Habit Restaurants: Bottoming Out

Summary

• Habit Restaurants reported mixed Q4 results, but the stock rallied.
• The company has seen a string of weak comps and weaker margins over the last couple of years.
• New initiatives plus an easier hurdle should place the company in a position to improve key metrics this year.
• The stock is incredibly cheap on traditional financial metrics.

Restaurant stocks provide an interesting opportunity after the sector was beaten down in 2017. As the strong comp sales of the previous years led to increased competition, the weak numbers this year will reduce competition in the next few years leaving some strong operators like Habit Restaurants (NASDAQ:HABT) generating much improved results down the road and hence higher stock prices.

Breaking The Trend

The valuation of restaurant chains are based principally on the ability to grow comp sales and the restaurant contribution margin. Naturally, the balance sheet matters and other factors play a role, but the direction of the stock is generally based on those two key factors.

The massive comp sales figures from 2014 through 2015 set Habit up for this current negative comp hit. Getting rated as the top burger concept by Consumer Reviews came back to bite the company as comparisons became tough.

Source: Habit Restaurants ICR presentation

The Q4 comps were no different from the recent trend with a 1% decline in comp sales. One though needs to keep in mind that unit volumes were only $1.5 million back in 2011 so the burger concept struggling after reaching $1.9 million in 2016 shouldn't be a surprise or a big worry. After this period of weakness that started in 2016, Habit now has an easier hurdle in 2018 and beyond.

The addition of drive-thrus and delivery could provide a boost to the concept on top of any improvement in the sector. The company expects to add 15 drive-thru locations in 2018 after adding four during Q4. Habit Restaurants will go from only 18 entering Q4 to a target of doubling the store count with drive-thrus to 37 by the end of this year.

Habit has an advantage over other high-rated burger concepts that don't offer the drive-thru option, especially in a generation that prefers to eat at home and chill.

Declining Margins

Helped by the huge comps prior to 2017, Habit Restaurants generated strong restaurant contribution margins above 21%. The burger concept never matched the 25%+ margins of Shake Shack (SHAK) currently and Chipotle Mexican Grill (CMG) in the glory years, but any concept will reward shareholders with those previous margins.

Source: Habit Restaurants ICR presentation

Contribution margins dipped in 2017 and Habit only forecasts a level in the 16% to 17% range in 2018. These margins will not impress investors and explain why the stock is only worth $230 million despite a sales target of $390 million for the year. At close to $9, the stock trades near the all-time lows.

HABT data by YCharts

Tax reform helps as Habit is now predicting an effective tax rate that dips to 30% or below from previous levels around 42%. The company though has to get back to generating solid profits for the tax break to matter.

Over the last couple of years, the market shifted as labor costs rose along with competition, but the best place to invest is in beaten down concepts that have a track record of strong performance. Habit has been absolutely crushed since the hot IPO back in 2014 when the stock briefly touched above $40.

Takeaway

The key investor takeaway is that the opportunity exists to build a position as the burger concept beats conservative guidance going forward. The initiatives around drive-thrus, delivery and potentially breakfast will provide a tailwind for comp sales that will boost the key metrics that drive the stock price for restaurants.

The initial target is for the stock to trade at a meager forward P/S multiple of 1.0, up from the current multiple of 0.6.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in HABT over 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.

The information contained herein is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities. Before buying or selling any stock, you should do your own research and reach your own conclusion or consult a financial advisor. Investing includes risks, including loss of principal.