It's Not The 'Next Chipotle', But Chuy's Is Worth A Look

| About: Chuy's Holdings (CHUY)


Investors have been searching for the "next Chipotle" -- the fast-growing restaurant chain that takes the country by storm.

None of the hyped newer restaurant stocks, such as Noodles and Potbelly, fit that bill, and those who bought early are hurting.

Chuy's won't be the "next Chipotle", either, but it does look interesting -- and worthy of investment if you have a healthy risk tolerance.

Chipotle Mexican Grill has been an appetizing stock to own over the past few years, and opportunistic investors have been offered some terrific entry points after a few poor quarters and worries of slowing growth that now seem silly in retrospect. But with Chipotle (NYSE:CMG) now firing on all cylinders, the stock is again commanding a big premium, with a PE of 60.

With that in mind, investors who like the company but not the current price may be on the hunt for a tastier alternative. While it's not the "next Chipotle" by any means, Chuy's (NASDAQ:CHUY) - another Tex-Mex restaurant chain - offers an interesting option at what could be a better price point.

After the hype
After its 2012 initial public offering, Chuy's had a great run-up, with its share price more than tripling over its IPO price of $13. Chuy's received a lot of hype. So did other restaurant IPOs like Noodles & Company and Potbelly, in part because many investors seemed to be looking for the next Chipotle - that fast-growing breakout restaurant stock that takes the country by storm. Noodles and Potbelly have tanked in the months since, down 47% and 61%, respectively, and it shouldn't be a big surprise. Neither of those companies possess the catalysts that Chipotle does with its lightning-fast operations and "food with integrity" message that permeates all of its endeavors. They also don't offer the uniqueness of a Buffalo Wild Wings, which has really settled into an underserved niche and continues to power forward.

Chuy's is no different in the first regard. But it's sit-down, quirky Tex-Mex eateries that feature a nacho bars built from what look like car trunks shoot to offer differentiation from the run-of-the-mill joints in a growing area of Mexican and Southwestern cuisine. Investors have recognized that potential, and even after the stock's recent drop, it still sits at close to double its IPO price.

What looks good
Between 2009 and 2013, Chuy's grew sales from $69 million to $204 million, a compound annual growth rate of 27.3%. For comparison, Chipotle - a rocketship of a restaurant stock - averaged an 18% GAGR over that time. Chuy's also managed to quadruple its net income over those years. Growth of the small chain is solid, and although its restaurants - which should number close to 60 by year's end - are spread across 14 states, it has little penetration outside its native Texas. That means there's a huge runway for growth ahead. Sales at existing restaurants were up about 2.4%, year over year, in the most recent quarter.

Management's plans are for methodical expansion at a rate of around 20% per year. Last year, it added nine restaurants. In 2014, it will add 11. The company is being selective about the markets it chooses to move into, which is a good thing. It spends an average of about $2 million on each new store, and it relies on financing for at least some of those costs.

One impressive note on new store openings: Chuy's locations, on average, can pay for themselves within two years of operations, the company says in its SEC filings. That's twice as fast as new locations for some other popular restaurant chains.

What's not so appetizing
Chuy's 48 restaurants in 2013 generated $24.2 million in operating cash flow. But the company spent $31 million on capital expenditures. This continues a trend for Chuy's in generating negative free cash flow as it expands. As an investor, I'd like to see the company close that gap and eventually start spinning off free cash.

Nothing says "solid growth company" better than paying for your expansion out of your operating cash flow, but right now, Chuy's is still a long way from making that happen.

Chuy's is still a relatively small chain. While the restaurants it has opened are doing well, it's still too early to say that Chuy's quirky Tex-Mex concept will appeal on a much broader scale the way Chipotle has. That leaves a question mark hanging over the company's long-term growth potential, another risk for investors getting in this early in the company's growth story.

The bottom line for investors
Chuy's can offer investors faster overall growth than a more mature Chipotle - and at a lower multiple. But it does so with much greater risk, as the company is still borrowing to fund its growth and its restaurants have not had enough exposure countrywide to say the concept will work in most markets. I've opened a small position in Chuy's in my portfolio, with plans to keep track of its progress as it expands in the coming quarters and years. For those with a high tolerance for risk, the stock looks appetizing.

Disclosure: The author is long CMG, CHUY.

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.