Description

Recent multiple expansion has caused Brinker to appear asymmetric to the short side. With a 2/3rds company-owned mix following recent 116-unit Chili’s franchisee buy and PF 3.9x net leverage, EAT is a levered way to express negative view on casual dining (CDR) space which faces multiple secular headwinds and is potentially in early stages of being more thoroughly disrupted. Thesis suggests CDR SSS moderate in 2H19 and beyond on fiscal policy lap, past-peak cyclical dynamics and re-emergence of underlying secular headwinds. Company-specific laps including “giving more for less” and off-premise push also suggest F19 SSS improvement to prove transitory. 

Given hefty operating and financial leverage, an inability to hit seemingly aggressive F20 (June) guide would likely put $30-32 in play (7x F20 EBITDA; every turn $10/share) with further downside potential on any stiffening in cyclical and/or secular headwinds. And with above-target net leverage, elevated refurb-cycle cap ex and real estate already largely monetized, historical aggressive fin’l engineering appears more limited as an offset to deteriorating FCF trends (share repo paused 2Q F19).

EAT was written up short on VIC in Jan 2018 or F3Q 2018 and much of prior thesis including eroding Chili’s brand value and deteriorating cash flow dynamics remains valid. But F19 results better than expected on 1/ positive traffic inflection (category uplift on fiscal policy relief, heavy promos including 3 for $10 and To Go mix shift); 2/ tax rate relief from 21% to 10%; and 3/ continued aggressive financial engineering including $448M sale lease back enabling another -16% reduction in share count. 

Updated view suggests waning fiscal-policy uplift and tough laps (i.e. 3 for $10 in F1Q, To Go +23% in F19) cause fund’ls to mean revert and narrative to shift back toward eroding brand value and secular headwinds including 1/ zero-sum, price-driven legacy CDR competitive landscape; 2/ over-stored CDR backdrop; 3/ diminished occasion frequency i.e. trad’l retail disruption; 4/ shifting consumer consumption patterns in favor of more convenient and healthy options; 5/ eroding brand value/decreasing relevance amid steady emergence of even more non-trad’l competition including cost-advantaged dark/ghost kitchens; and 6/ ongoing margin pressures especially labor which also presents operational challenges. Recent 4Q results supportive as Chili’s traffic inflected negative (-0.5%) after four consecutive quarters of gains and in-line results only made possible by Chili’s carrying +3.9% price vs +1.5-2.0% target.

Catalysts incl 1/ SSS miss vs F20 guide of +1.75-2.5% (vs +2.1% in F19) which assumes two-year company-owned SSS accelerate to +4% from +1% on +400bps tougher stack; and 2/ lower RL margin vs guide of -20bps to flat on SSS shortfall, delivery less incremental and/or franchise-buy underperformance. 

Risks include delivering against F20 guide and bearish positioning (30% SI). Worth noting outsized price in F4Q expected to “normalize in next couple of quarters.” While SI hefty, suspect large portion is in strong hands given outlook/downside potential. Further fin’l engineering possible (i.e. Maggiano’s sale) despite evidence of limits. Risk of sale seems modest given company-owned model, largely monetized real estate, deteriorating OCF trends and leverage. Carry a consideration given 3.5% dividend yield.    

Brinker is a $3.1B EV casual dining restaurant operator comprised of two brands Chili’s Grill & Bar and Maggiano’s Little Italy. EAT is primarily a play on Chili’s which is close to 90% of revenues and profitability PF for the recent acquisition of 116 franchise units. Following this acquisition company-owned/franchise mix is 67%/33% with franchise mix declining from 45% 5 years ago. Occasion mix is 87% dine in, 12% to go and 1% delivery and EAT signed an exclusive delivery partnership with DoorDash on Jun 11 (estimated mid-teens take rate). The company is based in TX which comprises 22% of company-owned units (FL 14% and CA 12%). 

The company’s articulated total shareholder return algo is +5-7% organic growth (+1.5-2.0% SSS; +0.5-1.0% capacity), 2-3% dividend yield, 6-8% share repo for total return of 13-18%. This compares with +1.9% company-owned 5-yr revenue CAGR on -0.3% avg SSS and +0.3% capacity growth adjusted for 103-unit franchise acquisition in F16.

Cash returned to shareholders has exceeded FCF year since F11 but share buybacks inactive since 2Q F19. FCF has been deteriorating from F16 peak and company is in second year of elevated cap ex of ~$150M owing to multi-year refurb program comprising 240-250 annual re-images. Street forecasts positive inflection in multi-year declining FCF trend in F20.

Recent Results

F4Q results were mixed (SSS miss, in-line EPS) while F20 guide above consensus. Better F20 guide on forecast acceleration in SSS (+1.75-2.50% vs F19 +1.5%) despite F4Q miss on negative traffic inflection, stiffer laps and decelerating industry backdrop. Chili’s price accelerated to +3.9% above target of +1.5-2.0% and is expected to “normalize over the next couple of quarters.” Notable that RL margins were guided -20bps to flat despite +2% SS at MP. F19 FCF of $123M (adding back tax on sale leaseback) -30% y/y and missed guide of $165-175M. Franchise attrition accelerated (F19 net units -3.6% vs F18 +2.7%) and F20 cap ex guide down y/y at $140-150M despite guided acceleration in F20 company-owned openings from 4 to 10. Buy in of 116 franchise units closed Sep 5 and is included in F20 guide. 

Risks

Proving out ability to hit F20 guide

Bearish positioning

Outsized leverage-driven variability

Even more aggressive fin’l engineering

Catalysts  

Mean-reversion in Chili’s traffic trend

SSS miss

Guidance cut

Evidence of heavier promo activity 

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Catalyst

Mean-reversion in Chili’s traffic trend

SSS miss

Guidance cut

Evidence of heavier promo activity