Risky Business: Del Frisco's
Jon is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Joining the ranks of publicly traded companies, Del Frisco's Restaurant Group (NASDAQ: DFRG) went public earlier this year. Del Frisco's is home to three similar, yet separate, restaurant chains: Del Frisco's Double Eagle Steak House, Sullivan's Steakhouse, and Del Frisco's Grille. All three are considered to be a high-end dining experience, with "the Grille" being the most casual and economic of the three.
There are many things to like about this company. They pride themselves on being top performers in regards to customer service. Operating margins are among the best in the industry. And revenue growth has been in the double digits this year. But while there are several things to like, Del Frisco's is a risky business, and therefore a risky investment.
A Luxury Item
Perhaps I am revealing my social class with this statement, but Del Frisco's is a luxury item. Consider these average ticket prices according to Del Frisco's prospectus:
|Restaurant Concept||Average Ticket|
|Del Frisco's Double Eagle Steak House||$100|
|Del Frisco's Grille||$45-$55*|
This company, I believe, recognizes that its ticket prices are on the high end. That's why they are pursuing more growth with "the Grille" concept. But at $45/ticket, we still aren't talking cheap. Darden (NYSE: DRI) has an average closer to $26/ticket for their restaurants.
Remember that when things get tough financially, it is the high end purchases that normally get slashed first. That's why both Wal-Mart and McDonald's did so well during the financial crisis of 2008. Instead of shopping somewhere expensive, people turned to Wal-Mart. Instead of buying a $10 burger at a restaurant, people settled for a Big Mac. If things get tight again, perhaps people accustomed to eating at Del Frisco's will order a steak at Longhorn instead.
Beef prices have been steadily rising over the last couple years. It has gone up an average of about 10% a year since 2009. The cost of goods sold is much higher than many companies would like. Ruth's Hospitality Group (NASDAQ: RUTH) was able to beat the street in their most recent quarter, but "unfavorable" costs for beef, ate away at what would have been an even better quarter. Even though Del Frisco's has some of the best margins in the industry, higher food costs will affect those margins unless menu prices go up. But as we have seen, menu prices are already pretty high. It may not be in their best interest to raise prices even higher.
2013 looks like it could be a tough year for beef prices also. Some estimates say that beef prices will spike another 5% next year.
I know that you're probably tired of hearing about Hurricane Sandy affecting the economy, but this must be mentioned yet again in Del Frisco's case. In Del Frisco's prospectus, they had an interesting statement in the risk section:
"Our New York Del Frisco’s location represented approximately 19%, 20% and 18% of our revenues in 2009, 2010 and 2011, respectively...any natural disaster...in or around New York City could...lead to a decrease in revenues." (emphasis mine)
So it turns out that about 1/5th of this company's revenue is brought in from one location. Needless to say, as goes this location, so goes the company. Hurricane Sandy obviously classifies as a natural disaster, and it is hurting New York City's economy. Citigroup estimates that businesses could lose up to 2% of their 4th quarter profits because of Sandy. If that is the case, and it's likely, this is going to hit Del Frisco's New York location hard. If that store gets hit hard, their overall earnings will also take a hit.
We started off looking at a couple positives. But the risks involved with this investment are just too real for me. As I weigh this one out for myself, I'm pretty sure the positive doesn't outweigh the negative. In the end, only time will tell. But for me, Del Frisco's is risky business.
thequast has no positions in the stocks mentioned above. The Motley Fool owns shares of Darden Restaurants and McDonald's. Motley Fool newsletter services recommend McDonald's. 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.