BJ's Restaurants (BJRI) surfaced on my radar as a stock which recently set new 52 week lows. A lagging share price, strong past growth performance and consistent probability always attracts my attention.
As the company targets further growth in the years to come, I believe there is real upside given the stability of operations, strong track record and very modest leverage employed. On potential further dips in the share price, long term investors could start to initiate a stake.
Who Is BJ's?
BJ's runs 177 restaurants in 23 US states, indicating that the restaurant chain has a lot of growth potential. As a matter of fact, management sees room to run 425 restaurants in the US in the long run.
The restaurant chain offers a wide range of menu items but is best known from deep dish pizzas and craft beer. With an average check size of $15 per guest, the company positions itself between fast casual dining chains and fancy restaurants. Despite the relative low check size, huge traffic numbers allow BJ to be profitable (despite the many menu items) with revenues per restaurant on average amounting to $5.7 million a year.
While the company and brand does not have much awareness with consumers, visitors like the value which they receive for their money, diversity of the menu and extensive craft beer offerings.
Margins have risen to multi-year highs around 7% of sales. Low food cost inflation and operational improvements which are driven by project Q, have been boosting the efficiency of the chain. With revenue growth in percentage terms slowing down a bit, pre-opening expenses of new restaurants create less of a drag on margins as well.
Growth is pretty impressive with 18-19 openings planned for 2016 along major interstates. Net costs for opening such a restaurant amounts to $4-5 million given the large size of each location. This suggests that capital spending needs now come in at $75-$100 million per year. Strong profitability and a strong balance sheet allow the company to finance this kind of growth. As a matter of fact, with percentage growth slowing down a bit, management has indicated that all growth can be funded by internally generated cash. This actually leaves the company some cash to engage in share buybacks as well.
Strong Growth (Potential)
BJ's has grown from sales of just a quarter of a billion in 2006 to more than $900 million by now as the billion revenue mark is within sight. Sales have increased by a factor of nearly 4 times over the past decade, largely driven by restaurant openings.
Given the potential for 425 restaurants, BJ's could grow the unit base by another 150% in the coming years. With openings currently taking place at 10% per year BJ's could theoretically operate 400 restaurants by 2025. In order to achieve this, BJ's has to stick to this 10% unit growth rate.
Average volumes now come in at $5.7 million. With a 2% comparable growth for existing restaurants, volumes could total $7 million by 2025. With a restaurant base of 400, revenues could come in at $2.8 billion. Huge capital expenditures will need to be made in order to finance this growth. The opening of another 250 restaurants will in all likelihood cost around $1 to $1.5 billion, with these costs being spread out across the coming decade.
The real question is what future margins could look like. Operating margins came in anywhere between 3 and 7% over the past decade, so it seems that a 5% margin is a fair number. If we generously assume a point leverage given the growth and scale advantages, margins could hit 6%.
These kind of margins and a $2.8 billion revenue base translate into operating profits of $170 million by 2025, under the scenario outlined above. Assuming very modest interest charges of $5 million and tax rates of 28%, earnings could come in at $120 million on an after-tax basis. That would be equivalent to $5 per share based on the current outstanding share base. It should be said that the company has been retiring shares at a steady pace. If gradual buybacks allow the float to be reduced to 20 million shares by 2025, earnings could top $6 per share.
BJ's has many levers to pull. In the rosy scenario outlined above, in which earnings per share of $6 by 2025 can be achieved, shares should easily be worth $100-$120 per share at the time. With shares currently trading at $40, there is compelling upside, even if it takes a decade to be achieved. Investors could increase their investment by 2.5 to 3 times, averaging at 10-12% growth per year. Note that the 6% margin target actually assumes that margins will come down a bit from the current margins which exceed 7% of sales. Any margin gains could create compelling upside to even this already rosy scenario.
The real concern is if things do not go according to plan. The expansion plans seem realistic in my eyes, but the other main assumptions behind the $100 target by 2025 includes a 6% operating margin target and 2% organic growth. Note that operating margins actually came in at 7.3% in the first half of this year, indicating that some margin pressure does not even jeopardize the rosy scenario. The industry currently benefits from low food cost inflation, although it should be said that part of the margin gains are hard earned given that the industry is very competitive.
The main concern might be the 2% comparable sales growth target as comparable sales actually fell by 0.2% in the second quarter of 2016. Part of that relates to the weakness in Texas, driven by the slump in oil prices. If we exclude this state, comparable sales were up by 1.2%. A bit worrying is the comment on the conference call that comparable sales were down 2% in the first weeks of July.
If we stress test our scenario I come up with a following situation. I assume that BJ's runs 400 restaurants by 2025, comparable growth is 0% over this ten year period and margins fall below long term averages at 4%. In this case I see revenues of $2.3 billion, and operating profits of $100 million. With interest costs of $5 million and taxes of 28%, earnings could come in close to $70 million, or $3.50 per share if buybacks are executed. That should still support a $60-$70 price target, for potential capital gains of merely 4-6% per annum. While investors would not become rich in such a scenario, they would still earn positive results, even if the growth story does not play out as planned.
As I believe that the assumptions behind a $100 price target for 2025 seem achievable, I am happy to buy the stock on dips in the mid- to high thirties. The modest check price, great track record, realistic growth numbers and continued buybacks while maintaining a strong balance sheet all support this thesis.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.