Description

Investment Viewpoint: In the consumer sector, with market sentiment having shifted from the euphoria over re-opening trades being overridden by worries of wage and food inflation and now with the investor fear/greed gauge moving to “Defcon 4” regarding a potential recession looming ahead, we have a contrarian idea for those brave investors who look at times like these to look for beaten-down opportunistic ideas that Mr. Market is mispricing for some reason. With the COVID tide now receding, we are seeing a divergence in the consumer sector between those companies whose sales growth and/or margins were temporarily lifted by the increase in disposable income from stimulus and out of office free time and are now mean-reverting and those companies that have made structural improvements to their business model leading up to and accelerated during the pandemic that are sustainable. We believe that Bloomin’ Brands (BLMN) is an example of the latter. The structural changes at BLMN include customer-facing improvements resulting in more consistent SSS comps, both 4-wall and corporate cost reductions & efficiencies translating into about a 250-300 bps margin improvement as well as deleveraging its balance sheet. Given the groundswell of industry and general macro concerns overhanging the markets, the company’s durable structural changes have been unrecognized by investors. The shares have been caught in the sector downdraft and been sold off indiscriminately to below pre-pandemic valuations resulting in the current market opportunity.

Consensus profitability estimates for FY22 are now factoring in a lower reset from FY21 due to the negative impact of higher food and wage inflation. However, due to the structural changes BLMN has made to its business model and balance sheet pre & during the pandemic, the company’s FY23 normalized EBITDA should track almost 50% above FY18/19 levels and EPS about 85% ahead of the same period. Despite the improvement to the quality of its business and the higher normalized profitability, on an absolute basis the shares are now selling at par with its average pre-pandemic (lower profitability & higher leverage) share price level while its EV/EBITDA multiple of 4.7x is below its historic range of 6.5-7.5x and its P/E of 8x is below its pre-pandemic range of 10-13x. Relative to casual restaurant comps, while BLMN has been among the companies to show the highest increase in profitability versus pre-pandemic levels and now has above industry average profitability, its shares are currently valued at the very bottom of the comps and about one-half the industry average based on calendar 2023 EBITDA and P/E multiples. 

Thus, the current share price discount to its comps suggests that BLMN is trading like the lower quality company that it used to be in the past, not the company it is today. Given the improvements to BLMN’s SSS growth, overall profitability and lower leverage, we believe this will translate into a re-rating of the stock. While we would not argue that the valuation should be on par with higher quality companies like Darden (DRI) and Texas Roadhouse (TXRH), which have been accorded EV/EBITDA multiples of 10-12x, we believe some upside to BLMN’s current bottom basement multiple is now warranted. We believe this margin reset could be realized over the next 12-18 months with consistent healthy execution and growing evidence that the improvements to its margins are durable. We suggest that a re-rating to 7x-8x multiple (which is still a significant discount to the perceived highest quality industry companies) is warranted. Under such a scenario, on FY23 normalized earnings, the shares could trade up to a range of $37-43/share, or upside of 80%-110%. 

We do not discount the risk that should the economy enter a recession, there will likely be some negative pressure on BLMN’s SSS comps and profitability. However, while no recession is the same, looking back at recent prior recessionary periods shows that the casual dining sector has fared relatively better than other sectors (QSR & fine dining) and applying the average sector impact of declines in SSS and margins recorded by the casual dining sector during the 2008/09 “great depression” to BLMN’s FY21 results shows profitability will still meaningfully exceed pre-pandemic FY19 levels. While the negative sentiment macro trade could overshoot the real risk to earnings resulting in some further near-term downside to the share price, this analysis suggests that investors are already pricing into the shares of BLMN a recession with a revert in profitability back to or below FY19 pre-pandemic levels.

Company Background: Bloomin’ Brands, Inc. is one of the largest casual dining restaurant companies in the world with a portfolio of four, differentiated core brands: Outback Steakhouse, Carrabba’s Italian Grill, Bonefish Grill, and Fleming’s Prime Steakhouse & Wine Bar. Between these brands, BLMN manages over 1,450 restaurants across the United States (in 48 states, Puerto Rico, and Guam) and 19 other countries. Of these, there are approximately 1,150 company-owned and 300 franchised locations. Additionally, BLMN operates nearly 50 off-premises kitchens—primarily in South Korea.

Bloomin’ Brands was founded in 1988 (originally as Multi-Venture Partners, Inc.) with the launch of its first restaurant under the Outback Steakhouse brand. In 1991, the company went public as Outback Steakhouse, Inc. before later being taken private in 2006 by Bain Capital and Catterton Partners. After a few years as a private company, Bloomin’ Brands, Inc. completed its second IPO in 2012 at a price of $11.00 per share under the leadership of CEO Liz Smith.

 Four Differentiated Brands: BLMN has four differentiated brands, but the clear focus of investors is Outback Steakhouse which is the foundation brand in the company’s portfolio and as illustrated below accounts for about 68% of overall revenues.

Outback Steakhouse was founded in 1988 with its first location in Tampa, Florida, as an Australian-themed casual dining restaurant. Outback is the strongest of the four core brands with about 60% of BLMN’s company-wide restaurant sales and 894 locations across its international and domestic operations.

 Carrabba’s Italian Grill was originally founded in 1986 with several locations around Houston, Texas. In 1995, the Carrabba’s brand was acquired by Outback Steakhouse, Inc. a few years after a joint venture between the companies. In 2021, the brand consisted of 219 domestic locations and yielded approximately 15% of company-wide restaurant sales.

 Bonefish Grill is a seafood restaurant first founded in 2000 with a location in St. Petersburg, Florida, and then acquired in 2001 by Bloomin’ Brands, Inc. to further differentiate its casual dining offerings with 185 locations and nearly 15% of company-wide restaurant sales.

 Fleming’s Prime Steakhouse & Wine Bar is the fine dining offering of the Bloomin’ Brands founded in 1998 with locations in Newport Beach, California. As a more premium brand, its 64 locations represent a smaller portion of the Bloomin’ footprint, but still provides nearly 10% of company-wide restaurant sales.

International Strategy

Bloomin’ Brands has grown its international presence over the last ten years with expansions targeted primarily in Latin America and Asia, with Brazil and South Korea serving as the anchors to their respective regions, where the company intends to operate with a smaller footprint than it does domestically. Additionally, BLMN has gradually expanded into Canada, Mexico, Australia, and Saudi Arabia with a strategy similar to theirs in the United States.

 The Outback Steakhouse presence in Brazil contributes over 8-10% of overall Outback sales and represents its largest international partner. This has given momentum to the company’s launch of the Abbraccio brand in Brazil, which is its localized version of Carrabba’s Italian Grill.

In South Korea, BLMN uses smaller formats of its restaurants and more off-premises kitchens to grow its franchise base and establish a proof-of-concept for success in Asia. Over time, the company has expanded its Outback brand into China, Japan, Indonesia, Malaysia, Thailand, and the Philippines with success.

Past Structural Changes Are The Foundation For BLMN’s Improved Business Model:  Much of BLMN’s current strategic positioning is a product of over a decade of internal development under the leadership of both Liz Smith and David Deno. While Liz was CEO, the company entered its second IPO in 2012 with the goal of rapid unit growth driving its top-line metrics. This led to large amounts of investment to build its infrastructure to support a greater number of units. Unfortunately, this strategy did not play out and resulted in a period of underperformance in the 2015-16 period pressured by increased competition in the casual dining sector resulting in greater discounting and weak SSS comps. In reaction to these problems, the company’s strategy began to shift somewhat. Management’s focus shifted from unit growth initiatives to enhancing the guest experience and improving the customer experience, especially at the flagship Outback Steakhouse brand. Additionally, initiatives already in place focused on improving the corporate digital platform and delivery capabilities and enhancing the customer loyalty program were put in place. In late 2016/early 2017 Gregg Scarlett took over as President of Outback and instituted a complete top-to-bottom review of the brand and then instituted a series of changes to improve the customer experience and business model. For an interesting read of the changes instituted under Gregg Scarlett, I would recommend reviewing his comments from the company’s May 11, 2019 Investor Day. 

In 2019, David Deno was promoted to CEO after some time as the company’s CFO. Under Deno, BLMN continued with a number of measures to enhance the guest experience and invest in third-party delivery options to grow off-premise sales. Additionally, under his leadership, there was an emphasis on going “back to basics” along with more of a shift and focus on improving the profitability of the individual restaurant brands and lowering corporate G&A costs. At the company’s 2019 Investor Day, management laid out a strategy of improving adjusted operating margins by 250 bps to 7% over the next couple of years. Further, management announced a $50 million investment in operations and employee experience; including detailed customer analytics, the use of new technologies in its kitchens, accelerating its move to digital & take-out, and improving labor management. The company’s initiatives consisted of lots of incremental measures, none of which on their own move the needle, but when combined together they have made a notable impact on overall margins. Additionally, with better knowledge of its customer base and improvements in food quality, BLMN has been able to spend marketing dollars more efficiently and get out of the game of using consistent promotional activity to drive increased traffic/sales.

Parallels can be drawn between many of the actions and initiatives that BLMN began instituting at the time and actions that Darden took prior to this time in reaction to pressures after activist investors Starboard Value took a position in the company in 2014 and pushed for major changes at the company. Given the successful transformation that Darden accomplished beginning in 2015/16 resulting in significant margin and multiple expansion, this was likely a role model for many of BLMN’s initiatives.

Leading up to and accelerating during the pandemic, many of the company’s initiatives began to really take hold allowing BLMN to outperform its casual restaurant peers and achieve its margin targets. Noteworthy, off-premise sales have proven to be a significant tailwind for the company coming out of the pandemic, appear to be sticky, and represent a source of incremental sales for the company which should help its SSS comps. For example, prior to 2019, roughly 15% of restaurant sales were off-premise. During the pandemic off-premise peaked at 45% of sales and has now stabilized at a rate of about 30%, or double pre-pandemic levels. As illustrated in the below table, BLMN's off-premise sales mix has grown to a level where they have consistently outperformed other casual restaurant comps.

With the reduction in labor costs offsetting fees from third-party services, margins on off-premises are comparable to dine-in margins. In addition to customer-facing initiatives, part of their success was due to new payroll management systems which allowed the company to pay their employees throughout lockdowns, therefore allowing them to resume operations much more smoothly than their peers.

Due to the combination of improved sales trends, higher AUV’s and various improvements to both 4-wall and corporate cost reduction and efficiency improvements, BLMN has been able to achieve a 250-300 bps improvement in its profit margins from pre-pandemic levels. As compared with other casual restaurants, BLMN has achieved among the highest increase in margins post-pandemic versus pre-pandemic levels. 

While some variability is expected given the impact of food & labor inflation and the timing of price increases, we believe these margins are sustainable. Not one to just stand still the company has discussed and put in place additional initiatives to increase restaurant efficiency which have yet to pay any dividends. For example, investments in new kitchen technologies & equipment such as server hand-helds, kitchen display systems (KDS) new ovens and especially clamshell grills (which allow 2-sided steak cooking simultaneously) will likely improve restaurant-level margins further by dramatically reducing back-of-house labor demands. While something like this may seem mundane, new technologies like these can have a meaningful impact on food waste send-backs and labor efficiency, which is a major restaurant cost center. Given that labor costs comprise about 60% of total restaurant costs, 60% of these costs are back of the house in the kitchens (who receive higher wages) and this technology can reduce kitchen staffing (maybe 6-7 cooks) hours or a cook by about 35%, this adds up to real dollar savings per restaurant. Such initiatives which will roll in during the next 12-24 months like this give us confidence that BLMN’s current margins are sustainable and could offset inflationary factors or macro-economic spending trends.

Post-Pandemic Profitability Is Estimated To Be Significantly Higher than Pre-pandemic Levels: The table below shows the financial history of the company and our current forecast. Noteworthy is that after a period of uneven growth and below industry margins in the years prior to the pandemic, the margin structure and profitability of the business stepped up thereafter due to the various structural changes and investments made in the FY16-19 period. These structural changes included various customer-facing improvements which benefited SSS com’s as well as cost and efficiency changes to both 4-wall and corporate expenses. Note, that some of the margin benefits, especially in the later periods, were masked by the $50 million investment program. 

Our estimates for FY22/23 are consistent with managements guidance as well as sell-side consensus. They also, factor in a temporary decline in margins in FY22 due to the impact of inflationary costs, with a modest improvement in FY23. So, while we do not have a divergent view on future growth and profitability post-pandemic, what is most notable is the growth in profitability in the FY22/23 compared with pre-pandemic levels, using FY19 as a benchmark. As illustrated in the table, FY23 EBITDA is estimated to be up over 40% from FY19 while EPS, aided by lower interest costs and shares outstanding, is forecast to grow about 85% over FY19.

The following chart highlights the roughly 250-300 bps higher inflection in BLMN’s margins, which we believe are sustainable due to the various structural changes in the company’s customer-facing initiatives, 4-wall efficiencies, and corporate cost savings.

Noteworthy, as illustrated below, the increase in BLMN’s profitability is inconsistent with a share price below pre-pandemic levels and 35%-40% below the reopening trade levels of a year earlier.

BLMN’s Bottom Basement Valuation Inconsistent With Improved Profitability & Poised for a Re-Rating Higher: The below table highlights the multiple accorded various casual restaurant shares based on consensus calendar 23 estimates. While there are clearly perceived differences by investors in the quality of individual business, what jumps out to us is that while BLMN has been among the companies to show the highest increase in profitability versus pre-pandemic levels and now has above industry average profitability, its shares are currently valued at the very bottom of the comps and about one-half the industry average based on EBITDA and P/E multiples. 

While we would not argue that the valuation should be on par with higher quality companies like Darden (DRI) and Texas Roadhouse (TXRH), which have been accorded EV/EBITDA multiples of 10-12x, we believe some upside to BLMN’s current bottom basement multiple is now warranted. We believe this margin reset could be realized over the next 18-24 months with consistent relatively healthy execution and growing evidence that the improvements to its margins are durable. We suggest that a re-rating to 7x-8x multiple (which is still a significant discount to the perceived highest quality industry companies) is warranted. 

Such a possible upward re-rating in the shares of BLMN following its improvement in margins would not be unique and would follow somewhat of a similar path to Darden. Following a push from activist Starboard, and under the leadership of a new CEO, the company sold its Red Lobster brand and focused on improving its margins in its Olive Garden brand in the FY15/16 period. Olive Garden, somewhat similar to BLMN’s Outback Steakhouse, was a somewhat mature brand. The following chart from a recent Jefferies report highlights the positive changes at BLMN in its SSS performance versus a peer group average and margins and with comparisons to similar improvements in the past at Darden.

Source: Jefferies

As illustrated below, following Darden’s success in improving its growth and margins, the valuation of the shares rose from about 8x in 2016 to about 12x in 2019. Thus, it would not be unprecedented to see an upward re-rating in the valuation of BLMN as a result of its success on both metrics.

BLMN’s Re-Rating Should Translate Into Significant Share Appreciation: The disparity relative to BLMN’s reset in profitability to higher levels, the deleveraging of its balance sheet, and the recent improvement in the consistency of its SSS comps all argue for a commensurate reset in the company’s multiple. As illustrated in the below table, assuming our assumption of a re-rating to a 7x-8x multiple on FY23 normalized earnings the shares could trade up to a range of $37-43/share, or upside of 85%-120%, in 12-18 months. A modest dividend yield of 3%, which we believe has little risk, adds to the return potential and is attractive for certain investors.

Brazilian Operations Not Accorded Any Value: BLMN’s operations in Brazil contribute roughly 8%-9% of overall revenues. While a relatively small part of the overall revenues they appear to provide higher profitability; albeit heavily influenced by swings in f/x rates. Noteworthy, over the pre-pandemic years, SSS comps have trended above corporate average and our understanding is that pre-pandemic, Brazil contributed about $30 million in EBITDA. Despite this, we do not believe they are being accorded any value by investors in the current share price as all the focus has been on the COVID shutdowns in the country.

With the country in the process of re-opening, we suspect that there will be a good amount of pent-up demand to return to in-person dining rooms as we have seen in other late opening countries such as Canada. As recently seen in Q1/FY22 results, a rebound in sales and profitability is likely in the near future, which could exceed pre-pandemic highs in both cases. This rebound in sales and profitability in Brazil should provide a little tailwind to profitability growth in FY22/23.

Additionally, in speaking with various industry experts, we understand that in the past the company turned down an offer of $400 million to sell the division, which equated to a double-digit valuation. While we do not believe management is interested in selling these operations in the near future (to capture the post-pandemic rebound), a future sale should be additive to shareholder value, including using proceeded to further de-lever the balance sheet.

The Biggest Risk Is A Recessionary Macro Environment:  Like any business BLMN faces a number of general execution and competitive risks. For any discretionary consumer business, macroeconomic factors have an impact on sales and profitability. With concern growing that the US is at risk of entering a recession, this risk rises to the top of the list and is clearly a major overhang to the share price. So, while I am not an economist, let me try to address this risk with some thoughts. Economists always say no recession is the same and a possible 2nd half 2022 or 2023 recession would be no different. Clearly, any recession would impact consumer discretionary income and sales for any restaurant company. Likewise, the impact of lower AUVs and overhead, as well as the likelihood of increased competitive pressures would pressure margins somewhat. This scenario would translate into a period of reduced earnings forecasts, which appears to be somewhat already discounted in the current share price. On the other hand, there are a couple of countervailing factors to consider. For example, what makes this recession different is that it would be following a period of pent-up demand from lockdowns, some of which have reopened relatively late. Additionally, as compared with the 2008/09 great recession, restaurants are underbuilt due to shutdowns during 2020/2021 whereas they were oversaturated in 2006-2008 leading up to the GFR. 

As discussed above, the re-opening of Brazil will provide some counterbalancing positive impact on BLMN’s sales. Also, most current reports indicate that the balance sheets of most prime target market customer base of casual restaurants are in healthy shape. Wage rates are also higher and the increases in grocery prices reduce the gap with spending to dine out.

In speaking to a restaurant industry expert on this issue, we took note of some interesting points which I will share. In prior downturns, Both QSR and fine dining sectors tend to feel the impact of macro downturns earlier and are impacted more. Noteworthy, the ending of government stimulus would be more impactful on QSR restaurants, which cater to lower-income customers. Looking back to the dot com bust, casual restaurants grew right thru the period, albeit slower, with positive comps. During the “great depression” of 2008/09 all sectors, including casual dining were impacted. Within the casual dining sector during what was probably the most severe recession in many decades, casual dining SSS comps declined peak-to-trough 2006-2008 about 200-300bps and EBITDA margins about 150bps. 

In a very general analysis, applying these dynamics to BLMN’s FY21 results would show an EBITDA decline of about 16% to $450 million, which would still be above FY19 levels. Given the 35%-40% decline in the share price from about a year ago, we believe this would suggest that investors have already priced in a possible decline in BLMN’s profitability due to inflationary and recessionary factors. 

Conclusion: We believe that at current levels the shares of BLMN are attractively priced and offer a very favorable risk/reward ratio as the structural and durable improvements to the company’s business model have not been recognized by investors, which should result in a re-rating of its valuation, while macroeconomic fears of a combination of both inflation and recessionary factors have already been overly discounted in the stock price.

Catalyst

• Continued healthy SSS growth.
• Delivering FY22 financial results consistent with management guidance.
• Showing that the current increase in profit margins and earnings are sustainable.
• A further reduction in leverage.
• Ratings increases by sell-side analysts.