EAT under new management
EAT reported a disastrous quarter; the guidance was worse, and the issues are not only one-quarter a problem. Despite all the bad news, the stock was only down 5%, which should say something to me, who has been bearish since the $60s. Is all the bad news priced in, and/or what could drive potential enthusiasm? We are staying SHORT and think there is a downside to $15-$20. The CEO is moving quickly, and all the moves might not impact the business as intended, especially in a recession.
The new CEO, Kevin Hochman, is not sitting still - "So we're working quickly to identify the things we can do to grow the business sustainably, improve the guest experience, reduce cost and complexity and implement more strategic pricing, which will, in turn, expand restaurant margins and grow profits. Our evolved pricing strategy will include providing focused everyday value for guests who need it but will move away from frequent and deep discounting. We will also rightsize the mix of everyday menu items offered on a deal, but we'll make sure there is something available for the cashed-out customer who needs a superior value to enjoy casual dining. We will also do a better job of recovering expenses for the inflated commodity and the added cost for delivering Chili's, Maggiano's, and our virtual brands. I have charted two teams of senior executives to make quick interventions that will build momentum in our business. One team is dedicated to near-term ideas to drive sustainable and profitable sales layers. They are being charged with identifying customer insight-driven sales opportunities and bringing exciting new initiatives to our dining rooms to help accelerate traffic recovery."
Hedgeye: Implementing a new strategy will take time and require significant investments. He used the phrase "intervention" seven times, suggesting there are problems that need to be fixed ASAP.
Improving Traffic Trends - "Some guests reacted to the challenging inflationary environment, particularly during the weeks of elevated gas prices. We also experienced approximately a 1% negative sales impact to the quarter that some restaurants are not able to fully open dining rooms, particularly at peak times were had to throttle back online orders giving limited staff availability. "I would note that Chili's traffic trend since the end of the quarter saw sequential improvement into August although they remain in the mid-single digit negative territory."
Hedgeye: The Placer.AI data confirm the declining traffic trends and the improvement toward the end of the quarter. Chili's is expected to exit the first quarter at close to 8% price, a level the brand will maintain throughout the fiscal year. Maggiano's will exit the first quarter in the mid-5% range and is anticipated to average closer to 7% for the fiscal year. An aggressive move on pricing is an "intervention" to protect margins, but what about traffic?
Margin Trends - "Moving further down the P&L, our fourth quarter restaurant operating margin was 10.3% down from the prior year due to the magnitude of inflation we experienced throughout the major categories at restaurant margin. Restaurant margin was also negatively impacted by approximately 80 basis points from lapping the 53 weeks of the prior year. Food and beverage costs as a percent of company sales were unfavorable by 310 basis points compared to the prior year. As you might expect, this was driven by higher commodity costs with inflation hitting close to 15% for the quarter, a high for the fiscal year. Every major commodity category was negatively impacted, with poultry being our largest year-over-year increase."
Hedgeye: 4Q22 was a difficult comparison, but the long-term decline in margins suggests lower levels of profitability in the future. The new CEO has a lot of work to do improving margins. Reducing discounting is part of the plan, but what will that do to traffic, especially with 37% of Chili's checks, including a discount? Watch what happens to comps and especially traffic when the company reduces the frequency and depth of price promotions. How long will it take to get to mid-teens margins?
The guidance looks aggressive - "Our current first quarter is likely to be the low point of our operating results for the fiscal year as we work through the cresting of inflationary pressures for our brands. With that in mind, let me provide some specific insights for the quarter that also helped define the expected meaningful positive progression of operating performance as we move into and through the remainder of the year. As is typical, we expect the first quarter to be our lowest revenue quarter generating between $920 million and $930 million of company sales for the period. The year-over-year impact of inflationary increases for the first quarter will increase costs in all the major categories of restaurant margin. Food and beverage expenses alone are expected to be up more than $50 million for the quarter. When combined with the lower revenue of this quarter, we expect restaurant operating margin to be between 4.5% and 5.5% for the first quarter. This restaurant margin will result in an overall operating loss for the quarter with a negative operating margin expected in the mid-3% range and first quarter adjusted EPS estimated in a range of negative $0.70 to negative $0.60. While anticipating a disappointing start to the fiscal year, we maintain a clear line of sight to meaningfully improved operating performance throughout the year as incremental pricing, lower food and beverage cost, and sales driving initiatives all kick in during subsequent quarters. Net income per diluted share, excluding special items, is expected to be in the range of $2.45 - $2.85 vs. a consensus of $3.65.
Hedgeye: The company will lose money in 1Q23 but will see a significant improvement over the balance of FY23. The company is betting on pricing, and the elimination of discounts will have an incremental impact as its moves through the fiscal year. The commodity cycle "we see materially improving as we get through the year and actually turned to a year-over-year favorable dynamic as we move into that fourth quarter." EAT only expects low single-digit traffic decline for FY23. They believe that the "interventions" they are taking today will offset the looming slowdown in consumer spending. Pulling this off will be close to a miracle.
