EAT - STRAIGHT UP THE MIDDLE

This turnaround story has been in place since mid-2010.  We got behind it then and, while it has not worked in a straight line, the stock has generally worked well as the company has taken share from Bar & Grill competitors. The Brinker story does not end there.

 

From the outset of this turnaround, Brinker has repeatedly invoked the McDonald’s “Plan to Win” of 2003/2004.  The question is whether or not Chili’s can enjoy as lengthy a period of success as McDonald’s has enjoyed for much of the past decade.  Over that period, McDonald’s has dominated its main rivals, Wendy’s and Burger King, on nearly every metric.  Even today, both chains are still struggling to keep pace with the finely tuned machine in Oakbrook.

 

 

STRAIGHT UP THE MIDDLE

 

Two years into the turnaround, there are a number of similarities we can point to between the Brinker turnaround and the one that McDonald’s engineered almost a decade ago.  We see an opportunity for Brinker to take significant market share over the next five years, expanding its competitive horizons beyond the Bar & Grill category and its traditional competitors like Applebee’s and Ruby Tuesday. 

 

The Bar & Grill category is on its last legs.  Historically, Chili’s was a hamburger concept that morphed into a Bar & Grill concept as it developed into a national chain.  Over the past ten years, the Bar & Grill space has become hyper-competitive with many of its constituent companies pushing to expand their menus to gain share.  Strained balance sheets, thinned out management teams and the sea change in consumer behavior that came about as a result of the Great Recession have hampered companies’ ability to do so, however. 

 

Despite this, the financial crisis was in some ways positive for Brinker only in that it compounded prior errors on the part of management to the extent that, for the sake of its survival, the company had no choice but to attack every aspect of its operations to endure.  When Doug Brooks announced his company’s version of the Plan to Win, Chili’s had posted its sixth consecutive quarter of negative same-store sales.  Central to management’s survival strategy was attacking the middle of the P&L – food and labor costs – and the company has seen plenty of success, thus far, following that strategy.

 

Having sold off non-core assets and now with Chili’s posting its fourth consecutive quarter of positive same-store sales, the future looks bright for Brinker as the benefits of its revitalization plan are beginning to show up in the numbers.  While we see Chili’s as a brand that is strengthening, Applebee’s is a company in a deleveraging process that is also somewhat restricted by its heavily franchised business model in that emulating the advancements Chili’s has made would be difficult if not impossible to bring about in an expeditious manner.  Ruby Tuesday’s is clearly a brand in decline.  Likewise, when McDonald’s began its turnaround, its competitors were also struggling; Wendy’s was dealing with activist investors and several CEO’s while Burger King was being starved of capital by multiple owners.  This allowed McDonald’s to take a measured approach to establishing itself as the best in its segment and then expand the scope of its business to take share from others within the restaurant space.  We see Brinker as being in the process of executing a similar strategy within casual dining.  The company is entering phase two, which is moving management to measure itself against a new group of competitors.

 

 

A HIGHER STANDARD

 

Chili’s is, in our view, leaving its traditional competitors behind.  Ruby Tuesday is a struggling concept and Applebee’s is lagging Chili’s in terms of technology.  One quote from management that spoke to this point came on 4/23/12 when CEO Doug Brooks, said, “we have made a lot of changes at Chili’s and one of the most significant changes we’ve made is how we look at ourselves.  We’re holding ourselves up to what we call benchmark competitors in the industry today”.

 

The investment Brinker is making in its Chili’s store base is ongoing and, in speaking with store managers we know that the benefits are far reaching in terms of customer satisfaction and food and labor efficiency.  The full benefit of this turnaround will not be evident until 2013 when the entire Chili’s system has been retro-fitted with the “Kitchen of the Future” format.  McDonald’s transitioning from batch cooking to a continuous cooking process in 2004 was a similarly important milestone for that company’s turnaround, enabling it to better serve its customers while also helping the stores to operate more efficiently.

 

Chili’s is nearing completion of a strategy that Darden and other casual dining companies would possibly do well to replicate; it has stopped growing and has focused on maximizing the profitability of its existing assets.  Comparing itself to the likes of BJRI, BWLD, PNRA and other concepts will only serve to maintain management’s current focus.

 

As we near the end of the kitchen remodel program, we expect a ramp up in new product platforms being introduced to the Chili’s customer.  We also anticipate significant implications for the company’s top line momentum as a result.  The question is whether or not Chili’s can go on a three- or four-year run of positive same-store sales.  We think it can.

 

While McDonald’s and Brinker operate in different segments of the restaurant industry, their respective turnarounds are similar in that they have centered on attacking the middle of the P&L.  With margins approaching 20%, if Chili’s can produce a string of positive same-store sales results, the flow through to the bottom line will be substantial.

 

EAT - STRAIGHT UP THE MIDDLE - eat mcd turnaround

 

 

NEW PLATFORMS BRING NEW COMPETITORS

 

Chili’s offering steak obviously pits the company against the likes of Texas Roadhouse and Outback Steakhouse.  Technological improvements in the Chili’s kitchen have allowed the company to add platforms, like steak, to its menu without adding undue labor to the P&L.  For example, the Impinger oven, which we have seen in action in several Chili’s stores, allows the company to easily produce flat bread and pizza.  We believe that this places BJRI, another new competitor, in Chili’s cross hairs. 

 

In conclusion, we believe that Chili’s has been executing its turnaround extremely well given the economic circumstances it faces.  One stark dissimilarity between the McDonald’s turnaround and Brinker’s is that the economic backdrop today is a world apart from what it was in 2004.  Our view of the casual dining category is sensitive to the macroeconomic outlook, particularly employment, but for any investors looking to increase exposure to casual dining, we believe that EAT will outperform over the longer term.

 

 

Howard Penney

Managing Director

 

Rory Green

Analyst

 

 

 

 


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