- Habit reported earnings on Wednesday and they weren't great.
- Traffic was 3% lower and margins continue to deteriorate.
- Guidance was very weak and the stock is still way too expensive.
Habit Restaurants (NASDAQ:HABT) has been one of my highest conviction shorts for some time now. Actually, since the company came public a few years ago, it has been a pretty easy target to short. The stock is less than a quarter of its peak value today and after another ugly quarter, I couldn’t be more assured of my conviction that Habit is a short.
Breaking the downtrend is going to be tough
The stock is bouncing around as I write this but even if we get a rally in the coming weeks, there’s a lot to contend with overhead for the bulls. The stock will first have to take out the $10.35 relative high set back in December, followed by the gap lower from early November at $12. Those are likely to be sizable resistance points and they are also a very long way up from here. Rallying certainly isn’t impossible but I think it is more than fair to say that Habit bulls have their work cut out for them. Conversely, with a strong downtrend still in place, new lows look like the easy path.
Revenue was much higher but that's it
Apart from the chart, the fundamentals of Q4 don’t really look that great. Total revenue shot higher again, this time by 15%, as Habit continues to open a bunch of new units. At ~200 company-owned units, Habit is still pretty early on in its development of its footprint. This is especially true in areas outside the western US, where it is heavily concentrated today, leaving lots of room for expansion. The problem is that while it is opening lots of units, the ones it has aren’t exactly superstars.
Comps were down 1% in Q4 on a 2% gain in pricing but a 3% loss of transactions. The second bit – transaction count – is very important when it comes to assessing demand for a restaurant chain. The hardest job of a restaurant is to get people to turn up and traffic is the best measure of this. A 3% decline is meaningful and it is also something Habit has been grappling with for some time. If Habit cannot sustain demand at 200 units, how will it do with 400? 600? That’s a big problem for me. I think people are trying to price the stock like weak comps are transitory but they have proven to be anything but.
Margins fell again in Q4, continuing the trend for the full year of 2017. Food/paper costs were up 100bps, labor was up 120bps and occupancy was up another 100bps. Those three categories are the biggest expense items for any restaurant and all of them moved very unfavorably in Q4 due in no small part to comp sales moving down. When that happens, costs get deleveraged and margins move lower. All told, Habit’s operating margin was 10bps in Q4; let that sink in.
2016's Q4 operating margin of 3.7% looks gangbusters in comparison but of course, that’s not a very good number either. Habit, like Shake Shack (SHAK), Noodles (NDLS) or any other once-hot growth story you can name from this sector, suffers from perpetually low operating margins and the situation is deteriorating, not improving.
Lots of new units but even lower margins
Habit guided for 30 new units this year, representing right around 15% unit count growth. It also guided for comps to be flat to slightly positive, so there’s no real tailwind there. However, revenue should be up in the mid-teens this year yet again as the company continues to aggressively expand.
The problem is that margins are slated to get even worse than they were in 2017 as management guided for unit margins to move down to a range of 16% to 17%. For reference, I calculated Q4’s unit margins at 17.3%, meaning that this year will be even worse than last year. Perhaps that is why analysts have Habit earning just 11 cents this year despite the massive move up in revenue. The simple fact is that this company hasn’t figured out how to operate its restaurants profitably enough to cover its support costs on a sustainable basis and given where guidance is for this year, that doesn’t look like it is going to change anytime soon.
As the supply chain becomes more and more stretched as a result of Habit expanding its geographic footprint, I have to think these margin issues will only get worse. Unit growth is going to continue for a long time and that’s fine, but profitability is a huge issue. The Q4 report was yet more evidence that Habit’s long-term trend is down until further notice.
This article was written by
I've been covering financial markets for ten years, using a combination of technical and fundamental analysis to identify potential winners (and losers) early, particularly when it comes to growth stocks.
Analyst’s Disclosure: I am/we are short HABT. 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.
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