Investment Thesis

With dining rooms reopened, the comparable sales of Brinker International, Inc. (EAT) have bottomed out. The off-premise business, strengthened by a virtual-only brand, can benefit from a resurgence of the pandemic even as virus fears keep customers away from indoor dining. Though delivery charges can strain the margins, the latest industry data suggest otherwise. The pandemic’s uncertainty needs solid financials, but the company’s gearing remains high, and the interest cover has dropped along with earnings. Yet, the balance sheet looks stronger compared to peers, and cash flows have remained robust throughout the pandemic.

Despite a meteoric rise since hitting a record low in March, the shares continue to underperform the sector on a year-to-date basis. The forward 12-month EV/EBITDA multiple stands at a discount to peer average, which, along with our EBITDA forecasts for the current fiscal year, suggests an undervalued stock. Brinker is, therefore, a ‘Buy for us as the company, thanks to a reinvigorated off-premise channel, looks well-positioned to ride out the downturn until a vaccine brings pandemic under control, most likely next year.

Binker International_Restaurant ImageSource: The Company Website

The New Normal

The pandemic-driven lockdowns that swept across the U.S. in March and April prepared the country for what was largely an unknown contagion back then. The health authorities ramped up the resources to fight a surge in cases, and businesses such as restaurants devised strategies to adapt to a new normal. When the stay-at-home orders closed the dining rooms, the QSR chains with robust off-premise channels thrived. The dine-in reliant casual operators bore the brunt of the impact as their comparable sales along with share prices plunged to multi-year lows in March. The lockdown measures have eased, and the dining rooms have reopened, albeit with capacity limits. But the resurgence of the pandemic keeps the dine-in outlook uncertain. Those who quickly pivoted to an off-premise-driven model will survive the disruption as the consumer tastes for delivery and takeout remain sticky as long as virus fears linger.

Recovery Continues

With over 1.6K-strong fleet of outlets mainly located in the U.S., Texas-based Brinker operates two casual dining brands: Chili’s Grill & Bar accounts for over three-quarters of company outlets generating ~90% of overall company sales, while the US-based Maggiano’s Little Italy is a polished casual concept serving Italian-American cuisine. As both brands witnessed the first full quarter of pandemic’s damage in Q4 FY20 (fourth quarter of fiscal 2020), the comparable sales of the company-owned outlets dropped ~36.7%. Buoyed by the off-premise success that partially offset the impact, the company went on to introduce a virtual-only brand. Launched in June, It’s Just Wings™, operating out of over a thousand company-owned outlets, is available only on the DoorDash delivery platform. The creativity to strengthen the off-premise channel paid dividends when dining rooms reopened in 84% of owned-outlets by June, leading to a sequential improvement in comps.

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With ~36% of owned outlets turning positive comps, negative comps at Chili’s dropped to ~10.9% in the first period of FY21 (fiscal 2021), down from a ~32.2% decline in Q4 FY21. Nevertheless, citing the COVID-19 uncertainty, the company issued no long-term guidance and projected a quarterly estimate for the just-concluded quarter instead. Yet, the latest quarterly results from Bloomin’ Brands, Inc. (BLMN) for Q3 2020 (third quarter ending September 2020) offer a glimpse of the current industry outlook.

Creativity Lifts Off-Premise Business

Both rivals in the casual dining space have a significant presence in the South, one of the hardest-hit regions from the summer surge in COVID-19 cases in the U.S. Despite the return of dine-in operations, Bloomin’ said the segment made up only 61% of sales as the company retained 50% of off-premise sales achieved during the lockdowns. The comp decline in company-owned outlets dropped from ~39.4% in Q2 2020 to ~12.8% as the recently-launched virtual brand started its expansion outside Florida due to strong consumer demand. Brinker, meanwhile, expects its virtual concept to generate ~$150 million incremental sales within the first year of launch.

Even with no novelty in the off-premise channel, the peers, Texas Roadhouse, Inc. (TXRH), and Darden Restaurants, Inc. (DRI), have witnessed a gradual improvement in same-store sales. Roadhouse posted a ~13.0% decline in comps in July down from ~14.1% in June, while Darden had only a ~ 29.0% decline in Q1 FY21 from 47.7% in the prior quarter as off-premise sales supplemented the dine-in operations. In the long term, the struggling independent restaurants offer another path for revival for well-established operators. Unable to cope up with pandemic-driven challenges, as many as ~100K independents in the U.S. will go out of business this year, according to National Restaurant Association, and the survivors will take their market share to thrive in a post-pandemic world. As the graph of Wall Street forecasts for comps indicates, Brinker is more likely to have met the targeted comp decline of mid-to-low teens for Q1 FY21, as dine-in operations gain steam and off-premise business retains the market share. Yet, the current consensus estimates of $3.3 billion of revenue for FY21 looks overly bullish as it implies a ~8.2% YoY (year-over-year) growth and 100.0% recovery of pre-pandemic LTM (last twelve-month) sales through Q2 FY20. Being conservative, we expect the revenue to remain flat for the year generating ~$3.0 – 3.1 billion, a recovery of ~91.0 – 93.0% of the pre-pandemic sales.

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Binker International_Same Store Sales_2 Source: TIKR.com

Rival Recovers the Margins

However, the off-premise-led growth could come at the expense of margins. During FY17-19, Brinker’s restaurant-level operating margin hovered at ~13.2-15.7%, as restaurant expenses that capture the effects of off-premise business made up ~29.8% of overall restaurant expenses on average. That proportion rose to more than a third in Q4 FY20, dragging the margins to ~6.4% as Brinker pivoted to an off-premise-driven model. But the latest data from Bloomin’ indicates the industry’s resilience to preserve margins even through a value-driven sales strategy.

In the latest quarter, Bloomin’s restaurant-level operating margin has surged to ~10.7% from ~2.1% in Q2 2020. The gap between the 2017-19 average of ~15.0% at 4.3 percentage points should further narrow as the sales momentum continues. Even through price discounting, menu optimization yielding efficiency gains have driven the margin expansion. For Brinker, however, a menu overhaul is not feasible as the company revamped its menu over two years ago. But, unlike Bloomin’, the company hasn’t yet resorted to discounting, and the virtual brand utilizing minimum capital resources is unlikely to be a strain on the cost base. Given ~11.6-13.8% of EBITDA margins in FY17-19, we believe a ~9.8-10.0% of EBITDA margin for FY21 in line with the consensus is appropriate with ~$297.2-310.0 million of EBITDA, implying ~9.2-13.8% of YoY growth.

Binker International_YTD Share PriceSource: Koyfin

Binker International_Valuation Multiples Source: Koyfin

Trading at a Discount to Peers

Since hitting the lowest in more than a decade, Brinker has risen nearly six-fold in value, but the year-to-date total return of ~7.7%, well underperforms the ~11.4% gain in the Dow Jones Restaurant & Bars Index. With a premium of more than a fifth to Brinker’s NTM (next twelve-month) EV/EBITDA ratio of ~13.1x, the peers, Roadhouse, Darden, and Bloomin’ trade at an average of ~15.7x. Assuming the latter, our EBITDA forecasts for Brinker indicate an upside of ~14.0-23.9%, a compelling ‘Buy’ in a casual diner fast adapting to the new normal.

Binker International_ValuationSources: The Author; Data from Seeking Alpha, and Author Estimates

Binker International_GearingSource: TIKR.com

A Peer Leading Balance Sheet

However, despite a slump from the recent peak, the company’s gearing remains high, while interest cover has depressed amid dwindling earnings. Yet, compared to peers such as Bloomin’ and Darden, whose cash flows turned negative in the pandemic, the company’s balance sheet looks solid, and operating cash flow has remained positive even through the slowdown.

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Binker International_Gearing_2

Source: Koyfin Binker International_Operating cashflow

Source: TIKR.com

Meanwhile, the pandemic is resurging in the U.S., and the authorities now fear the worst in the winter as the country just posted the highest single-day tally of new cases. Even though economic compulsions make another wave of mass lockdowns unlikely, the virus fears will keep the diners indoors. Nevertheless, unlike during the lockdowns, Brinker, thanks to reinforcements in delivery and takeout, is now well-equipped to offset the impact. Besides, the company’s liquidity, at ~$576.2 million, including a revolving credit facility worth ~$527.1 million, looks robust despite the recent credit downgrades. With enough firepower to tide over the slowdown, we believe Brinker is setting itself up to return to business as usual once the normalcy arrives with a large-scale vaccination drive against COVID-19, most likely in April 2021, according to experts.

Conclusion

Though lockdowns turned its comparable sales negative at the height of the pandemic, Brinker, having reopened its dining rooms, is heading for a sequential sales improvement. Pandemic’s resurgence can hurt the dine-in recovery, but the off-premise business is ready to resist the disruption. Despite the recent rally, the shares continue to trade at a discount to the average peer multiple, which indicates an undervalued stock with our EBITDA forecasts. Gearing level remains steep, and interest cover is low, but given its peer-leading balance sheet, we turn ‘Bullish’ on Brinker as the company survives the slowdown thanks to a creative off-premise business working in tandem with dine-in operations.

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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.



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