EAT – HOLDING FIRM

Despite Keith’s selling of EAT in the firm’s virtual portfolio, we remain confident in the long-term opportunities for Brinker shares. 

 

By now, many of our subscribers are aware of our unique process at Hedgeye that marries Keith’s macro and quantitative views with our company-focused fundamental perspective.  While Keith’s move here is primarily predicated on his broader view of the market, we want to reiterate that our fundamental, long-term view on Brinker shares and the company’s turnaround efforts at Chili’s remain unchanged. 

 

Specifically, Keith provided the following perspective on his move to sell EAT in the portfolio, “I'm going to take the loss here and sell the stock on an up day. Penney remains bullish for the long term here but is becoming increasingly negative on competitor balance sheets like DIN.”

 

I would agree with Keith that the MACRO environment will remain challenging in the near-term and overleveraged balance sheets will only magnify those challenges for certain restaurant companies, like DIN, but I would actually point to DIN’s balance sheet issues as a positive for Brinker.  As I outlined in my EAT Black Book, Brinker has a strong balance sheet and one primary reason I think the company will outperform in these challenging times, in the more challenging Bar and Grill segment, is that its largest competitor (DIN’s Applebee’s) does not have the financial capability to compete.  And, as I said earlier this week, I continue to believe it will be important to focus on those companies that are being proactive and creating leaner, more efficient cost structures as they will be better positioned to mitigate margin erosion in a tough sales environment.  To that end, EAT is one name that is pursuing a proactive strategy and remains a core focus name. 

 

To be clear, when I became more vocal on the reasons to own EAT, I stated that sales trends through the end of fiscal 2010 would be choppy as Chili’s attempts to decrease its reliance on aggressive discounting (and move away from “3 Courses for $20) and as customers adjust to the significant menu changes at the concept.  That being said, management’s efforts to revitalize the brand from both the retail and manufacturing sides puts the company on track to post significant margin growth at about the same time top-line trends should begin to recover, beginning in FY11; though I think the margin story will materialize even without a significant tick up in trends.

 

There seems to be a lot of confusion among investors about the timing of implementation for POS, KDS and kitchen retrofits and the subsequent 500 bp margin benefit (net 400 bps after depreciation) forecast to materialize by the end fiscal 2013, but management said very specifically at an investor conference this week, “So we do think more than half of the 500 basis points of margin improvement will be in place by the end of fiscal 2011.”  I do not think most investors were forecasting this level of growth in FY11 and management’s comment only strengthens my conviction that the street’s FY11 EPS estimate is too low.

 

Management seems confident about its potential earnings growth in the next two years.  EAT’s 5-year target to double EPS by FY15, off of the $1.40-$1.44 base, with 10%-12% EPS growth in FY13-FY15 implies 40% to 50% EPS growth from FY10 to FY12. This two-year target assumes 1% to 2% same-store sales growth, which seems achievable; though it does it rely on sequentially better 2-year trends going forward.

 

I am comfortable saying again what I wrote on April 20th, following Brinker’s fiscal 3Q10 earnings call, “I know things don’t happen in a straight line and there will be bumps in the road, but I want to be a little early on this one.  Once it gets going, it’s gone…”

 

Howard Penney

Managing Director


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