In the moat report card series, we test for the presence of a moat by analyzing the returns a company generates on the funds it invests -- its ROIC.
1. Over time, has the company earned a sufficiently high ROIC?
2. Is the ROIC of high quality?
3. Is the company maintaining and growing the returns it earns on invested capital?
For a full explanation of the scorecard, click here.
Here is a look at Brinker International's (NYSE: EAT) returns on capital to help us assess its moat.
ROIC history
Let's see how Brinker's three-year rolling ROIC has changed over time and in relation to its nearest competitor: Darden Restaurants (NYSE: DRI):
|
Company |
2007 |
2008 |
2009 |
5-Year Average |
|---|---|---|---|---|
|
Brinker's rolling ROIC |
14.2% |
16.6% |
17.6% |
14.8% |
|
Darden's rolling ROIC |
18.9% |
16.6% |
13.8% |
17.5% |
Data from Capital IQ, a division of Standard & Poor's.
Brinker's ROIC has increased consistently since 2004 on the back of its Chili's and Maggiano's franchises, and the company earns well in excess of its cost of capital. The company's closest competitor, which owns Red Lobster and Olive Garden restaurants, has also performed admirably. Other industry participants, like Applebee's operator DineEquity (NYSE: DIN) and The Cheescake Factory (Nasdaq: CAKE), have suffered declining returns on capital over the same period. Digging deeper, we see that Brinker has improved its results by catering to three key customer trends: stop-and-go lives, professionals, and experience- seeking. Customer-centric thinking and the adoption of a more flexible kitchen setup have helped focus on existing restaurants and drive returns. Brinker continues to be an industry leader, with more than 1,700 restaurants in 27 countries.
ROIC quality
Just like return on equity, there are only so many ways a company can juice its ROIC. The three levers are profit margins, asset turnover, and leverage. Here is the data for Brinker:
|
Brinker |
2007 |
2008 |
2009 |
5-Year Average |
|---|---|---|---|---|
|
After-tax operating profit margin |
5.6% |
6.7% |
6.2% |
5.7% |
|
Asset turnover |
1.96 |
1.98 |
1.95 |
1.92 |
|
Operating ROA |
10.9% |
13.2% |
12.1% |
10.9% |
|
ROA contribution to ROIC |
69.4% |
67.5% |
69.1% |
69.1% |
|
Leverage |
1.44 |
1.48 |
1.45 |
1.45 |
|
Its ROIC with industry leverage |
16.3% |
19.5% |
17.8% |
16.2% |
|
Industry ROIC |
14.4% |
12.4% |
11.2% |
13.8% |
Data from Capital IQ.
Brinker's profit margins have held steady at around 6% for more than a decade. However, a renewed focus on execution and efficiency has led to asset turnover increasing from 1.74 in 1999 to 1.95 in 2009. This seemingly small change has driven return on assets to 12.1% -- significantly higher than the 9.5% average of its competitors.
On top of its impressive operational performance, Brinker has used less leverage. When applying industry standard leverage to the company's operating performance, we see that its ROIC would look even more impressive when compared with its peers.
|
ROIC Growth |
5-Year Average |
Score |
Weight |
|---|---|---|---|
|
Average 3-year ROIC growth |
7.1% |
5 |
10% |
|
ROIC growth vs. Darden |
-3.1 |
4 |
20% |
Data from Capital IQ.
From our analysis so far, we should not be surprised that Brinker has improved its rolling ROIC for each of the past five years, with growth averaging 7.1%. While recent performance has been impressive, Red Lobster and Olive Garden were winning the battle just a few years ago. Darden's early ROIC growth keep Brinker and the Chili's gang from a perfect score in the ROIC growth category.
Pencils down
With all the numbers in, here's how Brinker International scored:
|
Weighting |
Category |
Criteria |
Final Grade |
|---|---|---|---|
|
30% |
Hurdle |
3-year average ROIC > 10% hurdle rate |
5 |
|
20% |
3- year average ROIC > competitor's ROIC |
5 | |
|
20% |
Quality |
High ROA contribution percentage |
4 |
|
10% |
Growth |
Rolling ROIC growth over time |
5 |
|
20% |
ROIC growth > competitor's ROIC growth |
4 | |
|
Total Score (out of 5) |
4.6 | ||
|
Final Grade |
A |
Even with an impressive global footprint and a strong brand, I am surprised that Brinker International scores an A and has a strong moat. The company's renewed focus on the customer's experience and operational excellence have distinguished its restaurants from others in the very competitive quick-service industry.
But sizzlin' steak fajitas and lasagna servings the size of a Smart Car don't automatically translate into a moat and high returns in the future. Prove the company's moat is enduring and buy at a reasonable valuation, and your portfolio will stand a better chance of surviving the scratches and flesh wounds that the market dishes out.
