Editor's note: This report was originally published October 28, 2014 at 06:09 in Restaurants. CHUY is down over -30% since Penney made this short call.
We’ve covered the majority of our shorts in the casual dining space, but remain bearish on a select few stocks. Today, we’re adding one of these names, CHUY, to the Hedgeye Best Ideas list as a short.
Three Key Points:
- In addition to being phonetically challenging, the Chuy’s brand is having difficult generating awareness is new markets. The street is assuming that other states will be able to produce the same levels of revenues and returns generated in its core market (Texas) as it pursues its nationwide expansion plans.
- The issues associated with a disappointing 2013 class of restaurants are not a one quarter issue. In fact, AUVs have declined every single quarter since 4Q12, a trend we believe will persist for the balance of 2015. The concept has already proven it doesn’t travel well, suggesting growth expectations are being overvalued in the marketplace today. Considering an onslaught of new, underperforming restaurants, the cost structure of the company is deleveraging. This, coupled with increasing food and labor costs, likely means that more margin deterioration is on the way – precisely what the street is missing.
- Trading at 33x consensus NTM EPS, CHUY is currently one of the most expensive publicly traded casual dining stocks. The company has maintained a premium valuation despite declining AUVs, returns and consensus EPS estimates. Furthermore, we believe 2014 and 2015 earnings estimates are too high, which would imply this 33x multiple is closer to 39x by our estimates. We see 30-40% downside in this name and believe 3Q14 earnings will be the catalyst the shorts are looking for.
CHUY has been on our Long Bench for the majority of 2014, until recently when we spotted several disconnects between the street’s expectations and reality. For this reason, we believe the current issues the company faces will take longer to correct than most are giving them credit for. At 39x NTM EPS, we believe there are too many risks in the current business, and the future of the business, to support such a multiple. Importantly, we believe 3Q14 earnings will be the downside catalyst shorts are hoping for.
Our short thesis focuses on the following:
- Disappointing new unit productivity
- Cash burn necessitates the current new unit growth rate
- Rampant support from the biased bulls (read: high expectations, aggressive estimates)
- Significant insider selling
- Strong sell-side sentiment and unjustified premium multiple
- Significant food inflation (dairy, beef, avocados, produce)
- Overly optimistic consensus food and labor cost assumptions in 2H14
- A lack of leverage in the business model considering higher year-over-year G&A, D&A and pre-opening spend
- Aggressive 2H14 and 2015 EPS estimates
- Approximately 30-40% downside to the name
We’re in the early stages of this earnings season and, so far, we’ve seen bigger casual dining chains posting slightly stronger sales trends than a year ago. While this trend is important to consider, some of this sales growth is coming at a significant cost to margins. To that extent, Wyman Roberts, CEO of Brinker, recently said on the company’s earnings call: “If you look at NPD numbers 12 months rolling August, the category hit the highest deal rate that it’s ever hit, and some players in there are reaching some pretty aggressive numbers.”
So while gas prices may be helping the macro picture, it’s undoubtedly difficult to gauge the impact that increased discounting is having on several players in the industry. What we do know, however, is that discounting is never good for margins.
Chuy’s looks to be one of the promising companies that can beat on the top-line, however, we suspect it will miss on margins and earnings. The bulls on CHUY will likely point to stronger industry trends and the unexpected price increase management enacted sometime in September (we believe) to help mitigate the margin pressure the company is facing. While both of these may likely occurred in the quarter, it will not be enough to save it.
The underperformance of new units, in addition to lower margins, puts the company in a difficult spot, increasing the need for the company to tap the capital market in order to deliver on aggressive unit growth plans. Over the past 12 months, capital spending has grown by 29%, while the cash burn has more than doubled to $12 million.
From a sentiment standpoint, one issue of concern on the short side is the 18% of short interest. The average casual dining chain is running closer to 9.8%, so Chuy’s issues are fairly widely known. Given the massive declines we’ve seen in restaurant stocks this year (with higher short interest) and the fact that insiders have been selling shares faster than gazelles, we believe the short side is a much better place to be.
We look forward to sharing more with you on the call.