Fogo de Chao (NASDAQ:FOGO) has a total of 37 company-owned, Brazilian-style, full-service, meat buffet restaurants (26 in US and 10 in Brazil, 1 Mexico). According to reviews on Yelp, their restaurant service and atmosphere are impeccable and the food/meat offerings are competitive to the peers in the market. At $50-60/person for dinner and $25-30/person for lunch, FOGO is a special occasion type of restaurant for most. The Brazilian steakhouse market is a niche segment with one other national competitor Texas De Brazil (37 locations) and various local mom-and-pops.
I recommend selling FOGO stock for the following reasons:
High cash burn: FOGO does $272m of sales per year and generates $15m in OCF but consumes $25m in new restaurant expansion and maintenance capex. The full service restaurant model is not a favorable one from a cash flow perspective as FOGO needs to spend $3-4m as initial capex to start a new location versus <$1m for a quick service, drinks-only restaurant. Given its low cash balance of $22m ($14m in US and $8m in Brazil), FOGO will need to raise additional capital through equity offering or tap its credit line soon. Either way FOGO stock will take a hit - either due to share dilution or due to increased interest expense. FOGO currently has $82m of undrawn credit in its 2015 $250m credit facility.
Highly levered balance sheet: FOGO's current debt-to-equity ratio is 70% ($165m/$239m). FOGO's main shareholder before and after IPO (June 2015) remains Thomas H. Lee, a private equity firm which still owns 80% of FOGO shares. They have loaded FOGO with a high amount of debt as a private company as part of the private equity leveraged buyout model to take advantage of low interest rates. All of the IPO proceeds in June 2015 went to pay off a portion of the debt instead of going to FOGO for operations. Therefore FOGO remains low in cash after raising $91m in proceeds from the IPO. Besides debt, FOGO also has tied itself with $450m capital obligations mainly from 10-20 years' rental lease for its restaurants. Instead of adopting a franchise model, FOGO uses a company-owned model and thus is much more capital intensive than most of its chain restaurant peers.
FOGO management is targeting 10%+ store growth (7 new restaurants) every year and 18-20% EPS growth in the long term. I believe the EPS target would be very challenging to achieve in the next few years. FOGO's upscale model works well in a good economy/stock market when there is a lot of discretionary and business entertainment spending. However, I believe that period has passed in the US and the next few years will likely be a tighter time.
Disappointing US same-store growth, unlikely turnaround in Brazil: Recently, FOGO's results have been disappointing due to difficult sales comp (World Cup Brazil in June 2014), riots/protests and poor economy in Brazil (Mar-August 2015), and depreciating Brazil real against USD. The outlook in Brazil does not look positive as FOGO just announced that its President of Brazil Operations, Jandir Dalberto, will be transitioning from his current position to other parts of the company. In the US, FOGO's 3Q15 restaurant same store sales growth was only 2.8% y/y, compared to 5.3% y/y a year earlier. Company reported that an increase in restaurant traffic was offset by lower average guest check size.
Despite recent stock decline from $20 at IPO to $17, FOGO is still very expensive trading at 12x EV/EBITDA ($542m/ $45m) given its mediocre growth outlook and stressed balance sheet and imminent financing needs. FOGO stock is likely to suffer once the company announces an equity offering or if the market pays more attention to its high debt burden. I recommend selling FOGO stock at $17.
Disclosure: I am/we are short FOGO.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.