Was the Second Quarter of Del Frisco's Restaurant Group Really That Bad?

Shares of Del Frisco's Restaurant Group (NASDAQ: DFRG  ) plunged as much as 18% following the company's release of second-quarter earnings. The reason? Its earnings per share of $0.20 came in a penny short of expectations and revenue of $67.4 million came in short of analyst expectations of $69.1 million. To top things off, management updated its guidance with caution stemming from delays in restaurant openings and even permitting difficulties associated with plans to commence lunch service.

In total, the market didn't like the news; while the shares recovered from intra-day lows to close down 12%, the market still reacted strongly to an earnings release that wasn't catastrophically bad. For investors who are interested in Del Frisco's for the long term, the question is whether this decline presents an opportunity to acquire its shares or reinforces a decision to opt for competing steakhouse brands such as Ruth's Hospitality Group  (NASDAQ: RUTH  ) or even Texas Roadhouse (NASDAQ: TXRH  ) . Here's a look at the latest quarter in light of the investment thesis that Del Frisco's presents an unique investment opportunity.

Strength on the top line
While its revenue fell short of analyst estimates, Del Frisco's did increase its revenue by 11.6% over the prior year. As a frame of reference, this growth is comparable to the expectation of 12% growth for Texas Roadhouse and roughly four times the growth expectation of 2.9% for Ruth's Hospitality; both companies are expected to report earnings in the next two weeks.

Del Frisco's revenue growth since its IPO clearly appears distinct from that of both Texas Roadhouse and Ruth's Hospitality:

DFRG Revenue (TTM) Chart

DFRG Revenue (TTM) data by YCharts

Taking a step back from consolidated growth, Del Frisco's reported an increase in comparable-restaurant sales of 2.3%. While it is certainly positive that Del Frisco's Double Eagle flagship brand reported its 18th consecutive quarter of positive comparable-restaurant sales with its 5.4% increase in comps, this strong performance was weighed down by growth of less than 1% from Sullivan's. The divergent performances of these two concepts will be important to monitor in upcoming quarters.


Source: www.delfriscos.com

Looking ahead, Del Frisco's remains committed to opening six locations during 2014 and five to seven locations per year going forward. However, it expects fewer restaurant operating weeks in 2014 because of temporary pressures; it expects delays to push the opening of a Del Frisco's Double Eagle and two Del Frisco's Grille locations later into the fourth quarter. Additionally, the company's Grille location in Palm Beach is experiencing delays in receiving authorization to serve brunch and lunch as well as the originally planned usage of its outdoor patio. 

While these issues forced management to revise its revenue estimates downward, they are temporary issues and do not impact the long-term growth thesis. Management revised the estimates downward due to the current run rate at Del Frisco's Chicago location; this struggle appears isolated at the moment, but it is certainly worth keeping an eye on in future periods.

Solid financial discipline
The big driver of the share price decline trickles down from the market's disappointment with top-line growth. On the expense front, Del Frisco's continues to deliver a cost of sales equal to 30% of revenue. The stability of this number over time is important given the rising costs of beef and other key ingredients on Del Frisco's core menu.

Thanks to tight control over costs, Del Frisco's earnings per share are expected to remain strong in 2014 at between $0.90 and $0.94. This is lower than analysts' prior estimate of $0.96 as a result of lowered expectations for revenue, but it is important to keep this in context. At the mid-point of the revised guidance, Del Frisco's trades at 24 times estimated 2014 earnings. Looking ahead to next year, Del Frisco's is trading at an attractive forward price-to-earnings ratio of 19 times 2015 earnings:

DFRG PE Ratio (Forward 1y) Chart

DFRG P/E Ratio (Forward 1y) data by YCharts

While this multiple is higher than those of Del Frisco's peers, it is quite reasonable in light of the company's superior growth potential. 

Expansion plans continue
One component of the second-quarter earnings release that deserves being reemphasized is the fact that the company's growth plans (both for 2014 and the long term) remain unchanged. Del Frisco's has just 41 locations today, and the company believes that it can grow its Grille concept from its 12 current locations to 170.

Thanks to a pristine balance sheet that consists of $12 million in cash and no debt, Del Frisco's has the flexibility to reinvest cash from operations into new restaurants or ramp up expansion financed by new debt issuance. 

In total, the current outlook for Del Frisco's calls for it to remain on track to deliver 17-20% earnings-per-share growth, as management illustrated in a recent presentation:

Source: June Management Presentation, http://investor.dfrg.com

It is a very simple model, but these reasonable targets combine to form compelling growth potential.

How much has really changed?
Del Frisco's didn't have a great second quarter, but did its recent results alter the long-term thesis? Not really. It is important for investors to monitor comparable-restaurant sales growth, particularly at Sullivan's. It is even more important for Del Frisco's to deliver solid results from Grille, its expected growth engine going forward. If management can deliver on these fronts, management's 17-20% EPS growth plan seems quite reasonable.

Considering the valuations placed on other restaurant chains with similar growth expectations, Del Frisco's valuation is just that much more attractive following the market's reaction to its second-quarter results.

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