Below please find the introduction to a full-length report on Brinker International Inc. (EAT, Financial) that was recently featured in Boyar Research's flagship publication Asset Analysis Focus.
Brinker International Inc. (EAT, Financial) is one of the world's leading casual dining restaurant companies.
As of March, Brinker owned, operated or franchised 1,647 restaurants under the Chili’s Grill & Bar (1,596 restaurants: 946 company-owned and 650 franchised) and Maggiano’s Little Italy (51 company-owned) banners. During fiscal year 2015, Brinker generated $3 billion in revenue from three sources including Chili’s company-owned restaurants (83.4% of fiscal year 2015 revenues), Maggiano’s (13.4%) and franchise and other revenues (3.2%).
Over the years, Asset Analysis Focus has been attracted to retail businesses that generate revenue pursuant to a franchise business model given the high margin and recurring nature of this revenue stream. Past examples of companies featured by AAF that fit this profile have included McDonald’s (MCD), IHOP/DineEquity (DIN), Wendy’s (WEN) and Midas, among others.
Although just 3% of Brinker’s overall revenue stream is generated from franchise/license sources, this revenue stream has accounted for ~35% of the company’s annual operating income over the past five years. The strong profitability of Brinker’s company-owned restaurants (17% restaurant operating margin at Chili’s) coupled with its high margin franchise revenues have enabled Brinker to generate robust levels of free cash flow and return a significant amount of capital to shareholders.
Since the beginning of fiscal year 2010, Brinker has returned $2.3 billion to shareholders in the form of share buybacks ($1.9 billion) and dividends ($384 million) combined to represent an astounding 85% of Brinker’s current market cap. Over that time frame, Brinker’s buyback program has resulted in a nearly 45% reduction in the company’s diluted shares outstanding with the company retiring its shares at an average price of $32.38 a share (~30% below the current share price).
While the company’s leverage ratio has risen modestly as returns to shareholders have exceeded free cash flow generation in recent years, the company can continue its strong pace of returning capital to shareholders while maintaining leverage at the current and manageable 2.4x leverage (net debt/EBITDA) level. This will be accomplished as capital expenditures moderate following a recent reimaging program and the company realizes the benefit of various growth initiatives.
In fiscal year 2012, Brinker embarked on a significant reimaging program of its restaurants intended to drive growth and increase future profitability. As part of this program, Brinker invested ~$250,000 in each of its stores to modernize its restaurants including a meaningful upgrade to its kitchen equipment.
With the reimaging program largely complete, Brinker is poised to benefit in terms of markedly lower capital expenditures and increased profitability. Over the past three years, Brinker’s capex has averaged ~$145 million on an annual basis but is expected to decline to the low $100 millions going forward.
Meanwhile the renovated restaurants offer a number of benefits, including the ability to introduce high-margin offerings and lower labor costs from upgraded equipment (lower labor and cleaning costs).
In addition to the reimaging benefits, there are a number of items that should bolster EAT’s future results, including the recent acquisition of underperforming restaurants from a Brinker franchisee, improved sales of high margin alcoholic beverages and opportunities to benefit from technology initiatives (online ordering platform and rewards program). In June 2015, Brinker acquired 103 underperforming restaurants from Pepper Dining. According to management, these stores generated an average of $2.6 million in annual revenue per store, well below the company average of $3.1 million.
Management believes it can bring the revenue and profitability of these restaurants to company averages by reimaging the stores. The sale of high margin alcoholic beverages at Chili’s restaurants is underpenetrated relative to its closest peers and management has a number of initiatives in place to expand this attractive revenue source. In January, management announced that it would partner with Olo, a New York City-based software firm, to improve its online ordering capabilities. Takeout orders (currently ~10% of Chili’s sales) are the fastest-growing part of the business and management believes there is a meaningful opportunity to continue the momentum, while setting the stage to capitalize on the currently untapped delivery market.
Meanwhile, the company believes its rewards program could be a source of meaningful future growth. In fiscal year 2015, the company introduced its MyChili’s Rewards loyalty program and has already attracted 5 million members. In early fiscal year 2017, Chili’s is set to join the Plenti rewards program (an American Express [AXP] rewards program), which will significantly enhance its rewards membership levels as Plenti has over 40 million members.
Brinker shares are trading approximately 25% below 52-week highs reflecting competitive issues from quick service restaurants and operating challenges in markets with oil exposure (~17% of revenue from Texas, Louisiana and Oklahoma). While the QSR discounting issues tend to occur from time to time, it does not present a sustainable long-term threat. The company’s exposure to regions of the country that are being negatively impacted by the energy downturn are worth monitoring although this weakness will likely be offset, at least in part, by the stimulus effect of lower energy prices, which essentially act as a tax cut.
At current levels, Brinker shares trade at 5.6x our fiscal year 2018 EBITDA estimate. We note that this represents a discount to Brinker’s median trading valuation over the past two decades and precedent industry transactions, both at ~8.0x EV/EBITDA. Applying an 8x multiple to our fiscal year 2018 EBITDA, we derive an intrinsic value of $69 per share representing 49% upside from current levels. If management continues to be aggressive with respect to share repurchases, which we expect to be the case, Brinker could buy back 26% of its shares outstanding at current prices by the end of fiscal year 2018, while maintaining its leverage ratio at 2.4x and modestly increasing its dividend. Brinker shares offer the potential for greater upside than our $69 intrinsic value estimate if the market values the company on P/FCF in fiscal year 2018, as we project FCF will grow meaningfully faster than EBITDA (57% FCF growth vs. 17% EBITDA growth in fiscal year 2018 over fiscal year 2015). Finally, if Brinker shares continue to remain out of favor, we would not be surprised if the company catches the attention of private equity as its strong FCF generation ($5.19 per share in fiscal year 2016), moderate leverage and good growth prospects would be particularly appealing to a financial buyer.
To receive an additional complimentary research report from Boyar Research please visit: www.boyarresearch.com/GF1
To download Boyar Research's full-length report on Brinker, please go to:
http://boyarresearch.com/bvg-pdf/EAT.pdf
Disclosure: Clients and Employees of The Boyar Value Group own shares of Brinker.
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