BJ's Investors Must Be Hungover After Earnings

Headaches, stomach pain, mood disturbances, and rapid heartbeat are all symptoms of a hangover. They might also describe how BJ's Restaurants (NASDAQ: BJRI  )  investors feel after the most recent quarter. The market was so rattled by this earnings report that the stock dropped 10% -- which only contributes to the stock having lost 50% in the last two years. What gives, and what hope is there for investors at this point?

What gives?
When we look back over the last couple years, BJ's Restaurants is a fast growing casual-dining chain and therefore traded at a high valuation. A growth stock often deserves a high P/E, but other times the market can get way ahead of itself.

When both the stock price and the P/E ratio are rising -- like BJ's and Chipotle  (NYSE: CMG  ) -- this can indicate that the stock is growing faster than earnings--in other words it's priced to perfection. All situations are different, but in BJ's and Chipotle's cases a little bad news caused big market corrections.

BJRI PE Ratio (TTM) Chart

BJRI P/E Ratio (TTM) data by YCharts

CMG PE Ratio (TTM) Chart

CMG P/E Ratio (TTM) data by YCharts

As you can see in both cases the P/E ratio and stock price largely rose and fell in tandem. Not all high P/E situations are like this. For comparison, consider high-flyer Chuy's (NASDAQ: CHUY  ) .

CHUY Chart

CHUY data by YCharts

Chuy's stock is up over 100% since its IPO, but its P/E ratio has fallen over 50% from the September 2012 highs. In short, the stock is trading more in-line with earnings than Chipotle or BJ's. It still trades with a rich valuation, with the P/E over 60. 

With the continuing Chipotle rally, the company's P/E is almost back to where it was in April 2012 before the stock crashed, though I'm not suggesting that the company is in trouble. Anyone who considers Chipotle's track record and future growth should believe in Chipotle's long-term opportunities. That doesn't eliminate the possibility of a temporary stock pull-back in the near future, though.

The market got a little ahead of itself with BJ's, and with the bad news of a 2.2% decline in comp-sales the stock came back down to earth. However, at current prices BJ's trades at a forward P/E of 24 -- just a slight premium to the industry average of about 20. So, is BJ's a good investment now that it trades at a more reasonable valuation?

Increased competition
BJ's cited increased competition as the main reason for decreased comp-sales and restaurant traffic. This pressure will only increase going forward. Darden's (NYSE: DRI  ) newly-acquired Yard House concept is primarily located in southern California -- BJ's territory. While Darden is experiencing growth problems with older concepts like Red Lobster and Olive Garden, the company is banking a lot on Yard House. Darden sees room for up to 200 Yard House locations nationwide, five times the current amount.

A wild card going forward is Ignite Restaurant Group's (NASDAQ: IRG  ) Brick House Tavern and Tap. This concept was the best performing concept for Ignite last quarter -- comp-sales increased 6.4%. Having seen success with Brick House, Ignite now plans to accelerate its expansion through franchising. Currently there are no Brick Houses in California, but doubtless this is on Ignite's radar.

If there is any consolation for BJ's investors it's that so far it looks like BJ's strongest competition is itself. The company noted that newer locations in California were cannibalizing sales at older locations. This is due to the company's "cluster" expansion strategy: fill out existing markets before moving into new markets to better capitalize on advertising and infrastructure. 

This doesn't look like a long-term problem now that BJ's is expanding into markets where it has a smaller presence, like Orlando. Expansion plans in 2014 call for 17-19 new locations -- 12% growth from current locations -- primarily in Florida. 

What now?
Though from an earnings perspective this was a disastrous quarter, business continues as usual for BJ's. It anticipates being able to maintain its growth targets by just using its cash reserves and free cash flow, without using its $75 million credit line.

As the company expands, revenue should also continue growing at a healthy pace. The uncertain factor is earnings per share. Over the past five years BJ's has grown trailing twelve month earnings per share by over 170%. This quarter's drop is an anomaly. I would wait for the next couple of quarters to come in before writing off this restaurant's ability to grow earnings.

Take a painkiller
Watching your investment crumble is painful. But for those who invested with the belief that this company can reach 400 locations, now is not the time to jump ship. Long-term there's still plenty of opportunity for BJ's. Given BJ's future growth opportunity and the current low valuation, it may be time to give this company a chance.

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