Brinker International, Inc. (EAT): Still A Great Investment

One classic investing mistake is assuming a company has grown as much as it can. I know many investors have made this mistake with companies like McDonald’s Corporation (NYSE:MCD) over the years. According to Peter Lynch, most restaurants go through multiple phases of growth in their lifetime. They start out, perfect their formula, expand, and then at some point, they reach saturation and have to find a way to grow organically. He liked following restaurants because the business is easy to understand and easy to track. Lynch said he couldn’t believe he missed Brinker International, Inc. (NYSE:EAT) since his girls wore their Chili’s sweatshirts to bed. I’m suggesting that roughly 30 years later, this company could still be a great investment.

Are They Done?
Brinker has been expanding domestically for years. The company’s Chili’s chain is found in most major towns. With over 1,500 restaurants, Brinker may or may not be close to saturation in the United States. I’ve heard the argument on more than one occasion that fast growth companies like Chipotle Mexican Grill, Inc. (NYSE:CMG) and Panera Bread Co (NASDAQ:PNRA) should be able to expand for years, and they have over 1,300 and 1,600 restaurants respectively. Though their layouts are different, the standard Chili’s restaurant isn’t all that different in size from a normal sized Panera or Chipotle. The biggest difference is Chili’s is a sit down traditional restaurant and Chipotle and Panera operate more of a ordering line. The fact that the United States supports about 14,000 McDonalds stores, argues that each of these concepts could continue to expand for a while.

Where there is very little argument is that Chili’s and their competition have vast opportunities overseas. Going back to Peter Lynch for a moment, he used to make the argument like this, if the United States can support a certain number of restaurants with about 315 million people, doesn’t it make sense that China alone with over 1 billion people could support at least as many restaurants? At this point India has over 1 billion people as well, and countries such as Indonesia and Brazil have 246 million and almost 200 million people respectively. The bottom line is, on a worldwide basis, Chili’s and their competition have many decades of expansion left.

These Numbers Are Anything But Boring
I’ll admit one of my primary mistakes in not following Brinker was, I assumed their earnings growth was slow. What might surprise investors is, Brinker is expected to report EPS growth that is only somewhat slower than Chipotle or Panera. In fact, in Brinker’s current quarter, while their sales only increased by 1.1%, their diluted EPS jumped by 13.6%. What’s even more impressive is analysts’ projections for EPS growth in the next few years.

The average analyst is calling for 13.84% EPS growth from Brinker over the next few years. This projected growth easily bests McDonald’s expected growth of 8.7%. While Chipotle’s EPS growth of 20.21% or Panera’s expected growth of 19.25% would seem to blow away Brinker, keep in mind neither of these companies pays a dividend. In addition, while McDonald’s sells for a PEG of 1.87, Chipotle’s PEG is 1.5, and Panera’s PEG is 1.2, Brinker’s PEG ratio is just 1.02. As you can see, investors are getting the cheapest relative valuation of the four companies.

Good Growth, But Fantastic Cash Flow
There might not be a better case for buying Brinker than their free cash flow production. To even the playing field, I look at free cash flow per dollar of sales. In theory, a company with the highest free cash flow from each dollar of sales is the most efficient transforming sales into spendable cash. Using this measure, only McDonald’s does it better by generating $0.15 of free cash flow per dollar of sales. The fact that McDonald’s is heavily franchised and has over 30,000 restaurants might have something to do with this performance. When you compare Brinker to their like sized competition of Chipotle and Panera, Brinker takes the crown. In fact, Brinker generated $0.09 of free cash flow per dollar of sales versus $0.07 at Chipotle and $0.04 at Panera.

Since cash flow helps to fund expansion, share buybacks, and dividends, the importance of Brinker’s free cash flow can’t be understated. The company expects to open about 30-35 international restaurants in 2013. These openings will only add to the company’s already prodigious cash flow. Brinker also retired 8.49% of their diluted share count over the last year. In addition, Brinker only uses about 45% of their free cash flow to cover the dividend. By comparison, McDonald’s uses 65% of their free cash flow. With a 2.4% yield, 13.8% EPS growth, and good cash flow to back them up, Brinker can help investors add some of Chili’s spice to their portfolio. If you are interested in keeping up with Brinker, consider adding EAT to your personalized Watchlist today.

The article Still A Great Investment originally appeared on Fool.com and is written by Chad Henage.

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