BJ’s (BJRI) has had an incredible run since the credit crisis in late 2008/early 2009, rising from a low near $8 per share to its current price over $50. While BJ’s offers a compelling value proposition to its customers — providing quality food and service at a reasonable price in an aesthetically pleasing environment — the stock price has increased dramatically above its intrinsic value.
Based on today’s closing price of $52.02, BJ’s currently trades at 49x my estimate of 2011 earnings and an EV/EBITDA multiple of 18.2 as broken down below:
- Closing Stock Price 11/8/11 52.02
- My 2011 Earnings Estimate 1.06
- P/E Ratio 49.1
- Equity Value 1,441.16
- Cash and Investments 49.378
- Enterprise Value 1,391.78
- My 2011 Projected EBIT 43.454
- Depreciation and Amortization 33.129
- EBITDA 76.583
- EV/EBITDA Multiple 18.2
Company Profile and History
BJ’s Restaurant first opened in 1978 in Orange County, Calif., centered on bringing the flavor of deep-dish pizza to California. The company BJ’s Restaurant Inc. acquired the BJ’s Restaurant concept in 1995 from its original founders and went public in 1996.
Over the years, BJ’s has expanded from a small service pizzeria to a full-service casual dining restaurant with over 100 menu items ranging from pizza to pasta to salad to additional entrees to desserts.
In 1996, BJ’s introduced its own handcrafted beers through its first Restaurant and Brewery in Brea, Calif. Within the last 10 years, BJ’s has expanded this concept nationwide and now runs over 100 restaurants. BJ’s signature deep-dish pizza and handcrafted beers have attracted customers and helped provide significant revenue and same-store sales growth.
BJ’s “casual-plus” restaurant concept seeks to provide a similar dining experience to “upscale casual” competitors such as Cheesecake Factory in terms of food quality, décor, and customer service, but at a lower cost.
As of last year, BJ’s average check per customer was $12.50 while Cheesecake Factory’s (CAKE) average check per customer as of the beginning of this year was significantly higher at $19.00. The checks at more casual restaurants such as Panera (PNRA) and higher quality fast food chains such as Chipotle (CMG) were not much less, clocking in at approximately $9-10 per person. Below are approximate numbers from each restaurant from data collected within the last 18 months: 
Past Financial Results and Customer Reviews
Below BJ’s strong revenue and same store sales growth through the recession is shown as well as improving operating margins and EPS:
The information above is obviously what has analysts and investors excited and proves BJ’s concept is resonating with customers. Total sales, sales per restaurant, operating margins, and net income are all expanding impressively. To arrive at average sales per restaurant, I used a weighted average of number of restaurants at the beginning of the year and at the end of the year. I also examined operating margins without non-recurring expenses related to legal settlements and natural disasters, which gives a true indicator of operating performance.
BJ’s is also in exceptional financial health. As of September 2011, the firm had $49.378 million of cash and investments, no interest bearing debt, and a tangible book value of $314.091 million. Although, as I will discuss below, the firm has significant off-balance sheet operating lease commitments, many of which are longer than 5 years in duration, as well as on-balance sheet "deferred landlord obligations" totaling $44.04 million as of September 2011.
Customer reviews on many sites, such as Yelp and urbanspoon.com, range from average to excellent. On a scale of 1 through 5, the average review is close to 4 stars, which shows the restaurant is resonating with people all over the country. Although specific reviews should be taken with a grain of salt, large sample sizes are often useful. Here are a couple of links with reviews from specific locations.
Now that we have described the positives attributes of BJ’s and what has led to the dramatic rise in the stock price the last three years, lets dive into the negatives and why I believe the stock now presents an attractive short opportunity.
Negatives and Additional Financial Info
While BJ’s food, customer service, and atmosphere has appealed to customers and helped improve total sales, revenues per restaurant, operating margins, and its stock price, the same cannot be said for its free cash flow shown below:
Source: Morningstar and SEC filings
While operating margins and net income have expanded rapidly, free cash flow is barely positive. This has to do with the high fixed cost to open a new restaurant. On average, BJ’s opens one new location per month, as they have averaged 10-15 openings per year since 2008, and according to their statements and the information provided in their SEC filings, they plan to expand at a similar pace in the future. Here is a link to a recent article discussing expansion plans for 2012.
Using information provided by the firm in the company filings, I break down capital expenditures, opening costs, and maintenance capex per restaurant below:
In annual reports prior to 2010, BJ’s not only provided capital expenditures related to new openings and existing locations in the current year, but also an amount related to future openings. In the 2010 annual report the amount related to future openings was not specified.
As shown, the cost to build a new restaurant ranges from $4.7 to $5 million. In addition, the cost to open a new restaurant since 2008 has ranged from $492,000 to $565,000.
If non-recurring expenses related to legal settlements are stripped out, the operating profit per restaurant is about $400,500, based on an estimated EBIT of $43.454 million for 2011 and a weighted average number of restaurants of 108.5. In addition, opening costs should be added back, as I will account for these funds in the cost to open a new restaurant, and I do not want to double count them. In 2011 this equated to an additional $7.345 million or approximately $67,700 per restaurant.
A normalized tax rate for BJ’s is in the high 20s. I assume a 28% tax rate using a normalized 35% U.S. corporate tax rate plus 3% for state taxes minus a 10% FICA tip credit, as according to current law BJ’s can deduct FICA taxes related to employee tips as discussed in more detail here.
NOPAT per restaurant is calculated below:
Using averages from 2008-11 of $4.83 million to build a restaurant and $527,000 in opening costs we see that the return on capital is clearly lower than the cost of capital, assuming the cost of capital is 10%:
Now that we have established the return on capital is clearly lower than the cost of capital, we must also consider the fact that operating margins have nearly doubled since 2008, increasing from 3.6% in 2008 to most likely over 7% for 2011. This has mainly been driven by customer traffic and increases in revenue per restaurant as shown above. Given established competitors within the industry, what is BJ’s potential? Below the median operating margins are listed for competitors:
If the numbers are examined further, it is clear that higher quality service, food, and environment equate to lower margins. PF Chang’s (PFCB) and Cheesecake, the two highest quality establishments of the bunch have the lowest margins, while Chipotle and Panera, the two restaurants with the lowest level of service, have the highest margins.
Given that BJ’s is more casual than PF Chang’s and Cheesecake Factory, but much more service-oriented than Chipotle and Panera, their margin potential probably lies somewhere in between.
In my projected earnings model, I assume BJ’s gradually improves its operating margin to the point where it reaches 9.8% by 2016. This equates to $636,000 in EBIT. Adding back restaurant opening costs so they are not doubled counted and adjusting for a 28% tax rate, we still see the return on capital below the cost of capital as shown below:
Even with expansion of operating margins to nearly 10% and average revenue per restaurant moving above $6.5 million, BJ’s would still not be able to generate enough operating income to exceed its cost of capital. To give you an idea of how costly it is to open a BJ’s, based on an operating margin near 10% as well as using the rest of my assumptions from above and also assuming a 10% discount rate, the net present value of opening a BJ’s would still be negative after 20 years!
Projecting future free cash flows, I value BJ’s at approximately $19 per share, far below its current stock price above $50. My model is shown below:
| 2011e | 2012e | 2013e | 2014e | 2015e | 2016e | |
| Sales | 610144 | 700850 | 793467 | 891010 | 993691 | 1101731 |
| Growth Rate | 18.74% | 14.87% | 13.21% | 12.29% | 11.52% | 10.87% |
| Restaurants (End of Year) | 115 | 127 | 139 | 151 | 163 | 175 |
| Restaurants (Beg of Year) | 102 | 115 | 127 | 139 | 151 | 163 |
| Sales per Restaurant (Weighted Average) | 5623 | 5792 | 5966 | 6145 | 6329 | 6519 |
| Growth Rate | 6.20% | 3.00% | 3.00% | 3.00% | 3.00% | 3.00% |
| Cost of Sales | 150763 | 173176 | 196061 | 220163 | 245535 | 272231 |
| Per Restaurant | 1390 | 1431 | 1474 | 1518 | 1564 | 1611 |
| Growth Rate | 6.90% | 3.00% | 3.00% | 3.00% | 3.00% | 3.00% |
| Labor and Benefits | 209942 | 241153 | 273021 | 306584 | 341915 | 379090 |
| Per Restaurant | 1935 | 1993 | 2053 | 2114 | 2178 | 2243 |
| Growth Rate | 5.30% | 3.00% | 3.00% | 3.00% | 3.00% | 3.00% |
| Occupancy and Operating Expenses | 125443 | 142693 | 159981 | 177904 | 196479 | 215727 |
| Per Restaurant | 1156 | 1179 | 1203 | 1227 | 1251 | 1276 |
| Growth Rate | 2.40% | 2.00% | 2.00% | 2.00% | 2.00% | 2.00% |
| General and Administrative Expenses | 38787 | 44508 | 49411 | 54408 | 59500 | 64688 |
| Per Restaurant | 364 | 368 | 372 | 375 | 379 | 383 |
| Growth Rate | 2.00% | 1.00% | 1.00% | 1.00% | 1.00% | 1.00% |
| Depreciation and Amortization | 33129 | 37145 | 41260 | 45441 | 49685 | 53985 |
| % of Sales | 5.40% | 5.30% | 5.20% | 5.10% | 5.00% | 4.90% |
| Restaurant Opening Costs | 7345 | 6327 | 6327 | 6327 | 6327 | 6327 |
| Per New Restaurant | 565 | 527 | 527 | 527 | 527 | 527 |
| Loss on Disposal of Assets | 1281 | 1402 | 1587 | 1782 | 1987 | 2203 |
| % of Sales | 0.21% | 0.20% | 0.20% | 0.20% | 0.20% | 0.20% |
| Natural Disaster Related | 0 | 0 | 0 | 0 | 0 | 0 |
| Legal Settlements and Terminations | 2037 | 0 | 0 | 0 | 0 | 0 |
| Total Costs and Expenses | 568727 | 646403 | 727648 | 812609 | 901428 | 994251 |
| EBIT | 41417 | 54447 | 65819 | 78401 | 92263 | 107480 |
| Per Restaurant (Weighted Average) | 382 | 450 | 495 | 541 | 588 | 636 |
| Per Restaurant ex non-recurring expenses | 400 | 450 | 495 | 541 | 588 | 636 |
| Operating Margin | 6.80% | 7.80% | 8.30% | 8.80% | 9.30% | 9.80% |
| Operating Margin ex non-recurring expenses | 7.10% | 7.80% | 8.30% | 8.80% | 9.30% | 9.80% |
| Other Income (Expense) | 208 | |||||
| Interest Income | -111 | |||||
| Gain/Loss on Investment Settlement | 614 | |||||
| Other (Net) | 521 | |||||
| Total Other Income (Expense) | 1233 | 701 | 793 | 891 | 994 | 1102 |
| Total Income Before Tax | 42650 | 55148 | 66613 | 79292 | 93257 | 108582 |
| Taxes | 11942 | 15442 | 18652 | 22202 | 26112 | 30403 |
| Tax Rate | 28% | 28% | 28% | 28% | 28% | 28% |
| Net Income | 30708 | 39707 | 47961 | 57090 | 67145 | 78179 |
| Diluted Shares Outstanding | 29093 | 29515 | 29810 | 30108 | 30410 | 30714 |
| Earnings per Diluted Share | 1.06 | 1.35 | 1.61 | 1.9 | 2.21 | 2.55 |
| Capital Expenditures (Total) | 84757 | 80945 | 83344 | 85742 | 88141 | 90540 |
| New Restaurant Openings | 13 | 12 | 12 | 12 | 12 | 12 |
| Capital Expenditures related to new openings | 64857 | 57957 | 57957 | 57957 | 57957 | 57957 |
| Carry over from prior year | not spec | not spec | not spec | not spec | not spec | not spec |
| Total Cap Ex for New Restaurants | 64857 | 57957 | 57957 | 57957 | 57957 | 57957 |
| Per New Restaurant | 4989 | 4830 | 4830 | 4830 | 4830 | 4830 |
| Existing Restaurants Opened | 102 | 115 | 127 | 139 | 151 | 163 |
| Cap Ex Related to Existing Locations | 19900 | 22988 | 25387 | 27786 | 30184 | 32583 |
| Per Existing Restaurant | 195 | 200 | 200 | 200 | 200 | 200 |
| Free Cash Flow | -4093 | 5878 | 16789 | 28688 | 41624 | |
| Discounted Free Cash Flow | -3721 | 4858 | 12614 | 19594 | 25845 | |
| Sum of Discounted Free Cash Flows | 59190 | |||||
| Discounted Terminal Value | 447981 | |||||
| Excess Cash | 49378 | |||||
| Total Equity Value | 556549 | |||||
| Diluted Shares Outstanding | 29223 | |||||
| Equity Value per Share | 19.04 |
Diluted Shares Outstanding as of September 2011
Assumptions: 10% WACC 4% Terminal Growth Rate
Related Parties
According to the most recent quarterly report, it is believed that Jacmar Companies owned approximately 11.5% of outstanding common shares as of Sept. 27, 2011. In addition, according to the most recent proxy statement, James A. Dal Pozzo owned 11.69% of outstanding common shares. Mr. Dal Pozzo is president of the Jacmar Companies. This means Jacmar and its CEO Mr. Dal Pazzo, who is currently on BJ’s board of directors, own in excess of 23% of outstanding shares.
Jacmar, through its affiliation with Distribution Market Advantage (DMA), a national foodservice distribution system, is currently BJ’s largest supplier of food, beverage, paper products and supplies, servicing BJ’s restaurants in California and Nevada, while other DMA system distributors service BJ’s restaurants in all other states. BJ’s believes Jacmar sells products at comparable prices to other vendors as determined by its competitive bidding processes that resulted in three year agreements in July 2006 and again in July in 2009. Through the end of September, Jacmar has supplied BJ’s with nearly $50 million of food and supplies in 2011.
It can never be known for sure, but it is possible Jacmar has leverage over BJ’s in terms of pricing. If I were a long shareholder of BJ’s, I would demand the firm switch to an annual competitive bidding process, or at the very least, check prices of competitors annually and disclose more information to shareholders.
Potential Free Cash Flow Problem
In the latest 10Q, BJ’s states the following on page 20:
“We expect to fund our expected capital expenditures for fiscal 2011 with current cash and investment balances on hand, expected cash flow from operations and expected tenant improvement allowances of approximately $5.6 million.
What are “tenant improvement allowances?”
From Choyce Peterson, a commercial real estate broker:
“Money for space development, commonly referred to as tenant improvement allowances, can serve as key leverage in negotiations with a landlord, either for lease renewal or relocation. In fact, in today’s commercial real estate market, many landlord’s fund 100 percent of building standard (and in some cases above-standard) installations required by tenants.
Tenants who have excellent credit, are willing to sign a longer term lease (seven-to-ten years) or who are larger in size (at least 15,000 square feet) should be able to negotiate having the landlord fund above-standard improvements such as plush carpeting, special lighting or large glass walls.”
Is this a red flag? BJ’s might be relying on negotiating leases or money for improvements and space development to free up cash flow to fund expansion, which according to the definition of "tenant improvement allowances" may result in a longer lease term. Perhaps they should cut back on expansion until their margin and free cash flow improve, and instead, focus mainly on improving traffic to existing locations. This could be a sign of cash flow troubles, which may force a capital raise in the future through issuing additional equity or raising debt, both of which may be harmful to shareholders.
As noted on page 56 of the latest annual report, long-term operating leases have increased substantially. Total operating lease obligations as of Dec. 31, 2010 were approximately $323.5 million, nearly $200 million of which has a duration longer than five years.
[Editor's note: This final section was amended by the author on Nov. 13, 2011.]
Changes/Additions to Auditors StatementAfter further research, such as examination of SEC filings of other firms and discussions with CPAs, as well as comments I have received, I am fairly certain the changes and additions to the auditors summary are immaterial.
While I believe BJ’s represents a compelling value proposition to customers -- providing quality food and service in a friendly environment at a reasonable price -- investors are pricing in too much growth and margin improvement into the stock and overlooking some of the red flags present in the financial statements, especially as it relates to the firm’s free cash flow and return on capital. For the reasons mentioned above, I believe there is potential for a solid return over the next few years by entering a short position in BJ’s.
Disclosure: I am short BJRI.
