A Recovery You Can EAT

Peter Lynch used to say that he liked keeping up with restaurants because their business is easy to understand, and he could count eating out as research. Brinker International (NYSE: EAT  ) is a company Lynch noticed years ago, but today many investors might believe the owner of the Chili's chain is simply too big to offer good returns. However, if you ignore the "too big to succeed" idea, this company might spice up your returns.

A better value
One of the best ways to compare companies that pay dividends with those that do not is by using the PEGY ratio. This ratio, used by Lynch, divides a company's P/E ratio by the sum of its projected growth rate and current dividend yield. The lower the number, the better the value as it is priced more cheaply relative to earnings growth and yield.

Among Brinker's peers, we can count companies like Darden Restaurants (NYSE: DRI  ) and its Red Lobster and Olive Garden chains. We can also count faster-growing concepts like Buffalo Wild Wings (NASDAQ: BWLD  ) and Panera Bread (NASDAQ: PNRA  ) . While Buffalo Wild Wings is more of a traditional restaurant, and Panera offers a fast-casual option, each is a competitive threat to Brinker's Chili's and Maggiano's chains.

Among these companies, Buffalo Wild Wings is relatively the most expensive. With a forward P/E ratio north of 30, and analysts calling for 18% EPS growth, the company's PEGY is 1.67 (30 / 18%). Darden is growing much slower than Buffalo Wild Wings, but investors are paying almost the same multiple with a PEGY of 1.58. Though Darden pays a 4.4% yield, the company is only expected to grow earnings by 6%. For a stock with a forward P/E ratio over 16.4, this combination of growth and income seems too little to justify the current valuation.

Panera Bread sells for a forward P/E of nearly 25, and analysts are calling for growth of about 17.5%, or a PEGY of 1.43. By comparison to its peers, Brinker's combination of traits seem more attractive. The stock sells for a forward P/E of about 15.5, but with expected earnings growth of 13.6%, and a yield of about 1.8%, the PEGY is 1.01. Brinker looks like a better value, but the natural question is, does the stock sell for a discount for a reason?

A recovery in plain sight
One of the most popular ways to measure a restaurant's success is by its same-store sales growth. One reason Brinker might be valued less than its peers is the company's relatively weak same-store sales results.

Buffalo Wild Wings and Panera Bread were the strongest performers of this peer group, with both companies reporting that same-store sales increased by 3.8%. On the other end of the spectrum, Darden reported that comps were down at its three largest chains. In the middle of the pack was Brinker, which reported Chili's domestic comps were down 0.3%, while international comps were up 2.3%. The company also saw a 0.2% increase in comps at Maggiano's.

Brinker did offer some color about how its traffic was doing rather than just reporting overall sales. Last year, the company's domestic traffic at the larger Chili's chain was up 1.5%, but this year, Chili's has been struggling with decreased traffic.

However, in the last three months, the company saw traffic decline 2.5% in April, 2% in May, and 1.7% in June. While the company still has a long road ahead, it seems clear that the trend is improving. If Chili's can continue to improve its domestic traffic trends, this will help the company's already prodigious cash flow.

Cashing in
If you want one reason to buy Brinker International, consider the company's peer-crushing free cash flow. Using core free cash flow (net income plus depreciation minus capital expenditures) per dollar of sales gives us an apples-to-apples comparison between Brinker and its peers.

By this measure, Brinker is unequaled, with $0.22 of core free cash flow per dollar of sales in the last quarter. Panera Bread comes in a distant second with $0.06 of free cash flow. Buffalo Wild Wings might be expected to grow faster, but the company's $0.03 of free cash flow per dollar of sales means investors might not see much from this growth. Darden is struggling with a huge debt burden, and generated just $0.01 of free cash flow per dollar of sales.

Considering Brinker's better valuation, improving traffic trends, and huge free cash flow, this growth story seems far from over. The company is expanding internationally, and has just scratched the surface of its potential overseas. If this looks like a company you may want to sink your teeth into, head over to Fool.com and get EAT on your Watchlist today.

The retail space is in the midst of the biggest paradigm shift since mail order took off at the turn of last century. Only those most forward-looking and capable companies will survive, and they'll handsomely reward those investors who understand the landscape. You can read about the 3 Companies Ready to Rule Retail in The Motley Fool's special report. Uncovering these top picks is free today; just click here to read more.


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