Brinker (EAT) Stock Up 31% in 6 Months: Can it Gain Further?

Shares of Brinker International, Inc. EAT have surged 30.7% in the past six months, outperforming the industry’s 1.9% growth. The outperformance can be attributed to expansion and sales-building initiatives along with increased investments in technology and continual focus on take-out businesses. However, a slowdown in some key international markets and overall high costs associated with restaurant operations might hurt its profitability in the future. Let’s delve deeper.

Key Catalysts

Sales Building Efforts Bode Well

Brinker remains steadfast in its goal to drive traffic and revenues through a range of sales-building initiatives such as streamlining of menu and its innovation, strengthening its value proposition, better food presentation, advertising campaigns, kitchen system optimization and introduction of better service platform. In 2016, the company also initiated a strategic plan — Vision 2020 — to propel revenues. This plan focuses on menu innovation in Chili's, continuous improvement in services and atmosphere to differentiate the brand and gain market traction for achieving long-term earnings per share growth target of 10-15%.

As the Chili’s business has been challenging for the past few quarters, the company has been making critical investments in the brand to mark a turnaround and gear up for improved performance over the long haul. In fact, in the fiscal fourth quarter, Chili’s turn-around strategies have paid off, with traffic and sales moving in the positive direction.

Digitalization to Drive Growth

Brinker is also investing heavily in technology-driven initiatives like online ordering to augment sales and boost guest services. This is because the digital wave has hit the U.S. fast-casual restaurant sector, with many restaurants deploying technology toward enhancing guest experience. Having installed a table top technology at all the company-owned restaurants in partnership with Ziosk, Brinker has now implemented handheld devices across California. This, in turn, is resulting in increased efficiency and speed.

Franchising in Focus

Unlike most peers, Brinker used to focus on company-owned restaurants to gain full control over its operations and profits. However, to survive in an industry that depends largely on franchising, the company had started to pursue expansion through franchisees and partnerships.

For instance, Brinker acquired 103 franchised Chili’s Grill and Bar restaurants from Pepper Dining Holding Corp in 2015. Notably, in fiscal 2017, Brinker’s franchise operated locations increased 40%. The strong growth should continue to boost the top and bottom lines. In fact, in fiscal 2018, the company’s top line benefited from growth in franchise and other revenues that offset the slow comps growth.

Concerns

We believe costs related to various sales-boosting initiatives, including advertising expenses, along with commodity inflation are expected to continue denting margins. Thus, the company’s profits in the upcoming quarters might remain under pressure despite its cost-saving initiatives. In fact, Brinker expects restaurant operating margin to contract 160-180 basis points in fiscal 2019 as it invests specifically in its core food equities.

Further, Brinker’s trailing 12-month return on equity (ROE) undercuts its growth potential. The company’s ROE of negative 26.8% compares unfavorably with ROE of 7.1% for the industry, reflecting the fact that it is less efficient in using shareholders’ funds.

Key Picks

Brinker has a Zacks Rank #3 (Hold). Some better-ranked stocks in the industry are Ruth's Hospitality Group, Inc. RUTH, Darden Restaurants, Inc. DRI and Dine Brands Global, Inc. DIN, each carrying a Zacks Rank #2 (Buy) .You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Ruth's Hospitality Group has an expected earnings growth rate of 26.4% for the current year.

Darden Restaurants reported better-than-expected earnings in the trailing four quarters, the average being 3.1%.

Dine Brands Global delivered better-than-expected earnings in the preceding four quarters, the average being 8.1%.

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