Is This Restaurant Stock a Buy After Analyst Upgrade?

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Recently, Brinker International (NYSE: EAT) had been upgraded by research firm Sterne Agee & Leach from Neutral to Buy. In the recent article published in Barron’s, the upgrade was due to the potential increase in comparable store sales from the roll out of new menu items in the upcoming several quarters. It seems to be quite attractive, but let’s dig deeper to find whether it should be a Buy.

Chili's and Maggiano's 

Brinker, incorporated in 1984, is one of the larest global franchise restaurant operators, with more than 1,580 restaurants, 100,000 team members in 32 countries. Brinker has two main casual dining brands including Chili’s Grill & Bar and Maggiano’s Little Italy. Chili’s revenue per meal averaged $13.66 per person in fiscal 2012, with 86% food and non-alcoholic beverage related and the remainder derived from alcoholic beverages. Maggiano's, with higher entrée selection prices, generated around $26.10 average revenue per meal per person, with 82.9% from food and non-alcoholic beverage and 17.1% from alcohol sales.  The majority of Brinker’s revenue has been from Chili’s brand, with more than $2.36 billion out of the total $2.82 billion, whereas Maggiano’s revenue was only $388.6 million in fiscal 2012. In the same year, Brinker has recorded a 2.7% growth in its comparable sales, including a 2.6% increase in Company-owned restaurants’ comp sales and a 2.9% growth in Franchise restaurants’ comp sales.

Strong Cash Generator With Constant Share BuyBacks

In the last 10 years, Brinker has generated consistently positive EPS, operating cash flow and free cash flow, along with the consistent reduction in its shares count. In fiscal 2003, it had 149 million shares outstanding, and it had only 73.1 million shares as of September. Trailing twelve months, the EPS was $1.97; its operating cash flow and free cash flow were $306 million and $171 million, respectively. In the first quarter of fiscal 2013, the restaurant chain reported to have only $268 million in total stockholders’ equity, nearly $700 million in both short and long-term debt, and only $64 million in cash. The reason for such a low equity figure was due to the high level of stock buybacks as discussed above. As of September, it had more than $2.34 billion in treasury stock.

Analysts Bullish

According to Restaurant News, Chili’s just recently rolled out the new steaks line, Over the Top Steaks, with three items, all priced for less than $12 with two sides. Along with the new menu items, Brinker told Christopher O’Cull, analyst of KeyBanc Capital Markets that the new back-office menu software and kitchen retrofit including combination oven and impinge conveyor oven would be completed by the end of the third quarter 2013. Sterne Agee & Leach wrote in Barron’s:

We expect that several of these new menu items will be rolled out in the spring of calendar 2013, which will likely provide a catalyst for improving comparable store sales over the next several quarters. In summary, our upgrade is not a call on the current quarter, but rather our view that Brinker should be able to consistently generate 10%-15%-plus EPS growth with the potential for accelerating comps in second-half calendar 2013 and beyond.”

..Not a Best Choice Among Peers 

Compared to its peers including Darden Restaurants (NYSE: DRI) and DineEquity (NYSE: DIN), Brinker is the cheapest in terms of PEG ratio. Brinker is valued at 11.93x forward earnings and 1x PEG, whereas Darden is valued at a similar forward P/E but at 1.25x PEG, DineEquity is the most expensive, with 16.48x next year earnings and 1.6x PEG. Among the three, Darden is the least leveraged restaurant chain, with only 0.8x debt/equity, whereas Brinker and DineEquity had 2.5x and 6.1x D/E, respectively. Not only having the lowest debt level, Darden is also paying the highest dividend yield, around 4.2%. Brinker is also paying a dividend, but with lower yield of 2.3%. DineEquity doesn't pay any dividends.

Foolish Bottom Line

Brinker seems to be the cheapest if we factor in the potential growth.  However, Brinker is not as compelling as Darden, with the highest dividend yield and lowest leverage level. However, the total contractual obligations climbed up to $45.3 billion, with nearly $1.6 billion due within a year. This high level of leverage relates to their business model of company owned stores. Interestingly, Darden is transitioning itsel. It will be a nice company to play going forward. 

hoangquocanh has no positions in the stocks mentioned above. The Motley Fool owns shares of Darden Restaurants. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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