Chuy's Holdings (NASDAQ:CHUY) has garnered a lot of attention from both bulls and bears. Bulls cite double-digit earnings growth and a long runway to expand the chain. Bears will counter that the stock is up over 100% since its IPO last year, and the P/E ratio is north of 80. With the company reporting earnings after the close on Wednesday, what do long-term investors need to consider?
Any investor who buys into Chuy's essentially buys into the company's ability to expand the business in order to grow revenue and earnings. With only around 45 locations the chain has quite a way to go before reaching its ultimate goal of 500.
Long-term investors need to pay extra attention to any information about restaurant performance in Richmond, Greenville, and Kansas City. The majority of Chuy's restaurants have been located in Texas up to this point, but more recently the company branched out into these newer markets. Some argue that the Chuy's concept won't resonate with diners in other regions. As the numbers start coming in we should be able to see whether or not that's actually true.
More importantly, the company has expanded into these newer markets with just one location each. Soon it will turn its attention to filling out these particular markets. As these markets fill out certain expenses like advertising and infrastructure should decrease -- just having one location in Kansas City is more expensive as a percentage than having six locations. Therefore it's important that these initial locations perform well so the company can fill out those markets.
Revenue and earnings
Last quarter revenue increased 23% and earnings per share increased 29% year-over-year. This growth was primarily attributed to 12 more locations in the second quarter this year than in the second quarter last year. Expect similar results this quarter.
One area of focus should be on if the company can continue growing earnings faster than revenue. For comparison, in its most recent quarter BJ's Restaurants (NASDAQ:BJRI) reported a 7% increase in revenue but a 47% decrease in net income. BJ's added new revenue from new units but lost ground with declining comp-sales. This comp-sales pressure contributed to higher costs -- cost of sales and labor, specifically -- which caused the net income loss.
Up to this point Chuy's has been improving efficiency and cost control, which has led to faster earnings growth than revenue growth. This trend needs to continue into the third quarter for the company to justify its lofty valuation with a forward P/E over 40.
I have a hunch that the majority of investors are going to be focused right here on comp-sales. Yet this isn't an area of extreme attention from Chuy's management. Rather than developing new initiatives and menu specials to drive traffic to its restaurants, management keeps focusing on opening new units and continuing to serve its signature made-from-scratch food, which it believes separates it from the competition.
Given the poor comp-sales performance from many restaurants it's understandable why investors would focus in here. Yet investors need to keep in mind that this chain only has 24 locations in the comparable store base. This small base could easily see wild up and down fluctuations in comp-sales, since one out of 24 locations has a bigger impact than one out of 240 locations.
I wouldn't be surprised if investors got rattled should Chuy's whiff on comp-sales; anything less than 1% comp-sales growth could send some running. I suggest a level head even if that happens. Long-term growth will come from expansion, and one off quarter for comp-sales doesn't constitute a trend.
On the flip-side, if Chuy's exceeds comp-sales expectations the stock could get a big boost. Chipotle (NYSE:CMG) turned in good but otherwise normal results last quarter, with the exception of exceptional 6.2% comp-sales growth. This sent the stock soaring over 15%.
With both Chipotle and Chuy's, I don't believe comp-sales is the most relevant metric to watch. These are growing chains, and their ability to expand their respective chains profitably is more important at this point. Many investors do focus on one quarter's comp-sales and (over)react accordingly, which creates a bumpy ride for long-term investors.
Amigos, keep it in perspective
A 13-week span of time isn't long enough to gauge the long-term viability of any business. However, we do look at quarterly results to try to identify trends. With Chuy's, be looking for these trends in restaurant openings and earnings growth, but at the same time keep it all in perspective with the whole story up to this point.
Jon Quast has no position in any stocks mentioned. The Motley Fool recommends BJ's Restaurants and Chipotle Mexican Grill. The Motley Fool owns shares of BJ's Restaurants and Chipotle Mexican Grill. Try any of our Foolish newsletter services free for 30 days. 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.