Two weeks ago, I warned investors to shy away from Bravo Brio Restaurant Group (NASDAQ:BBRG), the Italian dining company, even at a cheap valuation because of deteriorating fundamentals of the underlying business with no clear change in capital allocation strategy. This morning, our fears were realized as the company reported worse than expected performance and lowered its guidance for the full year. We hope that investors made it through the day unscathed, but in reality, readers of this article care more about the question: what do I do from here?
Summary of Our Original Thesis
- The company was trading at ~5x P/OCF, but half of the OCF was being deployed towards store growth, which we thought was value destructive while same store sales (SSS) were declining and took management's focus away from SSS improvement.
- We thought the capital being used for store growth should be deployed towards share repurchases, as management must think the stock is cheap since they repurchased $50MM worth of stock in a tender offer in late 2014 at an average price of $14.00 per shares.
- We could not invest in the stock at its current valuation because there was no sign management would change its course of strategy.
Updates from the Quarter
This week, the company reported disappointing quarterly results, sending shares down over 30% today. Same store sales continued their deceleration, now down 7.1% year over year. Some of this can be attributed to the industry-wide traffic declines we have been seeing, but these are still pretty bad results. Just as bad, the company reduced its same stores sales forecast for the year from -2% to 0%, now to -5.5% to -4.5% (which we still think might be aggressive).
GAAP net income guidance was reduced from $.65 to $.73, now down to $.15 to $.20. Overall, it was a terribly disappointing quarter in which management talked about a "period of transition" as they implement changes to improve comps, which doesn't make much sense to us as these investments led to a deterioration of the key metric they are focusing on. We don't totally blame management - its hard with as high of an avg. check as BBRG has with traffic declining, but that's even more reason not to open any more stores until if/when the SSS issues get fixed.
The highlight from the quarter, like it usually is with BBRG, was operating cash flow (OCF) which was equal to $11MM for the quarter. Sadly, over $7MM of it was spent on capex. For the full year, taking management's new guidance, the company should still produce $20-$22MM in operating cash flow. $12-$13MM of it will be spent of capex, so we should assume ~$4-5MM in share repurchases for the rest of the year (on a $75MM market cap). Again, what we would like to see is at least $15MM in share repurchases over the next 12 months if the price stays where it is (~20% of the float), or some reduction of debt, but were unsure if management will do this.
Is the Capital Allocation Strategy Showing Signs of Life?
The highlights of the call might come in the details. The company accelerated is share repurchase activity in the quarter, repurchasing ~300k shares at an average price of $7.37 (yikes compared to today, but actually not a bad price considering the price during the quarter). This amount of repurchases about doubles the amount from Q1, and management said on the call that they planned to continue repurchasing shares opportunistically (here's an opportunity!).
The other point was commentary of store count, as the company announced the closure of 2 stores in the back half of the year. But, there's still no talk about slowing the pace of growth of stores for next year. We understand plans have been made have to be finished this year, but when you are spending >$10MM on store growth (~50% of your operating cash flow) on stores when your current store base comps are severely declining, and you completed a tender offer of your stock at $14 a share, it makes no sense to us why you would not just cut off store growth and repurchase shares.
Why try to build a new house and split your focus while the house you currently have is in bad shape? This is especially true when you consider the company could theoretically repurchase over 30% of the existing float over the next 12-15 months instead of deploying it towards a currently declining business.
It's been a rough week for a stock that has had a bid decline this past year. Though the company has paid down some debt, and is currently trading at 3.5x full-year operating cash flow, we still suggest that investors stay on the sidelines. At its current price, we are holding out hope that this quarter's share repurchases start to become a trend, or even accelerate from here.
We think this decline in share price could become a catalyst for a capital allocation strategy change, but were going to wait until we hear that news from management. Again, we urge investors to monitor the stock and look for announcements on changes to the store count or for a rebound in same-store sales. But for now, we continue to urge caution and patience with the idea of entering into a position.
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.
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