Time To Start Nibbling at Restaurants?

There is an apparently large faction of people who expect that Americans, weighed down by their debt burdens and facing rising costs, will abandon restaurants and start cooking.  Yeah, right.  While I have been very negative on the industry, I want to say that I am rapidly warming up.  Similar to my recent views on Whole Foods (WFMI), the bear trade has played out, perhaps to an extreme.  In particular, I was bearish on two names and shared my views:

• Texas Roadhouse (TXRH)
• Red Robin Gourmet (RRGB)

I have no position in any restaurant stock at present, though I am personally very overweight the Consumer Discretionary sector and have significant exposure relative to the market in my two model portfolios - Top 20 and Conservative Growth/Balanced.  I covered my shorts too early on both names.  I confess still to never having stepped foot into either establishment.  For that matter, I don't believe that I have stepped foot into any of the names in the table below except California Pizza Kitchen (CPKI) once, but being a glutton and a wino qualifies me to at least understand what goes on in these places!  Let's just say I am not much of a chain kind of guy when it comes to food and drink.

Before laying out the bullish case for investing in restaurant chains, let's review why they absolutely stunk as investments over the past year or longer.  Here are my reasons, in no special order:

1. Customers getting pinched on discretionary income (rising costs, rising interest on adjustables)
2. Input prices killing them (nat gas, labor, food,
3. Biz models dependent upon store expansions vs. unfriendly capital markets
4. Valuations were too high considering same-store-sales deceleration
5. Some companies boosted growth by buying out franchisees (not sustainable growth)
6. Balance sheets not exactly pristine
7. Cash flow generation (lack there of) not a good thing

I am sure that there are some other good reasons, but these pretty much cover the bases:  Costs up, demand down, valuation too high.  Now, though, the story is out, in my opinion.  The valuations have come down.  Some chains - PF Chang's (PFCB) comes to mind in particular - have curbed expansion plans to focus on growth within the existing restaurants, and the ever-increasing input cost pressure may now actually be over.  Natural gas prices have plunged, and food inflation looks now to be behind us.  The longer-term bull case of convenience in a society starved for time can now play out. 

The table below lays out some metrics for the companies that I follow peripherally.  Note that PFCB, the first to scale back expansion, has reversed its multi-year downtrend.  I am not going to say which stock I would buy today, as I haven't really thought that through, though the highlighted ones would be the first ones I would evaluate.  I really just wanted to share that I am no longer bearish on the industry and expect that it could at least bounce here.

These companies, all of which I believe are "full-service" restaurants, are hopefully an inclusive list - please let me know if I have omitted one or erroneously included one:

 

Download stockselect_fullservice_restaurants.jpg

 

O.K.  So, what are we looking at?  Here are a few observations:

• What is that smell?  Worse than the dumpsters behind these restaurants - down over 20% this year after falling 29% or so last year
• LEVERAGE - Lots of debt, not even including operating leases
• Where is the cash flow?  Expansion (3rd to last column - zippo)
• Discounted Margins - 6% EBIT compared to close to 8% normally
• Discounted valuation:  PEs are about 60% of the past few years, P/S even worse at 40% median
• Some "deep value":  P/TB is 1.7 median, but FRS, CHUX, BJRI and BNHNA all very low despite relatively strong balance sheets

Here are my brief uneducated and probably irrelevant comments on some of the names:

• DRI:  Lots of debt and margins too high, but lots of shorts I believe (and lots of market cap)
• PFCB: got my attention for reigning in expansion and looks solid to me
• BOBE:  I don't know what it even is, but it's up this year and seems reasonable - rising estimates?
• EAT:  Whoops - been to Chili's - forgot to mention that above, margins are too high
• FRS:  Huh?  Looks pretty good for one I have never heard of - nice balance sheet and cheap
• CPKI: Looks o.k.
• TXRH:  Nice balance sheet and great valuation - open for lunch, guys!
• RRGB:  I hear good things about this one from my family - seems reasonable
• CBRL:  I plead ignorance again - most of profits come from restaurant not store - too much debt for me
• CHUX:  May have eaten here in a different life (and probably against my better judgment) at Madison Square Garden - dirt cheap, only one way for margins to go, decent balance sheet
• LNY:  I live too close to Mr. Fertitta to tell you what I really think, but if you didn't sell this stock, you had your chance
• RT:  I will be surprised if they survive
• BJRI:  First on my list to investigate further - deep value in some ways, but high PE - no debt
• DIN:  Sounds better than IHOP, too much debt
• SNS:  The only thing that has been shaken is the earnings and free cash flow
• CAKE:  I almost highlighted it - probably works and seems to have low expectations embedded
• BNHNA:  Nice balance sheet, my friend Chris loves it (they are contrarians), founder just died.

In summary, I don't know much about any of these companies, but their odor is starting to become a bit more appealing.  If any of you care to enlighten me further, especially about BJRI or perhaps even CHUX, I encourage you to either respond here or consider emailing me.

Disclosure:  I don't have positions in any stocks mentioned in this report, though I did buy some WFMI early this morning but sold it already.  I may buy WFMI before and/or after they report today.

Comments

[sdc13:]

I beleive this article is alot of bull**** & very irresponsible. Idon't know about all the resteraunt chains but I do know about a couple.Ruby tusedays for instance was moved to a hold buy oppurtunity by s&p.Sabrient research a buy Roshdale hold buy.RT beat the street on last quarterly report.IF you acually look at the income statements,PE,& it's balance sheet I think you will find it's fair market value is around 15.00-16.00 a share.In my [opinion] it's way undervalued; & with on the 5 minute fly need to get the article to the editor to collect my daily ego stroke attitude,it's quite understandable why the price is where it's at.Especially coming from a guy who states he's never even set foot in any of the resteraunts you mention in your article.I live in sw fla. FT.Myers Cape Coral area .The area has really slowed down badly do to lack of new housing starts & an over surplus of old,new,houses & foreclosures on the market.That being said i still see full parking lots as i pass by in the evenings &the couple of times i have eaten there at lunch the crowd has been decent.So maybe you should take a little more care before you speak.It also makes me wonder how accurate a take you have on the other's metioned.I'll bet lunch you guys won't print this or comment!!!Singed really steamed.

2008 Aug 05 10:35 PM

[ChickenLips:]

Funniest article on Seeking Alpha yet.

Is it really smart to invest in companies you don't really know anything about? Is it smart to tell others to invest in companies you have no idea what their business model is or who their customers are?

I loved this line: "Natural gas prices have plunged, and food inflation looks now to be behind us." I guess the author never goes to restaurants or gets out of the house period. Otherwise, he would have encountered $4 gasoline to get his car to these restaurants that have freshly printed menus with higher prices on them!

I'm not sure I would be pouring tons of cash into consumer discretionary stocks right now. The economy is too weak and winter is coming up. These winter heating bills are going to kill the middle class consumer who eats at these establishments. Time will tell.

2008 Aug 06 01:39 AM

[jay fredric...:]

Alan:

Your article is kinda lazy and lame. Never heard of Bob Evans? Ever been to the midwest, georgia, florida, northeast? Bob Evans is a restaurant that is always packed for breakfast due to the worlds best sausgae and gravy. Bob also sells sausage in more than 1800 grocery stores around the country.

For someone who has a bio that says you are an expert screener, this one event may prove otherwise. Or maybe you just don't like sausage and gravy?


Jay Fredrickson

i-5south.com

2008 Aug 06 08:38 AM

[Alan Brochs...:]

Thanks guys, I really appreciate your comments. Glad I could amuse you Filet Mignon and sorry to have perturbed you so much Jay and SDC. Let me get this straight - you guys think I am lazy and irresponsible? Let me try to address your concerns in order.

First, I was trying to be funny. If I can't have fun writing these articles on a subject about which I am extremely passionate (stocks and food), well, I am wasting my time. Second, I fully disclosed that I don't know what I am talking about (actually, I do). My goal was to stimulate thinking and encourage dialogue (civil would be nice - I didn't call anyone names). I am running these same ideas by my institutional clients, who seem to think I am onto something perhaps. Here is my free advice to all of you: LIGHTEN UP

Ok, SDC, congrats... Some reputable firms have buy ratings on RT. One of my clients loves it, but he loved it (fortunately never bought it) from a while ago. I warned him specifically about that one. The fact is that they are extremely leveraged. I don't have to eat there to know that. Second of all, I think restaurants in general are probably reasonable investments now. Sorry you seem to have a special place in your heart for RT - I am not saying to short it, just that they have more wood to chop than others. It's your money - invest in the stock if you want. They have $600mm in debt - I don't know the schedule of when they need to refinance it, but maybe you will lend them the money. I prefer a BJRI or some of the others who don't face these issues.

Filet, one can pretend to know a company all you want. I actually think that it is better not to delude myself into thinking I know a company so as to prevent overconfidence. I have done very well over the years, and I can't say that "intimate" knowledge of a company is a factor that has helped me one way or the other. I believe that I can read, especially what others think via the internet, and come to a reasonable conclusion about "common knowledge" and then judge if it makes sense. I really liked Krispy Kreme and went there a lot. Never invested. I drink lots of Coca-Cola - don't own it. One of my best stocks this month is National Instruments - I understand it big picture but I would be lying if I told you I understood the details (I am not an engineer). Specifically addressing your rather rude comment about my awareness, $4 gas prices and food inflation are what has already happened. I don't live under a rock - it just appears that the worst is now behind us and apparently priced into the stocks. Why else are they down so much? If you wait for $3 gasoline, these stocks will all be 20% higher.

Finally, Jay, I live in Texas. I don't eat breakfast out ever, I don't eat sausage. I have heard of Bob Evans - never stepped foot into it. Screening has nothing to do with it - it is taking into account several quantifiable variables. My "screener" doesn't have a qualitative sausage ranking! Lazy and lame? Your comment is quite rude. I spent a lot of time and put a lot of thought into what I believe is a fantastic idea. Because I am honest enough to tell readers that I am no expert on the details and because my style is to incorporate humor, you shouldn't insult me.

2008 Aug 06 11:39 AM

[wiseguy001:]

Alan, You appear to be a nice guy, educated and probably successful but (in hindsight) you have to admit you practically begged to be stoned. Putting out such a broad thesis without very specific, compelling facts was not wise. Ironically, I agree with your view that restaurants/consumer discretionary may be a good place to consider investing given some pretty beaten down names but you should go much deeper on the specific names and the quantitative logic behind them.

You did include a disclaimer but then you also contradicted yourself in your bio and some of your comments. I agree repliers should lighten up but so should posters

2008 Aug 06 12:05 PM

[Alan Brochs...:]

Hey, you are going to have to pay me if you want deeper! Kidding aside, I didn't expect a "heads-up" article conveying my observations would provoke such a negative response. I tend to get negative responses when I post negatively about a company or positively about the market or the economy! I think that the quantitative aspects are not only there but that I elaborated on them very specifically - the table, is as they say, worth 1000 words - high leverage, though varied across the companies, extremely discounted valuations on a number of metrics. Not sure what else you would have had me do.

2008 Aug 06 01:18 PM

[Bootstrap:]

Hi Allan,

I agree with your broad thesis. I have a write up on my blog regarding one of may favorite restaurants: The Cheesecake Factory.

You might want to check it out!
Best,
Bootstrap

2008 Aug 06 01:26 PM

[sdc13:]

My intention was not to convince anyone to anything.I actually hold stock in rt & acouple of others you mentioned.My point is the mere fact that your invited or employed to write a column suggests your peers respect your opinion.In light of that alot of people give weight to what you say weather or not you give yourself a disclaimer or not.My intent was to ruffle some feathers.Even so you are right rt is leveraged.The other side of that coin is rt has consistantly beat the streets concensus,exept for the 1st Qu. where they were off about .02 .There revenue should beat 1.4 billion in a year where they just revamped every store they own.They also outlined how they planned to tackle the debt they have incurred in the past year in there last conference call.So in conclusion ; last week or two one of the main writers of seeking alpha said go long on rt,sri & others.I didn't agree with everthing he had to say on all subjects but he deffinatly took some time to evaluate and explain his possition.{Not intended as a jab.}I have every faith that allen can justify his own oppinions just like the rest of us.But; regaurdless wheather i'am right or wrong,it's Allen's article & at least 50% of the people who read your article will take it as gospel truth; & oppinions can make or break a stock or a company depending on what you decide is gospel.Thanks for responding Allen. SdC13

2008 Aug 06 05:24 PM

[Tomato man:]

Alan,
I would highly recommend you make a stop at the Cracker Barrel Resturant nearest you. Being from Texas, you might enjoy their chicken fried Chicken, their catfish, their fabulous breakfasts with sawmill gravy, their steaks or practically anything on the menu. I make it a point to visit them particularly for their great menu prices and I have never had a disappointing meal. Food quality is consistent from store to store. Managers earnestly approached customers even before the shares plunged, to seek out their comments. I dont think you can beat their value of well done food preparation and service. Debt or not, I have seen their resturants consistently crowded with a clientele of older folks who are as fond of their food as I am. I am happy that they are accesible from interstates for a substantial but not expensive breakfast menu.
In spite of your comments, I have invested. My vote is based on my total approval of their products and their sensible idea of great food and service at reasonale prices.
I saw the time as opportune and saw that there is now a strong consideration to buy back stock to raise the share value.
I say they are in it for the long haul and will still be there when Red Robin Burgers are seen as exorbitant and overpriced and other trendy hangouts cannot endure the economic times ahead.
Tman

2008 Aug 07 01:41 PM

[Alan Brochs...:]

Thanks for your comments. Value is a good thing these days, and it sounds like that is their focus. Doesn't sound like my kind of menu - I usually eat out for things I can't cook myself. I also don't eat fried anything. I didn't make it clear in the article, but when I do eat out, I tend to avoid chains because I like to support local institutions and not pay for advertising and corporate overhead. I tend to eat ethnic foods out.

When you said that you invested "in spite of my comments", I am not sure what you mean. I think restaurants in general make sense as investments, but it looks like CBRL has a ton of debt. Specifically, they have almost $800mm in LT debt and very little equity. Part of what is going on is leveraging up to repurchase stock, which drives down the equity value since they are paying more than book value. So far, they have paid a lot more than the stock is currently worth, and I don't think a recession is a great time to be loading up on debt to buy stock. I could be wrong, but it seems to me that this is one of the last ones investors will want to buy given the increased leverage.

2008 Aug 07 02:21 PM

[brombonz:]

"These companies, all of which I believe are "full-service" restaurants, are hopefully an inclusive list - please let me know if I have omitted one."

I'm just guessing that by "full-service" you mean to exclude quick-service, buffet, cafeteria and take-out, leaving "casual service."

So this might suggest the inclusion of BUCA, BWLD, CASA, DAVE, DENN, ELXS (but you get sewage equipment, which isn't necessarily appetizing, in the bargain), GCFB, GRIL, JAX, MRT, MSSR, RUTH, or SHLL. In addition ARKR operates both casual and quick service restaurants.

2008 Aug 09 07:42 PM

[Alan Brochs...:]

By full-service, I meant service at the table, not quick-serve or cafeteria - yes. I left off BUCA intentionally due to its very small size ($9mm market cap). BWLD from what I could tell isn't full service. I left off MSSR, MRT and RUTH because they aren't "casual", but probably the same arguments suggest looking at them. CASA isn't in my database. DAVE and DENN could have been included. ELXS is less than micro-cap. GCFB and JAX fell below my minimum market cap, while GRIL isn't in the database. Nor is SHLL. Another I intentionally omitted was KONA. Thanks for the heads-up on these names!

2008 Aug 09 11:39 PM