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Key Takeaway

Brinker is a great company, but we fear it is becoming a victim of its own success.  As it stands, the 16% earnings growth on 4.4% sales growth that consensus expects in FY16 looks aggressive to us, particularly with industry sales and traffic rolling over.  We don’t see how they hit these numbers and expect estimates to be revised down as the year progresses.


Earnings Recap

Brinker kicked off restaurant earnings season this morning with a disappointing 3Q15 print, as same-store sales and traffic fell short of consensus estimates.  Despite the soft top line, EAT managed to deliver in-line EPS of $0.94 due in large part to lower than expected other operating and G&A expenses.  During the quarter, management repurchased 1.7 million shares of common stock for $104.2 million and paid a $0.28 dividend.  The stock is trading down on the day, with the majority of the casual dining group following suit.

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Soft Comps Are Concerning

After years of operating margin expansion driven by strategic investments within its restaurants (new kitchens, POS systems, fryers, tabletop tablets, remodels, etc.), the brand is entering a phase that will depend on top line trends for incremental leverage.  Despite the recent menu innovation around the Fresh Mex and Fresh Tex platforms, we haven’t quite seen the bump in sales or traffic that most were expecting.  Traffic declined -0.2% in the period, though it was +0.6% adjusting for the Christmas shift, and has now been negative in eight out of the past ten quarters.  While Chili's same-store sales continue to outpace the industry, according to Knapp, its gap is narrowing.  Management attributed this to the aggressive price increases competitors are taking and noted that consumers historically tend to push back once pricing reaches the 3% range the industry is currently running at.  EAT took +0.8% pricing in the quarter and plans to take an additional +1% price increase in mid-4Q in order to offset some of the commodity pressure (burger meat, fajita beef, salmon) they are seeing.

Food & Loyalty Are The Future

While soft comps are concerning, management is betting that initiatives taken to enhance the menu will ultimately prevail and drive future growth.  They expect the Fresh Tex menu to begin to resonate with consumers as they educate the market place on what exactly it is and plan to continue to leverage the Fresh Mex menu given its high profit margins.  Chili’s also eliminated a number of low selling items from the menu, in an effort to streamline operations (improve speed of service, food delivery temperature, etc.).  Management believes it has made, and will continue to make, the proper investments on the technology front (Ziosk, NoWait) in order to drive traffic in the future.  Loyalty, in particular, will be critical moving forward and EAT now has the technology in place that they can leverage to support this effort.

The Earnings Algorithm Is Changing

It’s clear to us that the fundamental earnings algorithm of the company is changing.  A model that once heavily relied on a seemingly endless stream of strategic operational improvements to increase margins is now transitioning to one dependent on sales and traffic growth.  This concerns us given recent trends and will continue to heading into FY16.  Loyalty could ultimately be the top line driver the company has been missing, but we suspect ramping up the program will take longer than most suspect.  Brinker is a great company, but we fear it is becoming a victim of its own success.  As it stands, the 16% earnings growth on 4.4% sales growth that consensus expects in FY16 looks aggressive to us, particularly with industry sales and traffic rolling over.  We don’t see how they hit these numbers and expect earnings estimates to be revised down as the year progresses.

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