Yogi Berra once said, "Nobody goes there anymore. It's too crowded ." This Yogi-ism is the perfect description of the problems facing Brinker International (NYSE:EAT) and its Chili's business. The Chili's concept is well known, respected, and it's so popular that people seem to be forgetting to go there.
It seems like we just went there
One of the issues facing Brinker International is the fact that its Chili's chain seems to have lost its unique flavor. Across the country when families are choosing where to go for dinner, one of the things I'm sure you would hear is, "it seems like we just went there."
When a restaurant becomes boring in the public's mind, you know the concept needs to make some major changes. Chili's operates over 1,500 restaurants . On the surface this wouldn't seem to be an issue, because there are multiple competitors that are similar in size.
Both Chipotle and Panera Bread have over 1,500 locations and yet these companies are expected to grow earnings at faster rates than Brinker. Darden Restaurants (NYSE:DRI) operates over 2,000 locations and even the fast growing Buffalo Wild Wings (NASDAQ:BWLD) operates nearly 1,000 locations. Clearly it's not the number of locations that hampers Brinker's growth.
However, the traffic results of Chili's and Maggiano's for the last few months paint a picture investors need to pay attention to. Chili's reported traffic declined by at least 3 % in each of the last three months. Maggiano's traffic declined by just 0.6% in July, but by September traffic was down 4.5% year-over-year. With significant traffic declines, the company's brands aren't resonating with consumers like its competitors' brands are.
Though Darden saw blended comps decline by over 3 % at its three largest chains, the company has been struggling to turn around its Red Lobster brand for years. By contrast, Buffalo Wild Wings reported same-store sales growth of 4.8 % at company-owned restaurants and a 3.9% increase at franchised locations.
This number could be a problem
The second issue facing Brinker is that the company seems to be wasting money on labor. In an economic environment where unemployment is high, it might seem crass to suggest that a company needs to make some cuts. However, the numbers are what they are.
Brinker and Darden each reported that their cost of labor as a percentage of revenue approached 32% in the most recent quarter. By comparison, Buffalo Wild Wings reported that labor used up about 28% of the company's revenue.
Considering that Brinker is growing its restaurant base at a much slower rate than Buffalo Wild Wings, the fact that it is spending far more on labor is a major concern. In theory, Buffalo Wild Wings' percentage should be higher since the company has to hire and train new employees for locations that haven't been completed yet. Brinker has essentially saturated the domestic market and should be far more efficient using its labor force.
The bottom line is, it hurts the bottom line
The third issue facing the company is that weaker traffic and higher labor costs obviously hurt the bottom line. While Brinker's diluted earnings per share increased by more than 16% versus last year, the company's cash flow tells a different story.
Looking at core operating cash flow (net income + depreciation), we can see that Brinker's cash flow growth has been very slow. The company's year-over-year core operating cash flow growth was an anemic 3% in the current quarter. This is part of why many investors don't like to rely on earnings growth. When a company shows 16% earnings growth but this only equates to 3% cash flow growth, you know there is a problem.
By comparison, Buffalo Wild Wings grew core operating cash flow by 26%. Though Darden saw its cash flow drop by more than 13%, the company's diluted EPS was actually down by more than 37%. No matter how you slice it, Brinker's disconnect between earnings growth and cash flow growth is potentially a problem.
In the end, Brinker operates a chain of restaurants that seems to be overshadowed by its competition. The company needs to operate more efficiently, redesign, and revamp the Chili's concept in particular. If Brinker can turn its traffic issues around this could be a stock with some spice. If not, the company's investors might be left with heartburn.