On March 19, The Wall Street Transcript interviewed Michael D. Smith, CFA, Restaurant Analyst at Oppenheimer & Co. Inc. Key excerpts, including his favorite sector picks, follow:
TWST: Who is at the top of that list?
TWST: What's the story on BJ's? It's not a household name.
Mr. Smith: I think BJ's had 55 units at the end of last year. They have a high return concept, and they get there because they have extra day parts. It tends to surprise people because it is just a pretty nice restaurant that sells their own beer. Of course, they make a pretty high quality deep-dish pizza and they have a menu that has probably 100 other items on it. They have a management team that is partially composed of people who came from Cheesecake Factory. So to a certain degree, the management team has been here and done this before, and they are starting to exploit out of the Southeast. They do have four stores in Texas, but other than that, it's basically California, Nevada, Arizona and Oregon. They opened a store in Tampa, and two more are scheduled in Florida this year and there will be a couple in Ohio. So they are starting to show their geographic legs, and there is no reason why they wouldn't be successful in these other markets. There's almost a whole virgin United States to expand into with the money and with the management team. I think it could have 25% to 30% growth for the foreseeable future.
TWST: Whom were they competing with? Where are they getting market share from?
Mr. Smith: Everybody. The target market is going to be the same people who use Chili's and Applebee's, because their average check is around $11 or $12, although they get that by having a number of people who will split a pizza. But they are not an expensive restaurant, and it's a higher quality experience because of a 7,500 square-foot box with 20- to 30-foot ceilings and large TVs. It's a different experience from what you get at some of the older types of concepts at the same price.
TWST: The other one you mentioned was McCormick & Schmick's.
Mr. Smith: Yes. It's upscale casual, which is a less competitive segment of the market. The competition for upscale fish houses tends to be primarily small locally owned operators, and McCormick & Schmick's, relative to the other companies we talked about, is a small system with about 67 units. They do a really good job with their fish. For two years in a row, they've been Consumer Reports choice for the number one seafood value proposition in America. They do a pretty good job, and they are the biggest in that particular segment. The business plan was designed to grow their earnings at around 20%, yet 2007 is expected to be a remarkably good year for them. They made the acquisition of a Canadian company with five units, which is going to be accretive to earnings. It looks a whole lot like McCormick & Schmick's probably modeled it after themselves, so you've got that going for them. They are opening 11 units, which is a continuation of their business plan to increase their numbered units 13% to 15%. They tend to almost always achieve positive comps of around 2% or 3% - they were 3% last year. Most of that was traffic. You've got some margin expansion coming through this year, and it's coming through for odd reasons. One, you had the higher prices for fin fish last year. You won't see that in the cost of goods sold, because they print their menu twice a day - they are protective of their margins. Their pricing levels might be a little bit lower, just because the fin fish will be normalized. They are moving into more and more tip credit states, so you have labor as a percentage of sales, and that will probably improve a little bit. According to them, anything over 1.7% comps allows them to leverage some of their fixed costs. So they've got it all going for them, and this is going to be a decent year.
TWST: Given their success, are they seeing more competition in the fish restaurant space?
Mr. Smith: We are seeing more competition trying to execute in the fish space. We've got OSI Partners (OSI), which has two concepts - Bone Fish Grill and Blue Coral. They seem to be bracketing McCormick & Schmick's, and the average check is probably $60 or $70. You've got Bone Fish with an average check of $25. But is there competition? Sure. Will there be more? Sure. Will they be able to survive? They are fairly likely to remain a leader of the group.
TWST: If all this takeover and leveraged buyout activity goes away, is that going to push multiples back down?
Mr. Smith: They are not out of the range, so I don't know the answer to that question, but it would probably make some of the companies trade more on their fundamentals. For instance, Applebee's is probably trading 15% or 20% higher than it would be, based upon the company having trouble hitting earnings estimates with traffic down 5%. So yes, some of them will go down and some of them might stay where they are.