BJ's Restaurants: Cheap, But For A Reason

Summary

• BJ's Restaurants had a tough Q3, with lower than optimal staffing levels weighing on sales performance and inflationary pressures in proteins, which impacted margins.
• While a path back to historical margins is possible with improved staffing and taking price, it could be a long recovery, especially with the unexpected emergence of new variants.
• After a 40% correction from the stock's highs, BJ's remains reasonably valued, but I don't see enough margin of safety to justify jumping into the stock here at $36.00.
• To summarize, I think there are safer bets elsewhere in the market, but I would become much more interested if the stock were to dip closer to $31.40 per share.

RLWPhotos/iStock Unreleased via Getty Images

2021 was a tough year for the restaurant industry, and the performance was quite bifurcated. While industry leaders like Wingstop (WING) and Chipotle (CMG) posted strong double-digit returns, many dine-in brands ended the year in negative territory. One of these names was BJ's Restaurants (NASDAQ:BJRI), which gave up all of its 2021 gains and ended the year down 10%. While BJ's should see a strong recovery in 2022 as staffing improves, it's less clear whether the company will be able to claw back all of its margin losses from pre-pandemic levels. So, with the stock offering only a slight margin of safety at $36.00, I think there are more attractive bets elsewhere.

(Source: Company Presentation)

BJ's Restaurants opened its first restaurant in 1978 and has grown steadily, increasing to 212 restaurants in 29 states as of the most recent quarter. However, after decades of thriving, the global pandemic has put a meaningful dent in comp sales and margins, with comp sales slightly negative on a two-year basis in the most recent quarter. This certainly hasn't been helped by the simultaneous surge in employees leaving the restaurant sector, with restaurant jobs still 800,000 below pre-COVID-19 peak levels (February 2020). Let's take a closer look at the company below:

(Source: Company Presentation)

In November, BJ's released its Q3 results, reporting revenue of $282.2 million, a roughly 2% increase from Q3 2019 levels. This increase in revenue was related to a slight increase in unit growth, with 212 restaurants in Q3 2021, up from 208 in Q3 2019. Unfortunately, comp sales remained negative in the period despite the increase in consumers dining out, with the Delta Variant putting a minor dent in traffic and making the staffing situation more complicated. At restaurants that were fully staffed, BJ's managed to post positive comps. However, across the system average, increases in team member exclusions led to lower seating capacity and limited hours (closing 1.3 hours earlier than usual).

(Source: Worldometers.info, United States COVID-19 Cases)

While Q4 was likely better due to reduced impact from the Delta Variant, the emergence of the Omicron variant likely put a small dent in sales in the final period of Q4, and cases continue to trend in the wrong direction. As of the most recent readings, daily cases came in near 300,000, and they are rising in every state except Iowa and New Mexico. This alarming number of cases may have contributed to softer traffic at BJ's in the holiday season, and could certainly impact a meaningful portion of Q1.

(Source: Company Filings, Author's Chart)

However, the issue isn't just minor traffic headwinds. This is because as of Q3, BJ's had only half of its restaurants at 2019 staffing levels, which doesn't leave much of a buffer if there were team member exclusions. Given the high positivity rate of the Omicron variant relative to Delta, this could translate to a higher proportion of team member exclusions due to positive cases. So, while it's difficult to measure the impact, we could see continued headwinds related to seating capacity and operating hours, which will impact Q4 and Q1 sales, and could also hit margins, with increased hiring/training required, and the possibility that BJ's may need to continue to pay overtime for staff that are able to work.

As shown in the chart above, revenue estimates for Q4 are currently projecting a ~2% increase in sales on a two-year basis ($296.1 million vs. $291.1 million), with similar growth expected in Q1 2022 ($308.9 million vs. $301.1 million). This is certainly a massive improvement from 2020 levels, and there's a meaningful upside to these figures if staffing levels can improve across the system. Still, these growth metrics pale in comparison to names like Darden (DRI), with ~10% revenue growth in its most recent quarter vs. 2019 levels, and Texas Roadhouse (TXRH), with more than 30% growth. Obviously, the latter benefits from its significant footprint in Texas, which has seen fewer restrictions and better staffing levels, evidenced by the below chart.

(Source: National Restaurant Associated, Bureau of Labor Statistics)

One could certainly argue that BJ's will bounce back from these issues and that as staffing levels improve, the company will see a meaningful recovery in annual revenue and earnings. While I don't doubt this will occur, there is a higher risk to this recovery owning BJ's vs. brands that are continuing to put up strong sales performance in both the dine-in and fast-food space. So, while a bet in BJ's could pay off if we don't see any new variants, or if Omicron fizzles out quickly and barely affects the Q1 results, the road to recovery could be a limp if another variant emerges later this year.

(Source: National Restaurant Association, Bureau of Labor Statistics)

The other major issue for BJ's has been margins, which are impacted by higher labor costs and inflationary pressures. While BJ's is in a better position than some peers due to its ~80% margins on pizza and alcohol and its bar setting, its restaurant-level operating margins dipped to 11.2% in Q3, a 230 basis point decline from Q3 2019 levels. Until traffic levels can improve and staffing levels can be retained at optimal levels, it will be tough to claw back these margin losses, especially with many restaurants guiding for more inflationary pressures in H1 2022.

In the Q3 Conference Call, BJ's stated that it does not see anything changing in its long-term perspective to get back to historical margin levels. However, the timeline on this is unclear, and it certainly looks like it could be pushed out based on the Omicron variant. So, with a higher share count due to selling 3.5 million shares at $20.00 in Q2 2020 and more shares in Q1 2021 combined with margin pressure, BJ's earnings recovery is well below that of industry leaders like Darden and Texas Roadhouse. This is shown below, with another year of net losses expected in FY2021 based on current estimates.

(Source: YCharts.com, Author's Chart)

Looking ahead to FY2022 and FY2023, there appears to be a light at the end of the tunnel, with annual EPS estimates sitting at $1.54 and $2.12. However, even if these estimates are met, FY2022 annual EPS would be more than 30% below the FY2018 peak ($2.35), while FY2023 annual EPS estimates would be roughly 10% below the prior earnings peak. If we compare this to brands like Darden that are buying back shares and enjoying positive comps, it's on track to see annual EPS increase more than 40% from pre-pandemic levels in FY2023. So, it's hard to argue for owning the stock unless we can buy a company like BJ's at a deep discount to its peers. Let's take a look at the valuation below:

Valuation & Technical Picture

Looking at the chart below, we can see that BJ's Restaurants has traded at an average earnings multiple of ~23 since the end of the 2016 cyclical bear market for the S&P-500 (SPY). Based on FY2022 earnings estimates of $1.54, BJ's trades at 23.4x forward earnings at a share price of $36.00. While this is near the historical multiple, assuming estimates are met, I would argue that an earnings multiple of 23 is generous given the industry-wide headwinds. This is because we could continue to see inflationary pressures over the next year, and staffing issues are also likely to persist medium-term.

The latter is evidenced by restaurant employment being below pre-COVID-19 levels, despite wage increases across the board (~800,000 fewer jobs than February 2020 levels). While BJ's noted that it has seen staffing levels return to near 2019 levels at half its restaurants, persistent labor tightness in the industry related to "The Great Resignation" could create more competition. This means that restaurants like BJ's may need to increase wages further over the next couple of years to ensure full staffing levels. Therefore, the pre-COVID-19 earnings multiples are less relevant.

(Source: FASTGraphs.com)

Based on what I would argue to be a more conservative multiple of 18x earnings, I see BJ's fair value closer to $38.20-39.20, even if we factor in FY2023 earnings estimates of $2.12-2.18. This does not translate to much upside for the stock from current levels, and certainly not much of a margin of safety. Even using just a 20% margin of safety to the upper end of fair value, the stock would need to dip below $31.40 to become attractive. Let's take a look at the technical picture below:

(Source: TC2000.com)

As shown by the chart above, BJ's Restaurants has seen a sharp decline from its early 2021 highs, with extreme exuberance among restaurant stocks following the news of vaccine approvals in December 2020. The stock has since fallen more than 40%, and this has left a strong resistance level overhead at $44.80, where the stock saw strong selling pressure in July, August, and September of last year. Meanwhile, the next strong support level doesn't come in until $29.25. At a current share price of $36.00, this translates to a reward/risk ratio of 1.30 to 1.0. For BJRI to meet my minimum criteria of a 4 to 1 reward/risk ratio, the stock would need to dip below $32.50. To summarize, this does not appear to be a low-risk buy point.

BJ's benefits from some of the strongest AUVs among its peers ($5.5+ million), and with an average guest check that sits below $20.00, the company should have pricing power. Meanwhile, though Q4 and early Q1 performance might be weaker due to team member exclusions and reduced traffic, the business should bounce back strongly by H2 2022 and FY2023. Having said that, with the stock trading at ~23x FY2022 earnings estimates and more than 17x FY2023 estimates, I don't see enough of a margin of safety here, especially if the recovery is slower than expected due to the continued emergence of variants. Therefore, while I think the stock would become more interesting below $31.40, I am remaining on the sidelines for now.

Analyst’s Disclosure: I/we have a beneficial long position in the shares of QSR either through stock ownership, options, or other derivatives. 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.

Disclaimer: Taylor Dart is not a Registered Investment Advisor or Financial Planner. This writing is for informational purposes only. It does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Taylor Dart expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.

Comments

[bazooooka]

Kind of meh now but this was a great one near twenty bucks

[SquareBear]

It’s hard to beat pizza and house-brewed beer margins, so BJRI earns their premium. But substantial labor / ingredient cost and traffic headwinds continue for casual dining.
It would be cool to see these guys cook up a fast casual concept in smaller boxes, a la Chipotle.