Solid Restaurant Growth Ahead
Del Frisco's Restaurant Group (NASDAQ:DFRG), the operator of 10 Del Frisco's Double Eagle Steakhouses, 19 Sullivan's Steakhouses, and 11 Del Frisco's Grilles, has the ability to support 170 Grilles in the United States according to consulting firm, Tango Analytics. With average restaurant sales of $5.2 million this represents $676 million in new potential revenue for the company. This would more than triple the company's revenue that it earned in 2013. Currently, there are 11 Grille brand restaurants, so there is plenty of room for growth. I think that this growth will lead to approximately 20% in annual stock gains based on expected increases in revenue and earnings growth.
Del Frisco's would benefit from expanding the Grille brand restaurants for a number of reasons. For one, the Grille restaurants have a lower cost of sales than Double Eagle and Sullivan's. This will allow for the company to expand its margins, thus contributing to higher earnings growth. Another reason is that the Grille concept sells less expensive meals in addition to Del Frisco's prime aged steaks. The lower cost meals are conducive for attracting a lunch crowd to supplement its dinner sales. The Grille restaurants also offer gluten-free meals in response to the growing trend of gluten-free eating.
The company is also seeing a sufficient amount of interested developers for accommodating the Grille concept at their sites. Del Frisco's is planning to open 5 new Grille restaurants in 2014. This could add approximately $26 million to next year's annual revenue.
Another reason that the Grille brand is attractive is because it fits into the mold of international expansion. Currently, Del Frisco's is focused on expanding in the U.S. However, the company stated in its Q1 conference call that it will eventually look to expand abroad. I think that the Grille concept would fit nicely into major cities such as London, Paris, and others. The company's foray into international markets will probably be further in the future as the focus right now is the U.S.
Strategically Placed Restaurants
Del Frisco's carefully selects its restaurant sites for optimal sales, reasonable construction costs, and attractive rents. Placing the restaurants in busy, business-oriented locations that also draw an evening crowd allows the company to benefit from lunch and dinner revenue. Focusing on areas with reasonable construction costs allows the company to get a solid return on its investment. There is no reason to pay too much for construction if an equally attractive site offers a lower cost. Likewise, choosing a site with reasonable rents allows the company to keep costs down. Going forward, Del Frisco's is likely to choose profitable sites, while avoiding the mistake of setting up shop in more expensive situations. Doing this strategically for each site will lead to higher earnings.
Valuation is Fair Based on High Growth
Del Frisco's valuation looks reasonable as compared to other restaurant growth companies. Some of Del Frisco's competitors include: Ruth's Hospitality Group (NASDAQ:RUTH) and Texas Roadhouse (NASDAQ:TXRH). Ruth's Chris Steak House has a similar upscale feel as Del Frisco's. Texas Roadhouse has a more casual atmosphere. My analysis shows that Del Frisco's has the highest average expected annual earnings growth rate of about 20% for the next five years (15% average annual revenue growth + 5% average increase in gross margin). Ruth's and Texas Roadhouse are expected to grow at an average of 15% and 12.6% respectively on an annual basis during the same period. This is based on Ruth's average expected annual revenue growth of 6% + an average gross margin increase of 9%. Texas Roadhouse's earnings growth is based on average expected annual revenue growth of 10% + a 2% to 3% average annual increase in gross margin. Del Frisco's is trading at 15.6 times EBITDA, while Ruth's and Texas Roadhouse are trading at 9 times EBITDA and 10.6 times EBITDA respectively. I think that Del Frisco's deserves the higher valuation because of its higher expected revenue and earnings growth rate. Investors are willing to give Del Frisco's a higher valuation in anticipation of higher growth. With Del Frisco's valuation and growth rate higher than its competitors, I think that the stock will likely trade at a similar pace to Ruth's and Texas Roadhouse.
To compare Del Frisco's to a restaurant growth company with a similar expected growth rate, I looked at Chipotle Mexican Grill (NYSE:CMG). Chipotle is trading at 27 times EBITDA and it has a 5-year expected annual earnings growth rate of 21 to 22%. With an expected growth rate just slightly higher than Del Frisco's, Chipotle is trading 1.7 times higher in terms of EBITDA. This shows that Del Frisco's is valued much more attractively. The reason for this is because Chipotle's is more well-known to investors and has been an outperforming restaurant stock as a result. Del Frisco's is not as popular. Investors have not yet given Del Frisco's a Chipotle's-style premium valuation. Therefore, I think that Del Frisco's stock has plenty of room for growth as the company expands and increases revenue and earnings. However, I don't think that Del Frisco's will get a valuation as high as Chipotle's any time soon.
Another company with a similar growth rate to DFRG is Buffalo Wild Wings (NASDAQ:BWLD). Buffalo Wild Wings is trading at 13.3 times EBITDA and it has a 5-year expected annual earnings growth rate of 20% (15% average expected revenue growth + 5% average annual increase in gross margin). Since BWLD is valued slightly lower than Del Frisco's with a similar growth rate, Buffalo Wild Wings is likely to perform slightly better than Del Frisco's. However, I don't think that Del Frisco's will be too far behind in performance due to its strong expected growth. Overall, Del Frisco's looks fairly valued on the high side, but not valued too high to the point where its performance going forward will be significantly hurt.
Solid Balance Sheet
Del Frisco's has a solid balance sheet with $16 million in total cash with zero debt. This puts the company in a great position for expansion. The company is not weighed down with debt. Del Frisco's has managed the business well using operating cash flow for expansion instead of burying itself with debt. The company has 1.4 times more current assets than current liabilities, which shows that it manages its short-term obligations well. There are over three times more total assets than total liabilities on the balance sheet. This shows the effect of having zero long-term debt, which has the company on solid footing with which to build its business.
Input Costs are a Risk
Del Frisco's input costs are highly levered to the price of beef. Beef prices are expected to increase between 5% and 8% annually. The company is factoring in a higher range of 7% to 9% annually. The good news is that some of this increase will be partially offset by the lower costs associated with the Grille concept. I also think that the company could pass some of these increases onto consumers with updated menu pricing. An extra dollar or two added to a $20 to $25 plate should not have a negative effect on demand in my opinion.
Del Frisco's looks fairly valued in terms of what it has accomplished and what it has the potential to accomplish in terms of future expansion. The company has achieved 17 quarters of positive comparable sales. I think that the company will continue to achieve incremental increases in comp sales as the economy continues to improve, which is likely to bring more customers into the restaurants and make it more likely for existing customers to spend a bit more per trip. The restaurants are placed in strategic locations which are conducive for comp sales increases due to heavy lunch and dinner traffic.
Further supporting the stock is the company's share repurchase plan. Del Frisco's has $6.3 million remaining on its stock repurchase plan. The continuation of stock buybacks through this authorization will make existing shares more valuable for shareholders, thus providing a stable base for the stock price.
The company's expansion efforts for the Grille concept are likely to bring in above average revenue and earnings increases going forward. I think that an average of 15% annual revenue growth along with an average of 5% annual increases in gross margin will produce 20% annual increases in EPS over the next several years. Therefore, I think that it is reasonable for the stock to approximately increase by 20% annually based on valuation and growth as more investors see the opportunity.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.