-2024. This would certainly help with increasing sales and annual EPS, but this growth won't be immediate with Chuy's noting that it would like to see construction costs come down a little and permitting timelines improve, with delays and higher build costs affecting its decision to ramp up on higher unit growth immediately next year.
That said, with Chuy's finishing the quarter with ~$82 million in net cash and ~$120 million in total liquidity, it is in a sound position to ramp up growth when it's ready and finding sites is not an issue, it's more the case of the development landscape improving to deliver this planned unit growth. Finally, the company has continued to reduce its share count in the period by buying back ~83,500 shares at $35.91, and there's room to continue its returns to shareholders with ~$47.0 million available on its share repurchase program as of quarter-end. Unfortunately, this hasn't led to a lower share count vs. 2019 levels, with the company issuing ~3.04 million shares at an average price of ~US$16.00 in Q2 2020 at significantly lower prices than it's been buying back shares over the past few quarters. Hence, the benefit to annual EPS has been limited.
Valuation
Based on ~18.2 million shares and a share price of $34.60, Chuy's trades at a market cap of ~$630 million and an enterprise value of ~$730 million. This leaves the stock trading at ~12.0x FY2024 EBITDA estimates and ~25.0x forward free cash flow on an enterprise value basis. And while these are reasonable multiples for a company with solid unit economics that expects to accelerate its unit growth rates post-2024 and grow at a ~10% pace, I still don't see enough of a margin of safety at current levels. In fact, I would argue that a more reasonable multiple for a medium-growth company-owned restaurant brand in the current interest rate environment is 18.0x free cash flow, suggesting that Chuy's has no margin of safety in place at current levels. And even if we apply a more generous multiple of 25.0x forward free cash flow to give the company credit for returning to higher growth, Chuy's fair value would come in at ~$35.80 per share.
Looking at the chart above, we can see that Chuy's 5-year average earnings multiple has come in closer to ~22.7, and the stock is currently trading at ~18.0x FY2024 earnings estimates, which might suggest the stock is undervalued. However, it's important to note that FY2023 will benefit from an extra week in Q4 and using FY2024 estimates of $1.89, the stock is only trading slightly below its historical average of ~22.7x earnings despite rates being the highest they've been in the 5-year period. Hence, I would argue that a more conservative multiple is 20.0x earnings, pointing to a fair value for Chuy's of ~$38.00 (assuming it meets estimates). And while that fair value figure points to a 10% upside from current levels, I prefer a minimum 30% discount to fair value in place to ensure a margin of safety, with the ideal buy zone for the stock once this discount has been applied of US$26.60 or lower.
Summary
Chuy's may be ~21% off its highs following the market-wide correction that began in late July, and the company appears confident in its ability to improve its unit growth rates following a period of no net unit growth over the past few years. This will provide a nice tailwind for annual earnings per share, especially if commodity inflation continues to decelerate, but even if it manages a ~10% unit growth rate, I prefer to buy non-franchisor restaurant stocks at less than 15x forward free cash flow to bake in a margin of safety, and Chuy's trades nowhere near this level today, and it doesn't pay investors to wait, like Restaurant Brands International ( QSR ) or Domino's ( DPZ ) which moved into low-risk buy zones at $50.00 and $298.00, respectively, hence why I started new positions.
Some investors might argue that paying up for Chuy's future growth makes sense and that the current price is cheap enough to buy on the outlook for a return to 7-10% unit growth. However, this is a market where minimal value is being given to future growth, as is clear across several sectors, and certainly among small-cap growth names ( IJT ). Hence, while I would consider Chuy's as a new position if we were to see a deep pullback below $27.00, I continue to see far more attractive bets elsewhere in the market for now, like Pet Valu ( PET:CA ) at just ~13x FY2024 earnings estimates with a primarily franchisor model and it being less discretionary than Chuy's.
For further details see:
Chuy's: A Foggy H2 Outlook With Industry-Wide Traffic Slowing