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Brinker International Is Too Cheap to Ignore

The restaurant industry enjoyed a brief comeback in 2021 as most units reopened for walk-in business after suffering a long period of operating losses during 2020. However, the recovery proved to be short-lived as more problems emerged, primarily cost inflation and labor shortages.

One popular restaurant company that is experiencing these issues is Brinker International, Inc. (NYSE:EAT). The company is one of the worlds leading casual dining restaurant companies. It operates two concepts, Chilis Grill & Bar and Maggianos Little Italy, as well as two virtual brands, Its Just Wings and Maggianos Italian Classics.


Founded by Norman Brinker in Dallas, Texas in 1975, Brinker owns, operates or franchises more than 1,600 restaurants in 29 countries. It currently has a market capitization of $1.0 billion.

Thanks to the recent headwinds, the stock has become undervalued by my estimates. Here's why I think this company has what it takes to tackle the challenges and come out stronger.

Virtual brands

The virtual brand concept is relatively new and involves a delivery-only business model. The concepts use existing kitchen space at its restaurants, Chilis for Its Just Wings and Maggianos for Maggianos Italian Classics. This allows for higher margin revenues without having to increase capital expenditures for new stores or new kitchens. This will also enable the company to capitalize on the growth in delivery and to leverage excess kitchen capacity in existing physical restaurants.

Tackling challenges

Brinker has recovered well from the beginning of the pandemic, with revenues increasing 8.4% for the fiscal year ended June 30, 2021. Operating income more than tripled to $199.3 million and earnings per share increased to $2.83 from only $0.63 in the prior-year period.

For the fiscal third-quarter results (the fiscal third quarter ended on March 31), same-store sales were very strong with Chilis increasing 10.3% and Maggiano's increasing 50.5%. However, the company could not escape commodity cost inflation or prevalent labor shortages in the industry. The operating margin decreased to 5.0% from 6.3% and restaurant margins decreased to 12.2% from 13.9%, Management stated it was facing "some of the most challenging commodity and labor cycles many of us have ever seen.

The companys balance sheet is in reasonably good shape with net debt of $975 million and predicted Ebitda for full fiscal 2022 that approaches $400 million. In addition, the company generated free cash flow of $102 million in the first nine months of fiscal year 2022.

Valuation

Despite intense inflationary and labor pressures, earnings per share is expected to be roughly flat in full fiscal 2022. Adjusted EPS last year was $3.12, and consensus estimates call for EPS of $3.15 for fiscal 2022. That is within the companys guidance issued in May for EPS in the range of $3.05 to $3.30.

That puts Brinker's stock at a forward price-earnings ratio of just 7. The enterprise-value-to-Ebitda ratio is 5. Brinker got rid of its dividend in 2020 and has not reinstated it yet. I expect the dividend to be resumed at some time in the next two to three years.

Guru trades

Gurus who have purchased Brinker stock recently include PRIMECAP Management (Trades, Portfolio) and Michael Price (Trades, Portfolio). Gurus who have sold or reduced their positions in Brinker stock include Jim Simons (Trades, Portfolio) and Joel Greenblatt (Trades, Portfolio).

Conclusion

Brinker's stock appears to be substantially undervalued at this time compared to its current and predicted earnings as investors are panic-selling and giving no credit to the virtual restaurant concept or the proven ability to manage inflationary pressures. The company has planned additional initiatives to help offset some of these pressures such as menu simplification and a more efficient server system by using handheld tablets and new kitchen equipment. Over time, I believe the stock should return to normalized valuation levels.

This article first appeared on GuruFocus.

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