Del Frisco's Restaurant Group (NASDAQ:DFRG) operates 35 restaurants in 19 states in three segments. Ten Del Frisco's Double Eagle Steak Houses provide the upscale steak house experience with an average check of about $100. 19 Sullivan's Steakhouses provide a side of live music to a quality steak house experience with an average check of about $60. And six Del Frisco's Grilles provide a more fun bar and grill steak house experience, including lunch, with an average check of about $50.
In 2009, the company had revenues of $160M and net income of $8.6M. In 2010, this grew to $166M in revenue and $8.7M in net income. In 2011, this grew to $202M in revenue (+22%) and $9.0M in net income (+3.4%). In 2012, this grew to $232M in revenue (+15%) and $13.8M in net income (+53%).
However, the outlook for 2013 looks to slow down a bit. Adjusted earnings per diluted share jumped from $0.79 in 2011 to $0.94 in 2012, but company guidance is for $0.92 to $0.96 in 2013 on comparable restaurant sales growth of 1.5% to 2.5% (4.2% in 2012). On the bright side, the company expects long-term EPS growth in the 18% to 20% range, based on 8% to 10% unit growth and 3% to 4% comparable restaurant sales growth.
Adding New Restaurants
DFRG added two Del Frisco's Double Eagle Steak Houses, in Boston and Chicago, as well as three new Del Frisco's Grilles, in Phoenix, Washington D.C., and Atlanta, in 2012. The company's main focus in 2013 is on adding Grille restaurants. One Grille was opened in Houston in the first quarter of 2013, another will open in Santa Monica, CA, in the third quarter, and three more are planned to open in Palm Beach, FL, Fort Worth, TX, and South Lake, TX, in the fourth quarter of 2013. The company plans to expand its footprint by 10% annually going forward.
Del Frisco's Double-Edged Sword of Growth
On the positive side, each new restaurant adds to total revenues and profits. In addition, cost of sales are lower with the Grille restaurants than the other two concepts, so each new Grille that is added reduces the total company cost of sales percentage, which is looked on favorably by the stock market. Total company cost of sales run at 30.8%, driven by 31.5% at the Double Eagles, 30.8% at the Sullivan's, and 28.1% at the Grilles. This is a key part of the strategy in the company choosing to make all of 2013's new openings consist of Grilles, and 2014 is likely to continue that idea. Management stated on the conference call last week that five of the six new Grille restaurants are outperforming their initial performance projections.
On the negative side, the Double Eagle in New York City accounted for 18% of total company sales in 2011. That is one restaurant, out of 34 at the time, driving 18% of total sales. More importantly, that one restaurant has margins and profitability that give DFRG a significant portion of its competitive advantage. The Del Frisco's other than the one in NYC have operating expenses that run close to 50.5%. That is pretty much in line with publicly traded competitor Ruth's Chris (NASDAQ:RUTH) at 52% and Morton's (NYSE:MRT) at 54%. That, combined with food costs of around 31% for all three companies, yields margins net of those expenses of around 15% for Morton's, 17% for Ruth's Chris, and 18.5% for Del Frisco's non-NYC restaurants.
However, the NYC Del Frisco's has operating expenses closer to 19%! Adding in similar food costs of around 33%, this restaurant produces margins net of those expenses closer to 48%, more than double any of the three above. With an 18% weighting on that 48%, the total company weighted-average jumps to well over 20%.
The problem is that each new restaurant opened by DFRG reduces the weighting on the outsized margins provided by the NYC Del Frisco's, something that is looked on less favorably by the stock market. Therein lies the double-edged sword of growth facing DFRG.
DFRG chose an unfortunate moment for its IPO. The offering had an initial expected pricing of $14 to $16, but went public on July 27, 2012, into the peak of fiscal cliff fears, which took the offering price down to $13.00. The stock traded down to $12.00 that first day, then rallied back to close at $13.00, but was still considered a disappointing debut. In the nine months since then, the stock has traded as low as $11.73 and as high as $19.00, and currently sits at $18.41, a much less disappointing 42% above its IPO price.
Prior to the IPO, the company was majority owned by private equity group Lone Star Fund. The IPO took 31% of the company public. On March 13, 2013, Lone Star sold another 23% of the company in a secondary offering priced at $17.00 per share.
First Quarter 2013 Results and Outlook
The quarterly report for the first quarter of 2013 on the morning of April 30th was a mixed bag. Earnings per share were in line with estimates, although down from the prior year's quarter, while revenues were up 13%, which was a slight beat, however, comparable restaurant growth came in light at minus 0.5% -- opposite guidance of a 1.5% to 2.5% increase in 2013. The company stated that first quarter had started out slower than expected, but March had picked up considerably and that momentum had continued into April (DFRG's fiscal quarter ended on March 19th). Due to that improvement, the company reiterated the prior growth guidance.
The stock opened down 1% following this report, but finished the session up 1.2% to $16.91. However, a larger catalyst would arrive the next day. May 1st brought news of an upgrade to Strong Buy (from Outperform) at Raymond James with a price target of $22. The stock jumped 7% at the open to $18.10, but as the market sold off on May 1st, DFRG fell back to $17.17. However, the market recovery of the next two days saw DFRG trade up to $18.86 before settling into the $18.41 current price mentioned above.
DFRG trades at a forward P/E ratio of 17. This compares to a forward P/E ratio of 17.5 for RUTH. However, DFRG has $11M in cash on its balance sheet and no debt, whereas RUTH has $8M in cash and $45M in debt. One may also want to consider that RUTH jumped 14% to a 5-year high on Friday following an impressive earnings report. Also worth keeping an eye on is that DFRG's guidance for 2013 assumes double-digit inflation in beef prices. This was the case when the projection was made last quarter, but has since reduced to below zero as mentioned by management on its conference call last week, where they used the words "we are experiencing much more favorable cost than we initially anticipated."
Investors should consider the double-edged sword of growth when contemplating an investment in DFRG, as well as the positives and negatives in the company's future outlook. An argument can be made that DFRG deserves a higher valuation than RUTH based on the significant competitive advantage on margins discussed above, and RUTH is up 54% YTD compared to 13% for DFRG.