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Short Squeeze Alert at Brinker International

- By Jonathan Poland

Casual dining restaurants are adjusting to a new generation of spenders and competition. This has placed immense pressure on many to adjust and pivot their marketing and even their models.

Brinker International Inc. (EAT) still boasts two of America's most iconic restaurant brands - Chili's Grill and Bar and Maggiano's Little Italy. In the last 12 months, Brinker generated north of $150 million in net income on $3.1 billion in sales, good for $3.44 per share. It's also paid out $1.52 in dividends, which is up from the 44 cents in dividends per share it paid out in 2009. The company has also bought back a ton of stock over the last decade, reducing its outstanding shares from 104 million to under 39 million. This has helped put it in a position to document upwards of $4 per share this year.


All this financial performance hasn't stopped the short sellers from keeping the stock down over the last five years.

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A short squeeze is an extremely fast increase in the price of a stock that occurs when there is a lack of supply and an excess of demand. This usually happens with a security has a large number of shares sold short. When these short sellers cover their positions, the volume increase drives the price higher.

These shorts have gobbled up more than 41% of the float. Yet, things look good for the company financially. Brinker's latest quarterly statement showed earnings of 83 cents (GAAP) per share on revenue of $790.7 million, up 3.2% year over year thanks to same-store sales rising 2.9%. Operating margins, however, fell 2.5% due to higher rent and labor costs, which was like chum in the water as the stock fell over 15% in late January and hasn't rebounded to the $48 level it was at before the earnings report was released.

Short sellers will likely point to the long-term debt Brinker is loaded down with, which is currently north of $1 billion or four times operating cash flow. The company has been paying down debt, with sale-leaseback transactions that freed up $456 million to reduce total borrowings by nearly $350 million.

Yet, profit growth can solve that problem and the company is seeing steady sequential improvements in sales across its network. The real problem long term is going to be margin contractions. If the company cannot pass on higher expenses from food, labor and rents to its customers, then there's little chance for it to add value for shareholders.

Given the company's history in the restaurant business, dating back to 1975, it's likely that management will figure out a way to deal with these financial risks. In the meantime, the dividend is secure and, at 3.5%, should give investors another reason to buy at this price point. In a short covering scenario, the stock could make gains for a full two weeks based on its current short ratio. Only time will tell when this will happen, but it will as long as Brinker continues to perform well.

Disclosure: I am not long or short EAT.

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This article first appeared on GuruFocus.