Brinker had barely managed to make our list of the ten most popular restaurant stocks among hedge funds for the third quarter of 2012 (see the full rankings); hedge funds tend to be preferring quick service restaurants such as McDonald’s Corporation (NYSE:MCD) or Starbucks Corporation (NASDAQ:SBUX). For example, billionaire Ken Fisher’s Fisher Asset Management owned 2.1 million shares of Brinker at the end of the quarter, but had much larger positions in other restaurant stocks (including McDonald’s). Check out Fisher’s favorite stocks.
In its most recent quarter, ending in September (this was the first quarter of the company’s fiscal year ending June 2013) Brinker reported a 2% increase in revenue versus a year earlier. With restaurant expenses seeing very little growth, earnings were up 18%. While we doubt that Brinker will continue that growth rate, particularly as most of it came from better margins rather than expanding the business, the stock trades at only 16 times trailing earnings and so even moderate improvement in the bottom line would justify the current price. Sell-side analyst estimates have Brinker’s forward P/E, for the fiscal year ending in June 2014, at 12. We would probably need to see continued growth in revenue and earnings to convince us that the company will get there, but at this point we’d lean towards buying.
Many quick service restaurants are growing fairly quickly- Starbucks, to take an example, reported revenue growth of 11% in its most recent quarter compared to the same period in the previous year, and has announced plans to significantly increase its store count. However, we’re not very optimistic on quick service restaurant stocks as they tend to carry high multiples- Starbucks is trading at 30 times trailing earnings, nearly double Brinker’s P/E multiple. McDonald’s is an exception to the general trend: it is actually priced modestly, at trailing and forward P/Es of 17 and 16 respectively. Note that this places it about even with Brinker, even though McDonald’s has actually been seeing lower sales and net income than a year ago. Of course the company does have a powerful brand, and likely merits something of a premium for that, but Brinker appears fairly undervalued relative to quick service restaurants.
Of course we can also consider other full service restaurants such as Darden Restaurants, Inc. (NYSE:DRI) (owner of Olive Garden and Red Lobster as well as several smaller restaurant brands) and DineEquity Inc (NYSE:DIN), which owns Applebee’s and IHOP. These restaurant stocks are even cheaper, relative to their earnings, than Brinker: Darden’s trailing P/E is 12 while DineEquity’s is only 9. DineEquity is a bit of a special case as that company moves towards more of a franchise model; while the stock is up 49% in the last year, the most recent data shows that 12% of the outstanding shares are held short. It could be a good value opportunity, but there are enough complications that it’s not a screaming buy. Darden looks appealing, both compared to Brinker and to the quick service restaurants we’ve discussed. Not only does it match a value-level multiple with modest growth in its business, it pays a dividend yield of over 4% and- perhaps surprisingly for a business that would be dependent on consumer spending- the stock’s beta is only 0.7. We think that it would be a good stock to buy.
We do think that Brinker looks interesting, and that there’s a good chance Griffin’s investment in the stock will pay off. We certainly think that the spread between full service and quick service restaurants has gotten a bit wider than the growth potential of the two types of businesses. Darden, however, might be an even better value.
