2023-07-16 21:51:31 ET
Summary
- Despite the strong financial results, my recommendation is HOLD due to the high valuation of the stock and the lack of additional growth catalysts.
- In 1Q23, the company posted a 12% YoY increase in revenue due to both a 6.2% increase in average ticket and a 1.8% increase in traffic.
- Operating margin increased to 7.4% due to higher prices in the restaurants of the chain.
Introduction
Shares of Chuy's (CHUY) have risen 43% YTD. Despite the fact that the company posted strong operating and financial results in 1Q 2023, my recommendation for the company's stock is currently HOLD.
Investment thesis
In my personal opinion, restaurant management stocks were an excellent bet on the post-covid economic recovery, however, I believe that this investment idea has already been implemented at the moment, because: firstly, in accordance with management comments , traffic in the restaurant chain has already recovered to 70% compared to 2019. Secondly, the company's stock has already posted a strong gain of about 43% YTD, outperforming the S&P index, which rose 18% YTD. Thirdly, in accordance with the multiples, the company's shares are traded significantly more expensive than the sector median. In addition, I believe the current valuation is based on fairly positive guidance for 2023 and strong management commentary on current and future trends, so I see no additional upside catalysts/drivers to lift the stock.
Company overview
Chuy's owns and operates full-service restaurants. The main positions in the menu of restaurants are dishes of Texas and Mexican cuisine. As of the end of Q1 2023, the company operates 99 restaurants in 17 states. The company operates in the US market.
1Q 2023 Earnings Review and my expectations
The company reported better than investors expected . The company's revenue in Q1 2023 grew by 12% YoY due to an increase in comparable sales by 8% YoY. The main driver of comparable sales is a 6.2% increase in average ticket, while traffic increased by only 1.8%. Gross margin increased from 73.9% in Q1 2022 to 74.5% in Q1 2023 due to increased prices for products in the restaurants of the chain. You can see the details in the chart below.
Margin trends (Company's information)
Operating expenses (% of revenue) decreased from 67.8% in Q1 2022 to 67% in Q1 2023. The largest contribution to the reduction in operating expenses was made by a decrease in other expenses and expenses on occupancy, while expenses on labor and G&A increased. Thus, the operating margin increased from 6.1% in 1Q 2022 to 7.4% in 1Q 2023. You can see the details in the chart below.
Margin trends (Company's information)
I would also like to note that the company has no debt on its balance sheet for the 1st quarter of 2023, while the amount of cash is $82.6 million. In addition, the company raised its forecast for adj. EPS for 2023 from $1.60-$1.65 to $1.71-$1.76.
My expectations
In line with management's comments during the Earnings Call following the publication of 1Q 2023 results, in April (2Q 2023) positive trends in comparable sales continued. I believe the company sees both an increase in the average ticket, thanks to the recent increase in product prices, and positive traffic dynamics against the backdrop of a relatively weak quarter last year.
However, I believe that we may see less strong results than the market expects. First, in line with market data and my expectations, we may see a slowdown in inflation in the second half of 2023, which may put pressure on the average ticket and, accordingly, the dynamics of revenue growth.
Secondly, the main stage of traffic recovery in the restaurants of the network has already been completed, for example, traffic has recovered up to 70% compared to 2019. Thus, I do not expect serious support due to the restoration of attendance.
Yes, so we're running traffic in kind of the mid- to upper 70s right now of what we did in 2019.
Risks
Margin: raising raw material costs due to inflation, rising wages, inefficient marketing spending, declining economies of scale can have a negative impact on the operating profitability of a business if the company fails to pass the inflation on to the consumer
Revenue: on the one hand, a decrease in the level can support the operating profitability of the business, however, this may put pressure on revenue growth due to a decrease in the average check
COVID: the return of restrictions and therefore reduced traffic in restaurants could have a serious negative impact on the company's revenue.
Drivers
Revenue: the introduction of new menu items such as Wild Burrito and Hatch Beef can support revenue by both increasing the average check and attracting traffic to the chain's restaurants. In addition, an effective digital media marketing strategy can help drive additional traffic.
Valuation
The current valuation grade is D+. On P/E ((FWD)) and EV ((FWD)) multiples, the stock trades at 23.7x and 15.4x, respectively, which is 54% and 59% higher than the sector median. On the one hand, the company's stock deserves some premium over the broader market, thanks to both robust business growth and relatively high operating margins. On the other hand, I believe that the current valuation level has more downside risks than upside drivers.
Conclusion
I would like to say that I like both the company's business model and the current trading trends of the business, which is why I avoid the Sell recommendation. However, at the moment, after strong growth in quotes, high investor expectations based on management comments and a relatively high valuation in accordance with multiples, I see more downside risks than additional growth drivers. Thus, for the moment, I'm sticking with the HOLD recommendation for the company's shares. On August 3, 2023, the company will publish results for the 2nd quarter of 2023.
For further details see:
Chuy's: Strong Trends But Upside Is Limited