Don't Write Off This Company Like I Did

Chad is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

I'll admit that for years I wrote off Brinker International (NYSE: EAT) as a company I wished I could have invested in. I remember reading about Peter Lynch mentioning Brinker as one of his favorite stocks that he didn't buy. He said he knew about the company from his family's visits, but he didn't follow his own advice. While other companies like Chipotle (NYSE: CMG) and Buffalo Wild Wings (NASDAQ: BWLD) get more press because of their faster expected growth, Brinker keeps on going. 

The restaurant industry is highly competitive, and while other companies that started at the same time as Brinker have fallen by the wayside, the company continues to find ways to grow. Even facing stiff competition from newer entrants like Chipotle and Buffalo Wild Wings, Brinker's Chili's chain is still a destination restaurant for millions of Americans.

Just as an example of how difficult it is to stay relevant, competitor Darden Restaurants (NYSE: DRI) has been struggling to turn around the Red Lobster chain for years. While Darden has shown continued success at Olive Garden, the company isn't expected to grow as fast as Brinker. Many people might make the same mistake I did and assume that Brinker's growth days are over. Some might even ignore Brinker in favor of tracking the faster growing Chipotle or Buffalo Wild Wings. However, those two chains have suffered recently from difficult comparisons, and challenging input inflation.

Brinker, on the other hand, has diversified its menu enough that one particular cost won't necessarily derail growth. Just to help investors break some assumptions they might have about Brinker, let's take a look at the company's recent quarter.

While Brinker won't get an award for the most exciting revenue growth, with an increase of just 2.5%, there is much more to this company than growth. The company increased diluted EPS by 23.3% due to a combination of revenue growth, share repurchases, and cost controls. Brinker's primary chain, Chili's, showed comparable store-sales up 2.8%, and the smaller Maggiano's comps. were up 0.9%. The company also showed good operating cash flow growth of over 10%.

Brinker management is committed to repurchasing shares and retired 2.5 million shares at an average price of $34.52. Since shares are currently trading at under $31, investors have a chance to buy at a price below what management just paid. What might be more impressive is that the company has now retired 8.4% of their diluted shares since last year. The company has made these share repurchases happen through their free cash flow, and this is one measure in which Brinker excels.

When it comes to free cash flow production, one of the aforementioned companies produces more on average than Brinker. The best way I've found to compare companies free cash flow production is through their free cash flow per $1 of sales. Using this measure, the category leader is Chipotle, which generates $0.20 of free cash flow per $1 of sales.

However, the comparison to Chipotle is a bit unfair because the company is more of a take-out restaurant, rather than a traditional sit down restaurant like Chili's. Looking at Brinker and their direction competition, they lead the way. Brinker generates about $0.06 of free cash flow per $1 of sales. Darden Restaurants and Buffalo Wild Wings generate $0.05 and $0.03 of free cash flow, respectively. This free cash flow outperformance also makes Brinker an attractive investment because of its yield and potential for dividend increases.

Brinker pays a current yield of 2.6%, and in the most recent quarter this dividend used 54.50% of free cash flow. While it's true that Darden pays a higher yield at 3.8%, the company also uses more of its free cash flow, at nearly 62%. In addition, Darden's struggles at the Red Lobster chain cause me to cautiously approach the company. Since neither Chipotle or Buffalo Wild Wings pay yields, investors have to hope for capital gains.

As investors in both companies have found out recently, these capital gains may be more difficult to achieve than they once thought. Brinker, on the other hand, is expected to grow earnings by about 13.5% over the next few years. Since the company's cash flow growth has been slightly trailing EPS growth, in theory investors might expect 10% growth in the dividend during this same time frame. If you look at a combination of factors, Brinker might be one of the best values in the restaurant industry.

Brinker currently sells for just under 12 times next year's projected earnings. While Darden sells for about the same forward P/E ratio, this competitor is expected to grow slower by almost 2% per year. Both Buffalo Wild Wings and Chipotle are expected to grow faster, but each company's recent earnings call into question if this future growth will be realized. In addition, each of these companies sells for a forward P/E ratio that is almost double what Brinker sells for. When you look at buying an established restaurant for under 12 times earnings that is expected to grow at 13.5%, that already might be a good enough deal for some investors.

However, when you add in a 2.6% yield that is likely to grow by double digits over the next few years, you get a great combo plate of growth and income. Investors shouldn't make my mistake and overlook Brinker; I would suggest adding this company to your personalized Watchlist today.

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MHenage has no positions in the stocks mentioned above. The Motley Fool owns shares of Buffalo Wild Wings, Chipotle Mexican Grill, and Darden Restaurants. Motley Fool newsletter services recommend Buffalo Wild Wings and Chipotle Mexican Grill. 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.If you have questions about this post or the Fool’s blog network, click here for information.

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