Habit Restaurants (NASDAQ:HABT) is a well-established company with a strong track record of same store sales and strong target delivery confidence. Many of you have read the first part of this pair of articles. If you have not, you can find it here. The idea is that I will be analyzing two companies that are competitors in a pair of articles. Though the subject of both articles will be the pair of companies, each article will primarily focus on one of the companies.
In these articles, we analyze Shake Shack (NYSE: SHAK) and Habit Restaurants in the fast-casual segment of the restaurant industry. The first article focused on Shake Shack. For those of you who would like a quick summary, the basic idea is that the stock price has outgrown the growth story of the company itself. I would definitely recommend taking a look at it as it offers perhaps a different perspective on Shake Shack and in addition perhaps a bit of overview on the fast-casual segment.
So let's jump right into it. Habit Burger Grill is a fast-casual restaurant that specializes in made-to-order char-grilled burgers and sandwiches, offering "combo" meals at relatively low prices. It has 142 locations across America with 117 in California alone. Though the stock is quite new, the company itself is quite well-established. As you can see from the graphs below, made with data from the company's 10-K, Habit has focused the majority of its growth on the coasts with a majority of the growth within California.
Part of this has been the company's push to adhere to its historical roots as being a traditional "Californian" burger. In fact, it is this push that fuels some of the demand and brand awareness. As a proud Californian myself, I must say that Habit burgers are indeed placed quite well and as you can see, have been growing and expanding quite rapidly. (Graph is mine while data is from the annual filing)
Looking at the stock performance (Source is Capital IQ), it doesn't take an expert to see that the stock has indeed been quite beaten down. I think this has been perhaps a bit unjustified and the long-term growth story is definitely backed by a management team that delivers. Those of you who have read the first part of this pair of articles will know the anecdote I added about the two Shake Shacks within 500 feet of one another in the JFK airport terminal. Perhaps the second half of that anecdote is that when I landed in LAX at 9:30 pm, I was greeted by a Habit Burger with a long line of customers.
So rather than build our model like I did with Shake Shack with very aggressive growth estimates, let us perhaps just model growth perfectly in line with management guidance. Looking back, management has been fairly good with hitting growth targets and gives relatively conservative estimates.
In addition to this, let us look at some of the costs associated with the business. Indeed one of the big headliners that I am sure many of you have already thought of is the risk associated with having so many locations in California and the newly raised $15 minimum wage. Now this will affect costs for many companies, including Habit Restaurants, but something that has not been so closely considered is the other input costs that make up a more significant portion of HABT's costs. Looking at the chart below (Source: Bloomberg), we can see that many of the input costs associated with operations are projected to remain the same or decrease, with beef being the largest input cost for food, according to HABT's annual filings.
Now let us look at a DCF that I made with some of these assumptions built in. For this model, let us assume that the increase in the California minimum wage can be offset in the near term, at least partially, by the decrease in input costs. Now for the long term we will use some hand-wavy economic theory about the effect of a minimum wage increase on nominal and real wages to assume that in the long run, prices of goods adjust to the higher minimum wage and everyone is right where they started before the wage increase (I really hope I did not open a Pandora's box here… If you are struggling with this, maybe you would like to just create your own scenario, but we can agree that a company would not just accept lower profits as a result of minimum wage changes). In addition to these assumptions, I also assumed that Same Store Sales would continue on their current trajectory and remain in line with consensus and management guidance. Overall, I think the DCF assumptions are reasonable and not overly aggressive. For those wondering, I have also not included any change in their taxes moving forward, which is very likely under the new administration.
As you can see from the sensitivity table, there might be some potential upside according to our model. But just to reiterate, this model and DCF are not for the creation of a price target. In the case of HABT, I am using it to provide us a general idea of where the company is heading. I do not think the DCF is robust enough for a price target, but definitely helpful to look at.
Moving on to some quick comps, the same we used in our Shake Shack article, we can see that, relative to the average of direct comps, HABIT is trading below on an EV/EBITDA basis. Using this average, we can calculate an implied share price using the average EV/EBITDA of comps and applying it to HABT. A few important things to note when it comes to this comp spread. Firstly, the implied share price is very crude, perhaps much more so than our DCF model. In addition, I have McDonald's Corp. (NYSE:MCD) listed here not as a comp but as a comparison between the fast-casual sector and a mature fast food chain. Looking again at EV/EBITDA, one question can be asked: Is 1 Shake Shack really worth 3 Habit Burgers? If the answer to that question is "no" then perhaps there is more to this story than appears.
Looking at analyst coverage on HABT (I know, I can't believe I said those words either but in this case, hear me out), we can see that the range of consensus estimates places a price target of $17-25, according to Bloomberg and Capital IQ. I think if you look closely at HABT, the numbers will show you that HABT is a company with strong fundamentals in a growing industry. Unfortunately, it has been overshadowed by the "hype" of some of its competitors.
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.
Additional disclosure: I am not a registered investment advisor or broker/dealer. Readers should conduct their own research and due diligence and obtain professional advice before making investment decision. I will not be liable for any loss or damage caused by information obtained herein. Readers are solely responsible for their own investment decisions.