Last week at an investor conference, Greenlight Capital's David Einhorn presented several stock ideas, one of which is his bearish stance on Chipotle Mexican Grill (CMG) which he said had a "nosebleed valuation." The hedge fund manager went on the say: "History says sooner or later, even the restaurants that generate the biggest enthusiasms on Wall Street come back to earth." Recently I've analyzed another Mexican restaurant chain called Chuy's Holdings, Inc. (CHUY) which went public in July and also sports a "nosebleed valuation" but lacks the brand awareness, size and scale, and overall financial strength of Chipotle.
Chuy's is a full-service restaurant concept offering a distinct menu of authentic, freshly-prepared Mexican and Tex Mex inspired food. As of August 31, 2012, the Company operated 37 restaurants in eight states, including Texas (23), Tennessee (5), Kentucky (3), Oklahoma (2), Alabama (1), Indiana (1), Georgia (1) and Florida (1). For the twelve months ended June 24, 2012, the Company generated net sales of $149.4 million and Adjusted EBITDA of $23.8 million (15.9% margin).
History and Concept Overview
Based in Austin, TX, Chuy's operates 37 full-service Mexican and Tex Mex inspired restaurants in the South and Southeast. Chuy's has grown from eight restaurants in 2007 to 31 restaurants in 2011, and is expected to operate 39 restaurants by year-end 2012. From fiscal year 2007 to the twelve months ended June 24, 2012, the Company's annual revenue increased from $42.1 million to $149.4 million and Adjusted EBITDA increased from $5.7 million to $21.8 million, representing compounded annual growth rates of 32.5% and 34.8%, respectively.
Chuy's operates in the $6 billion Mexican casual dining space, a category without major national competitors (the only casual dining segment without a $1 billion brand). The Company has a 30-year history in Texas (its core geography and home to 23 of its 37 units) and is now moving outside of Texas for growth. Chuy's has expanded into several Southeastern markets including Nashville, Kentucky/Indiana, Oklahoma, Atlanta, Alabama and Florida. The Company plans to open new restaurants in both established and adjacent markets across Texas, the Southeast and the Midwest where management believes they can achieve high unit volumes and attractive unit level returns.
The Company's restaurants range from 5,300 to 12,500 square feet in size, each serving an average of 400,000 customers per year. All of the Company's restaurants are leased. In terms of restaurant sales, Chuy's high average unit volumes of $5 million are comparable to Brio Tuscan Grille ($5 million) and are just below BJ's Restaurants ($5.8 million). Chuy's has produced positive same-store sales in four out of the last five years, with average 2007-2011 comps of +2.4%. Chuy's average check of $12.99 delivers exceptional value to customers, which is key in the Mexican category. The business mix is balanced with 60% dinner and 40% lunch. Alcohol beverage mix is high relative to most casual dining peers at 20%.
Under the Company's investment model, new restaurant openings have historically required a net cash investment of approximately $1.7 million. Chuy's targets a cash-on-cash return beginning in the third operating year of 40%, and a sales-to-investment ratio of 2:1 for new restaurants. On average, returns on new units opened since 2001 have exceeded these target returns in the second year of operations. Even for a young company, Chuy's is showing the profitability of its high-volume restaurants with top quartile performance at approximately 18-19% restaurant level margins.
Recent IPO and Ownership
On July 27, 2012, Chuy's completed its initial public offering (IPO) of common shares at $13.00 per share. The Company issued 6,708,332 shares of common stock, including 874,999 shares sold to the underwriters in the IPO pursuant to their over-allotment option. The Company received net proceeds from the offering of approximately $79.4 million which were used to repay the Company's loans outstanding under the Company's credit facility. The total outstanding debt under the credit facility after the repayment was approximately $5.0 million. Jefferies and Baird acted as joint bookrunners on the offering, while KeyBanc, Raymond James and Stephens acted as co-managers.
Goode Partners LLC, a private equity firm, currently owns 57% of the outstanding shares. Subsequent to the July IPO, Chuy's float is only 39% of its shares outstanding; the remaining 61% of the shares are controlled by management (4%) and Goode Partners (57%). The lock-up period is set to expire in January 2013, at which time Goode Partners may begin monetizing its investment (a risk to the stock price).
Based on last Friday's closing stock price ($27.59 per share), Chuy's has a market capitalization and enterprise value of $439 million (see my analysis). This equates to 2.9x sales, 20x Adjusted EBITDA, and 56x net income based on last twelve month ("LTM") financial metrics, pro forma adjusted for the IPO. Based on Wall Street research, analysts estimate Chuy's will grow its revenue by 29% in 2012 (to $168 million) and 21% in 2013 (to $204 million), with Adjusted EBITDA growing to $23 million and $28 million in 2012 and 2013, respectively. Based on an enterprise value of $439 million, Chuy's is trading at 19x 2012 estimated EBITDA and 16x 2013 estimated EBITDA.
To determine if Chuy's multiples are reasonable, I examined a group of seven high-growth restaurant companies, including BJ's Restaurants (BJRI), Bravo Brio Restaurant Group (BBRG), Buffalo Wild Wings (BWLD), Chipotle Mexican Grill , Ignite Restaurant Group (IRG), Panera Bread (PNRA), and Texas Roadhouse (TXRH). This "peer group" of high-growth restaurants is trading at an average of 10.3x 2012 estimated EBITDA and 8.7x 2013 estimated EBITDA. Chuy's 2012 estimated EBITDA multiple of 19.2x is 187% of the peer group average multiple of 10.3x. Chuy's 2013 estimated EBITDA multiple of 16.0x is 183% of the peer group average multiple of 8.7x.
Many analysts believe Chuy's should trade at a premium to other high-growth restaurant concepts due to its robust growth trajectory and high-ROIC unit development, but multiples close to twice its peer group are unrealistically optimistic. What's a reasonable premium? It tough to say precisely, but if you apply a 25% premium to the peer group 2013 average EBITDA multiple of 8.7x, you get to a multiple of 10.9x. If you apply this 10.9x multiple to Chuy's 2013 estimated EBITDA of $28 million, you arrive at an implied market capitalization of $300 million, or $18.81 per common share. That's $8.78, or 32%, below the current share price of $27.59.
I will note that Chuy's average stock price target from Wall Street research is $21.33 per share, or 23% below the current share price. Moreover, Jefferies and KeyBanc have a "hold" rating on the stock, while Baird and Stephens have an "outperform/overweight" rating.
Highly competitive industry: The restaurant business is intensely competitive with respect to food quality, price/value relationships, ambiance, service and location. In the Mexican food category, the Company competes with full-service restaurant chains such as On the Border, Chevy's Fresh Mex, El Torito and Abuelo's, as well as QSR restaurant chains such as Taco Bell (YUM), Chipotle, Del Taco, Qdoba, and Moe's.
Managing rapid unit growth: With fewer than 40 restaurants, the Company has a smaller base of restaurants than most, and with that comes incremental risk as it continues to grow at a rapid pace. Execution risk encompasses the risk associated with rapid infrastructure development, personnel growth, IT system scaling, and high capital requirements.
Food and labor costs: Food and labor combined represent approximately 60% of Chuy's sales (with food roughly 26-28% and labor roughly 30-32%). If food commodity prices or labor costs increase, the Company may not be able to pass these cost increases through to customers due to the price-sensitive nature of the Mexican food segment.
Economic factors: Sales for the Company may be affected by macroeconomic factors that influence consumer spending and any downturn in the economy (particularly regional issues impacting Texas, its largest market) would adversely affect the Company's growth and profitability.
Chuy's is a fast growing and highly profitable chain operating in the Mexican casual dining segment. With no national player in Mexican casual dining, Chuy's has the potential to assume a leadership position within this fragmented segment. The Company anticipates opening at least 50-55 units during 2012-2016 which would bring its total restaurant count to roughly 87 units. Management sees long-term potential for Chuy's to achieve more than 300 domestic units, which isn't unreasonable given its potential for further expansion in Texas and the wide range of development opportunities across key Southeastern and selected Midwest markets. Key to the Company's success will be management's ability to execute in an environment of rapid growth within the highly competitive restaurant industry. For investors, Chuy's common stock is currently priced beyond perfection, leaving no room for any hiccups such as moderating unit growth, macroeconomic weakness, declining same-store sales, higher commodity food prices, or consumers' reluctance to embrace the concept in new markets. I believe Chuy's shares are fairly valued in the high teens to low $20s; I would be a buyer below $17 and a seller above $24.