Happening in 10 minutes | EAT | Black Book Presentation

10/20/20 01:48PM EDT

We continue to believe that the current market environment favors the restaurant more prominent players, especially in the casual dining space.  We will run through several reasons we like Brinker, but many of our views can be applied to several companies in the space.  As a result, we are also adding TXRH to the best Idea long list as well.  

Fundamental Reasoning to be LONG EAT:

ACCELERATING/DECELERATING SAME-STORE SALES

Is it that simple?  Do fast money and retail investors care about acceleration and/or deceleration in same-store sales?  What we have learned coming out of the pandemic is that the absolute level of same-store sales is less important than the rate of change (i.e., are sales recovering).  The role of day traders trading on just headlines can substantially impact security prices, and it is not for just a few hours.  For the balance of the next six months, most companies will see a positive direction rate, while a few will see slowing trends.  Others have expectations that appear to be too aggressive, given structural changes to consumer spending behavior.

IT'S JUST WINGS

The company's blockbuster news came with its announcement that in 6 months, it has created a new "ghost kitchen" brand, "It's Just Wings," and rolled it out to over 1,100 company stores.  The brand has the potential to do $150 million in revenues in the first year in business.  To put this in perspective, in 2020, WING is estimated to do $1.9 billion in systemwide sales over 1,500 stores.  The simplicity of cooking wings allows the new brand to leverage existing buildings, equipment, and labor. The company commented that even after aggressive pricing and marketing, serving quality ingredients and packaging, and paying the last-mile logistics partner fees, its generating strong incremental cash flow.  The new offering's impact is such that 36% of company-owned Chili's restaurants ran positive comp sales over the past month.  In total, off-premise meals have grown from low teens to more than 50% in the fourth quarter, with only a slight dip as dining rooms reopen.  The CEO did mention the possibility of doing a second "ghost" concept, but that is getting ahead of reality.  There is more work to do to see how this plays out, but the potential is a complete game-changer.  The momentum suggests that EAT can beat sales estimates over the next six months.  

OPERATING MARGIN LEVERAGE

The real leverage to the EAT story will come from more efficient operations as sales recover.  In 4Q20, the restaurant operating margin was 6.4% as sales improved during the quarter margins improved to 12.2% for the June period, which is just 100bps below 2019 levels.  Assuming an improving operating environment, the company is set up for additional margin improvement. Management identified efficiencies, further opened dining room capacity, and leveraged sales from It's Just Wings.

BALANCE SHEET GETTING BETTER

Coming into the pandemic, EAT had too much leverage.  Lesson learned.  In the future, I suspect that strengthening the balance sheet will be an essential part of its financial strategy, and debt reduction will also benefit the equity.  The equity offering done in 2Q was slightly negative (raising approximately $139 million). It was used to pay down the revolver.  Currently, the overall total debt stands at $1.194 billion, reducing $234 million from the end of 3Q20.  The revolving credit borrowing stands at $473 million, with the facility now maturing in December 2022.

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