Brinker International: Strong Execution Supports Premium Valuation (NYSE:EAT)

Investment thesis

Brinker International, Inc. (NYSE:EAT) has good growth prospects ahead. The company’s revenue should benefit from increasing guest satisfaction through improving service levels and continuous launches of value meal offerings, which should continue to gain good traction in an inflationary environment. In addition, increased advertising through social media and television should help the company increase top-of-the-mind awareness and market share gains. This should support guest traffic and sales growth, and help the company to outperform the broader industry. Lastly, the carryover impact of previous price increases should also help the company’s sales growth ahead.

On the margin front, the company should benefit from carryover pricing, a favorable cost environment, operating leverage, and productivity and efficiency initiatives. While the company is currently trading in line with its historical averages, I believe there is room for further upside as the company continues to gain market share and outperform the industry. This along with good revenue and margin growth prospects and double-digit EPS growth estimates should provide good returns. Hence, I continue to rate the stock as a buy.

Brinker International’s Revenue Analysis and Outlook

In my previous article, I discussed the company’s good growth prospects, benefiting from the company’s focus on the improvement of key performance indicators and market share gain from increasing advertising. The company has reported earnings for its fourth quarter of fiscal 2024 since then, and similar dynamics were seen. The company’s stock price has also increased by ~7% since my previous article, validating my stance.

In the fourth quarter of fiscal 2024, the company’s revenue continued to benefit from price increases. In addition, guest traffic growth due to improvements in key performance indicators like fewer dine-in guests with a problem thanks to the company’s focus on providing better service levels, increase in advertising, and the introduction of new value meal menu items also helped the company’s sales. This has resulted in a 12.3% Y/Y growth in the company’s total sales to $1.2 billion. On a comparable sales basis, the company’s total company-owned restaurant sales (comprising 99% of total company sales) increased by 13.5% Y/Y, reflecting an 8.2 percentage point benefit from price increases, a 4.4 percentage point benefit from guest traffic growth and a 0.9 percentage benefit from favorable mix shift.

On a segment basis, the company’s Chili’s restaurant segment delivered a 14.8% Y/Y comparable sales growth due to price increase, favorable mix, and good traffic growth. This was thanks to good traction towards the introduction of Big Smasher Burger on the company’s 3 For Me value meal offering platform and an increase in advertising. The company’s Maggiano’s restaurant segment’s comparable sales grew by 2.5% Y/Y due to price increases and favorable mix shifts, partially offset by lower guest traffic.

Looking forward, I believe the company should continue to deliver revenue growth benefiting from continuous improvement in guest satisfaction, increase in advertising, and carryover price increases.

Over the last two years, the company has done an impressive job in improving overall guest satisfaction. This has been done by focusing on internal key performance metrics. These include dine-in guests with a problem, a metric that declined from 5% in FY2022 to just 2.7% in FY2024. In addition, the company introduced new value meal offerings on its menu, which has been helping it gain good traction in an inflationary environment. This has helped it increase guest traffic at Chili’s restaurants, as Chili’s restaurant AUVs have increased by $440,000 to $3.6 million over the last couple of years.

The company plans to continue executing further guest satisfaction enhancement initiatives to support revenue growth ahead. For this purpose, the company is continuously investing in restaurants to improve service levels by increasing the efficiency of managers, waiters, and bussers in their day-to-day tasks, freeing up their time to provide better service to guests. In addition, value meal offerings have also been a major contributor to improving the overall guest experience in an inflationary environment. The company’s 3 for Me value meal offering for $10.99 launched back in 2022 has been the center of this initiative. In the fourth quarter, the company added Big Smasher Burger to this category, which is an almost half-pound burger available along with bottomless chips, salsa, and bottomless drink at $10.99. This value meal helped the company drive guest traffic in the fourth quarter and helped it beat the industry traffic by 9.4 percentage points.

Management expects traction towards its Big Smasher value offering to continue in the coming quarters as well, which should support guest traffic and sales moving forward. Moreover, the company is also on track to increase its value offerings further by introducing value meals in its Fajitas category beginning in Q2 FY25. So, I expect EAT’s good execution towards improving guest satisfaction through better service levels and offering food at attractive entry price points to continue driving its sales growth for the full year.

Additionally, the company’s focus on increasing advertising of its value offerings through social media and TV streaming is also helping it increase top-of-the-mind awareness and market share. In the Q4 FY24 earning call, while answering a question on the traffic growth, CEO Kevin Hochman commented,

Clearly, we’re winning market share. You just do the math, we’re winning market share. I will tell you, I think that the biggest thing, I’ve said this in the past is, the fact that we’re more relevant, and we’re more top of mind, and we’re more on air, and we have a very attractive value out there. I think that’s really just kind of growing some trips. So I don’t think someone was saying, “Hey, I was going to go to this fast food place, and now I’ve decided to go to Chili’s tonight.” I think it’s the fact that we’re front and center and relevant not just on TV but in social media. I think you see this in pop culture more often. And then it’s just triggering them to be in that consideration set that we talked about at Investor Day a couple of years ago and causing them to want to come to Chili’s. So I don’t think it’s a specific thing where it’s like we’re sourcing from these 2 concepts. It’s so broad-based, and I think it’s really a more function of we’re more top of mind, we’re more relevant, and so we’re more in the consideration set for people to choose to come to us.”

As the company keeps investing in advertising and marketing for its value meal offerings and keeps delivering better guest experiences, its market share should further increase and support sales growth ahead. Also, while there are concerns about the overall restaurant industry slowdown due to macroeconomic uncertainties, management has not seen any weakness at Chili’s so far. It expects Chili’s to continue outperforming the industry guest traffic in the coming quarters, with support from above tailwinds.

Further, the company took price increases in fiscal 2024 to offset inflationary costs, which helped it deliver comparable sales growth despite lower guest traffic. I expect the impact of carryover pricing to continue supporting comparable sales along with guest traffic recovery in the coming quarters.

Overall, I am optimistic about the company’s sales growth prospects.

Brinker International’s Margin Analysis and Outlook

In the fourth quarter of fiscal 2024, the company’s margins benefited from price increases, 140 bps Y/Y favorable food and beverage costs, and 130 bps Y/Y favorable labor costs. In addition, improving operational efficiency and sales leverage through increased guest traffic also benefited the margin growth. This helped the company offset wage rate inflation of ~3.5% Y/Y. As a result, the total company-owned restaurant margin increased by 180 bps Y/Y to 15.2% and the consolidated operating margin increased by 60 bps Y/Y to 6.1%.

Looking forward, I believe the company should continue growing its margins. The carryover impact of previous price increases should continue to support margins in the coming quarters. In addition, a favorable cost environment as inflation further moderates should also support the margin growth. I also expect an increase in guest traffic as the company continues to gain market share, which should provide operating leverage for margin growth.

In addition, the company has also been focused on improving operating efficiencies at its restaurants. For instance, the company has reduced menu items by 22% over the last couple of years and has eliminated some prep steps, simplified administrative tasks, and other complex processes. This has helped it reduce costs and increase the productivity of its restaurant employees. Moving forward, the company plans to continue taking initiatives to further reduce costs and improve productivity. In line with this, EAT is further simplifying prep steps. This includes a much-simplified avocado prep, reducing time spent portioning brisket, a new bulk bread and Chicken Crisper procedure, and the introduction of a new process that reduces the time required to grill steaks. Moreover, the company is also investing in technology and has recently rolled out an AI-enabled labor forecasting tool that will help general managers accurately and efficiently manage and forecast labor schedules. These productivity initiatives should also help margin growth moving forward.

I expect the productivity benefits from these initiatives along with carryover pricing, favorable cost environment, and operating leverage to more than offset elevated labor and marketing investments. Hence, I am optimistic about the company’s margin growth prospects over the coming year.

Valuation and Ratings

Brinker International is currently trading at a 14.82x FY25 (ending June) consensus EPS estimate of $4.68 and a 13.29x FY26 consensus EPS estimate of $5.22. Over the last five years, the stock has traded at an average forward P/E of 14.16x.

The stock price has seen a good run-up in the last year, and I was able to capture this upside with my bullish articles in August 2023 and May 2024. Since my article in August last year, the stock is up 111.64% while from May it is up 6.85%. When I covered the stock last year, it was trading at a significant discount to its historical average P/E and was showing promising turnaround progress. While the company’s turnaround is still progressing well, the valuation based on the current fiscal consensus EPS estimates is a slight premium to historical levels.

I am not too worried about it, though, as valuation based on FY26 (ending June) consensus EPS remains attractive. Further, given the company’s solid execution and significantly improved performance record recently, its valuation multiple deserves to be at a premium versus the historical levels. So, I believe the company can continue to maintain higher than historical P/E in the coming years. This coupled with double-digit earnings growth means that we could see double-digit CAGR from the stock in the coming years. So, I continue to see further upside and maintain my buy rating on the stock.

Risks

• Inflationary conditions are still tough and if there is another leg down in restaurant spending by consumers it could negatively impact growth.

• The execution so far has been excellent, but if the company faces any challenges in the execution of its customer satisfaction initiatives, productivity savings plans, or marketing strategy, it could negatively impact its growth and margins.

Takeaway

I believe Brinker International’s stock can deliver a good upside. The company has done an impressive job at improving overall execution, which has resulted in guest satisfaction improvement and operational efficiencies. Moving forward, the company plans to continue its focus on further enhancing guest satisfaction through better service levels and continuous value meal launches. In addition, higher advertising should also increase top-of-the-mind awareness and help it gain market share along with traction toward value meal offerings. This should lead to guest traffic outperformance as compared to the industry and support revenue growth. Margins are also expected to continue expanding thanks to the carryover impact of prior price increases, a favorable cost environment, operating leverage, and productivity initiatives.

While the current P/E is at a slight premium versus historical levels, it is well-deserved given the improved execution recently. I believe there is room for further upside as EAT continues to gain share and post double-digit EPS growth over the coming years. Hence, I continue my buy rating on the stock.