2023-12-09 08:24:08 ET
Summary
- Chuy's Holdings posted slightly better Q3 sales than I expected and it reported significant margin expansion despite modest pricing.
- Meanwhile, the company remains confident that it can accelerate unit growth and open 6-8 new restaurants per annum going forward, a significant improvement from ~3% growth this year.
- In this update we'll dig into the Q3 results, industry-wide traffic trends, and whether it's worth paying up for the stock here.
Just over two months ago, I wrote on Chuy's Holdings (CHUY), noting that the stock wasn't offering enough margin of safety at $35.00 despite its ~20% correction. The stock suffered a further drawdown to $31.60 in the broad-based correction for small cap space ( IJS ) but has since rebounded to 37.00 after a better than expected Q3 report. Meanwhile, the company noted that it hopes to see acceleration to 10% unit growth in FY2025, and opened its 100th restaurant in the period. In this update we'll dig into the Q3 results, industry-wide traffic trends, and whether it's worth paying up for the stock here.
Q3 Results
Chuy's Holdings ("Chuy's") released its Q3 results last month, reporting quarterly revenue of $113.5 million, a 6% increase year-over-year. The increase in revenue was driven by a higher store count because of new unit openings and 2.0% comp sales growth, and with the company opening its 100th restaurant in the period (3rd of the year). And while the comp sales were attributed to menu pricing with a 1.8% decline in avg weekly customers, Chuy's noted that it outperformed its peer group from a traffic standpoint, helped by successful LTOs with its Chuy's Knockout offerings in the period (Hatch Green Chili Burger), Chicken Tinga Enchiladas, and Steak Burrito Bowl. The company also attributed traffic outperformance to the value gap relative to its casual dining peers, and with lower pricing than other Mexican concepts like Chipotle ( CMG ) that have priced above the industry over the past few years and Del Taco ( JACK ) at nearly 7% pricing in the most recent quarter.
Digging into the sales performance, sales were solid in July and August but softened in September and a "flattish" October to start Q4, but the company's newest Knockouts came into effect in late October, with the company noting that it was "encouraged" by how this barbell approach was resonating with guests. Notably, these fresh LTOs came into play just in time for quick-service traffic appearing to have rebounded in late October through November, and with Chipotle noting that it continues to see positive traffic results as recently as its Q3 call in late October, and October comp sales reversed its fall slump to finish +1.4% according to GuestXM data.
In late Octobe r, we introduced our first barbell approach to the CKO platform with Braised Short Ribs as a higher-priced CKO menu item, along with Stuffed Avocado and the Elvis Presley Memorial combo offering. We are encouraged by the early feedback thus far."
- Chuy's Holdings, Q3-23 Conference Call
Besides only minor traffic declines despite the challenging macro environment that outperformed casual dining peers, the standout in the quarter was Chuy's margin performance. This was evidenced by 19.4% restaurant level margins which were up 190 basis points year-over-year, benefiting from lower cost of sales because of commodity deflation, and the company holding the line on labor at 30.4%, offset by a slight increase in operating costs (higher delivery sales, increase in repair/maintenance costs). Notably, Chuy's margin performance is well above many of its lower average ticket casual dining peers like BJ's Restaurants ( BJRI ) at ~11.9% and ~14.0% for Bloomin' Brands ( BLMN ) and Chuy's achieved this despite very modest effective price of ~3.5%.
Finally, adjusted net income improved to $7.9 million or $0.44 in the period, FY2023 annual EPS is now guided to $1.85 - $1.90 (~$0.09 impact from the extra week), and this will translate to over 30% annual EPS growth adjusting for the extra week assuming the company delivers at the high end of guidance. It's worth noting that earnings per share will benefit from a lower share count with the company repurchasing ~539,000 shares in Q3 at a price of $37.10, but this is still far better performance than what we're seeing from other names in the space. In fact, CHUY's annual EPS will be up over 80% from FY2019 levels while other restaurant brands like Cracker Barrel ( CBRL ) have seen steady declines in annual EPS despite more aggressive pricing and share repurchases which should have to better hold the line on margins/earnings.
To summarize, Chuy's results were solid, and its social marketing appears to be paying off nicely, suggesting it should weather Q4 well even if we see continued choppy traffic trends.
Industry Wide Trends
Moving to industry-wide traffic and trends, same-store sales and same-store traffic have been in a steady decline after lapping easy comparisons in Q1 (Omicron in Q1 2022), with this felt in quick-service restaurants as well. Fortunately, traffic recovered in October, with the best-performing segment being quick-service according to Black Box, and Chuy's management appeared upbeat about its overall sales performance in its Q3 Call in early November. The company shared that it believed some of this to be related to its value gap relative to some of its peers, highlighted in the below charts and images. As we can see, Chuy's had one of the lowest average tickets in 2022 of ~$18.00 (average menu item of ~$12.00) and has maintained pricing below the industry average this year, and it also offers significantly more value relative to Chipotle with a full meal and unlimited chips/salsa vs. a basic chicken burrito and chips/salsa for a similar price at Chipotle.
The above comparison does not mean that loyal Chipotle customers are going to rush to Chuy's and stop dining at Chipotle and Chipotle's new Chipotlanes, speed of service/convenience and brand loyalty certainly stand and shoulders above many of its casual dining peers. Still, it is positive to see that Chuy's management is being mindful of the traffic declines industry-wide and increased competition and prioritizing its value proposition over margins, which should pay off in the long run. In fact, management shared that its new class of restaurants is outperforming expectations (albeit helped by being in better-performing states) and that it expects to ramp up unit growth rates with another restaurant in December (4 in 2023) and 6-8 new restaurants going forward, with the potential for 10% growth in 2025. If achieved, this could help with a re-rating in the stock, with Chuy's suffering from being a lower-growth story since 2018 with no unit growth (multiple closures in 2019).
While the return to unit growth is a positive development and the company will benefit from continued commodity deflation in Q4 which should help it to price below its peers, the macro outlook is far from rosy, labor inflation remains sticky, and I think the unit growth estimates of up to 10% in 2025 could end up being ambitious, especially if development delays don't improve which several operators have called out this year. Plus, while Chuy's may have a great value offering, it's not clear if we'll see a continued pullback in industry-wide traffic next year as many consumers continue to get close to being tapped out, with excess household savings now below March 2020 levels for the bottom 20% of earners. Finally, while lower gas prices are a tailwind short-term, oil prices typically bottom in early December, suggesting this tailwind that may have benefited November could reverse over the coming weeks. Let's see whether this looks priced into CHUY below and if the stock is offering a margin of safety.
Valuation
Based on ~17.9 million shares and a share price of $36.80, Chuy's trades at a market cap of ~$660 million and an enterprise value of ~$770 million. This leaves the stock trading at ~12.5x FY2024 EV/EBITDA based on FY2024 estimates, a valuation that doesn't leave much margin of safety relative to its pre-COVID-19 multiple of ~13.0x EV/EBITDA. And using what I believe to be a more conservative multiple of 12.0x EV/EBITDA given the much higher-rate environment and more challenging macro backdrop and ~17.3 million shares, I see a fair value for Chuy's Holdings of $36.90. This suggests limited upside from current levels, and I am looking for a minimum 30% discount to fair value for small-cap names, with CHUY's ideal buy zone coming in below $27.00.
Obviously, there's no guarantee that the stock dips to these levels and CHUY has found strong buying support in the $31.00 region year-to-date a very choppy traffic environment for restaurant brands. Still, I prefer to buy at a deep discount to fair value or pass entirely, and I prefer to buy when stocks are hated, like when I suggested that the stock would enter a buy zone below $26.00 in my December 2021 update. So, with CHUY's priced near fair value and up significantly off its 2022 lows, I would view any rallies above $39.60 before March as an opportunity to book some profits.
Summary
Chuy's had a solid quarter in Q3 and continues to benefit from its new Chuy's Knockout Menu [LTOs] which are providing incremental sales, as well as its relative value vs. some other casual dining concepts and other Mexican options. Meanwhile, margins improved meaningfully in Q3, came in above my expectations and are well above pre-COVID-19 levels, a positive divergence from many of its peers. That said, I prefer to buy small-cap retail names when they're trading at or below 12x forward earnings assuming they are not declining businesses, and while Chuy's aims to return to mid-single-digit unit growth, it's trading closer to fair value and tough to justify chasing above $37.00. Hence, I continue to see more attractive bets elsewhere in the market, with one name including Supremex ( SXP:CA ), which trades at less than 5x forward earnings.
For further details see:
Chuy's Holdings: A Solid Q3 Despite Difficult Macro Backdrop