EAT: MORE MONEY LESS WORRY

Investors that put dollars behind the notion that “they can’t comp the comp” or “this will be the same old Brinker” will get run over, in my opinion.  I feel good about this one.

Outside of macro issues like consumer confidence, the lack of job growth and commodity pressure the restaurant industry is not in a recession.  There are companies that are struggling, but it's a great time to be taking market share and Chili’s is one of the brands that are best-positioned to take significant share.  As we recently saw from Olive Garden’s response to the $6 lunch, Chili’s does not just compete in the “Bar and Grill” space; the broader industry reacted to this price point.   

The title of this note sums up my thoughts coming out of the Brinker analyst meeting in Raleigh, N.C., this weekend which was one of the best EAT analyst meetings I have attended.  It was a great meeting for two reasons.  First, having the entire senior management team at the meeting in an actual restaurant where so many of the initiatives could be explained and debated sent a strong signal.  Second, the meeting was well-attended by a number of Brinker employees with varying skills and experience-levels that helped bring the whole picture together.

In terms of the sell-side community, the meeting was not very well-attended.  For me, this was an important meeting from which I gained a lot of insight.  I would find it hard to believe that any attendee could leave that meeting not feeling impressed by the Chili’s transformation and how it is playing out.

Brinker is another restaurant company that I have been covering for nearly 20 years.  I have seen the company transform many times from small cap Casual Dining start-up; Chili’s revitalization 1.0; the failed multi-brand company strategy; to a weakened industry leader that grew too fast and now on to the “industry innovator” and Chili's revitalization 2.0 we are seeing today. 

Say what you want about the management team, Brinker’s CEO, Doug Brooks is a survivor and now thriving under the new business model.  I also consider Doug one of the strongest CEOs in the industry and the survivor mentality is coming through in the in corporate philosophy of better before bigger. 

It also important not to lose sight of the fact that over two years ago, Doug brought in a new management team with fresh thinking to embark on Brinker’s new path.  Over the past three years, he has sold off non-core brands, bought back 20% of the stock and are now in the middle of what could be one of the most significant brand rejuvenations I have seen in casual dining.  There is a still lot of work to do but the pieces of the puzzle are in place. 

I remember walking out of the analyst meeting in March of 2010 and thinking they have finally found a way to have a real competitive advantage in the bar and grill space, but it could be bigger than that.  At that time, the story was about cutting margins and perhaps stabilizing sales trends but the investment community gave management no credit for technological advances which were, at the time, conceptual at best.  We are now seeing it come to life in the restaurant.

Management perfectly illustrated the impact of the restaurant innovations by displaying slides of time and motion studies that highlighted the difference between how crews work in the new kitchen versus the old kitchen.  The new equipment (ovens etc) simply the back-of-the-house processes and also allow more flexibility in terms of what the restaurant can serve.

Taken together, it’s all about improving margins, creating “less stress” for the employees, lowering labor costs and improving the food quality for the guest.  All of the above leads to more money in the pocket for the store managers!  Not a bad formula! 

While they have accomplished a lot since then from a margin stand point, the "technology" part is just coming to life now.  The sell-side is not giving them credit, because all of these “intangibles” are unquantifiable, so trying to imply what it means for same-store sales is an unknown - at this point.  The options the back-of-the-house technological improvements provide the concept with are more varied than I thought.  The Combi oven is a steamer/oven that allows the staff to cook ribs and pasta and is also self-cleaning.  The CTX oven is a conveyer-belt style oven that cooks quesadilla and other items and the Impinger oven allows the staff to cook flatbread and pizza.  There are many other platforms that the new technology opens to the company and, from a competitive standpoint, the Chili’s store-base will be peerless from a kitchen-technology standpoint.

With respect to this menu innovation, the meeting provided us with a chance to experience the new kitchen’s capabilities first-hand.  For part of the meeting we became guinea pigs in make shift “test kitchen” as the culinary team came to life showing us how that can use the technology to innovate the food.  In the coming years it’s likely that we will see food platform around pasta, flat bread dishes, pizza, fish and chicken. 

If you are a brand like Chili’s in a highly competitive segment like Casual Dining, looking to create new news that your competitors will not be able to replicate will be a real advantage.  My guess is that EAT has a multi-year head start on the competition and most of the smaller players will possibly never be able to compete.   Additionally, if a company is 95% franchised, it may be difficult to orchestrate such a system-wide overhaul as Chili’s is doing.

Judging by the type of questions being asked after the tour of the kitchen, there were some analyst that were starting to think a little differently.  People were asking questions like, “how long will it take for the competition to catch up to you?” and “Who else is putting this technology to work?”  This is the third time I have toured the “kitchen of the future” and I pick up new insights each time.  It is a game-changer for the Chili’s brand. 

The company did not change guidance and reiterated its capability to achieve  400 basis points of net margin improvement from its Plan to Win.  Given that they are half way home the numbers seem very believable at this point.  It's interesting that those detractors who were negative from the outset have now drifted their thesis to assume that the margin improvements are unsustainable and will compromise the customer experience.  I am extremely confident that the opposite is true and, unlike some detractors, I have taken significant time to investigate and analyze the company’s strategy and how it is being executed.   Management is confident, the staff is more content and less stressed and store managers are highly galvanized. 

I think the Chili’s momentum is real and will persist for quite some time.

Howard Penney

Managing Director

Rory Green

Analyst