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What Chuy's Management Doesn't Want Shareholders to Focus On

By Andy Gould – Sep 23, 2016 at 5:11PM

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Investors should pay close attention to these three things going forward.

Image source: Chuy's Holdings.

Chuy's (CHUY -1.26%) is the casual Tex-Mex restaurant chain that's on a mission to double its store base over the next three to five years. Quarter after quarter, Chuy's management consistently points to its impressive revenue growth and store-level cash flow (EBITDA) numbers as evidence that its future is a bright one.

However, Chuy's last quarterly report also revealed a few things that could be troubling for shareholders. While I think Chuy's makes for an enticing long-term investment, here are a handful of items we'll want to keep an eye on in the quarters to come. 

Could negative traffic be pointing the way to negative comps growth?

In the second quarter of 2016, Chuy's posted positive year-over-year comparable restaurant sales growth of 1%, its weakest performance since the company went public in 2012.. Dig a little deeper, however, and you'll see that quarterly traffic actually declined 0.5%. The 1% positive comps number was the result of a 1.5% increase in the average guest check. (It's worth noting that these issues are not unique to Chuy's, with the broader restaurant industry posting same store sales decreases of 0.7% and traffic declines of 3% for the quarter.) 

Additionally, management lowered their comps growth guidance for full-year 2016 -- from 2% to flat-to-1%. Is Chuy's just being prudent, given the slowdown in the industry? Or is it possible that Chuy's 24 consecutive quarters of comps sales growth are on the verge of petering out?

Higher costs for food, labor, and occupancy could hit Chuy's right in the EBITDA

Chuy's experienced higher beef costs last quarter and is already seeing increases in produce, chicken, and dairy prices early in the third quarter. As a result, Chuy's expects its cost of sales (as a percentage of restaurant revenue) to rise from 25.5% to the low 26% range during the back half of 2016.

Chuy's also saw increased labor costs last quarter related to the opening of new restaurants and now expects that those cost pressures will continue for the balance of the year. As a result, labor costs as a percentage of revenue seem likely to rise above last quarter's figure of 32.7%. 

Finally, Chuy's is set to enter the Chicago and Miami/South Florida markets in 2017. New market expansion is crucial for the company's growth plans, but these two markets in particular have been noted as "higher rent districts" that will result in higher occupancy costs going forward. In fact, the company expects occupancy costs as a percentage of restaurant revenue to rise from last quarter's figure of 6.4% up to the "high 7s to low 8s" over the next few years.

Taken together, the items above have the potential to compress Chuy's sterling restaurant-level EBITDA margins -- perhaps by two percentage points or more, according to my math.

Is store growth about to slow down, too?

There may be nothing is as important to Chuy's future as continuing to open new stores. Over the past five years, annual store growth has averaged nearly 25%. And as recently as June 2016, CFO Jon Howie stated that even from today's larger base, the company believes it can continue to grow its restaurant count by around 20% a year.

However, on Chuy's second quarter 2016 conference call in August, CEO Steve Hislop said that, moving forward, they were comfortable setting expectations for annual store growth in the "high teens." Now, high teens could mean 19%, which isn't all that far from 20%. Or it could mean 17%. Either way, it would appear that Chuy's is beginning to dial down expectations. Keep in mind, though, that Chuy's goal to double its store base in three to five years only requires 15% annual store growth.

Are these anything more than fluffy white clouds on the horizon?

It's too soon to tell if there's any kind of storm brewing here. Although Chuy's is not currently suffering from negative comps, contracting margins, or stalled growth plans, any one of these would cause investors some serious heartburn.

Personally, I think it's likely Chuy's will manage its way through all these challenges. But after besting analyst estimates for five quarters in a row, it looks like the company will have to overcome a few new headwinds if it's going to continue its impressive streak of outperformance.

Andy Gould owns shares of Chuy's Holdings. Andy Gould has the following options: short January 2017 $30 puts on Chuy's Holdings. The Motley Fool owns shares of and recommends Chuy's Holdings. The Motley Fool has the following options: short October 2016 $30 puts on Chuy's Holdings. 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.

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