Description

BJ’s Restaurants, Inc. (BJRI)

Summary

We focus on smaller companies with Ft. Knox balance sheets and large & sustainable free cash flow yields and we are typically seeking a double-digit FCF yield or higher on an unleveraged basis.  The objective is for the sustainable FCF to eventually drive up the share price to a more reasonable valuation, through share buybacks, debt reductions, dividends, or accretive acquisitions.  Obviously, it is important we have a management team that cares about shareholder value.  We also focus on small-cap stocks because there is a much better chance to find an attractive investment opportunity which is under-followed or undiscovered.

BJ’s Restaurants (BJRI), a casual dining restaurant chain with 190 restaurants in 23 states.  BJRI is value-oriented and seeks to provide a $25 restaurant experience for about $15, or a “casual plus” approach.  The Company’s menu features deep-dish pizza, proprietary craft beers, and a wide selection on appetizers, entrees, pastas, sandwiches, specialty salads and desserts, including the “Pizookie” cookies.  BJRI’s craft beer is produced at brewers using its proprietary recipes.  The Company’s average check is about $14.50 and average restaurant size is about 7,700 square feet, with almost all restaurants leased.

BJRI believes its potential market in the U.S. is 425 units and it currently has far less units than other casual dining brands such as Applebee’s (2,050 units) and Chili’s (1,530 units).  The Company added 17 restaurants in 2016 and expects to add about 10 in 2017.  We believe BJRI can grow units about 5% to 6% per year over the next several years.  Importantly, BJRI’s strong free cash flow generation has enabled it to repurchase substantial shares outstanding concurrently with the growth in units.  In 2016, the Company repurchased about 2.5m shares for about $39 per share, in 2015 the Company repurchased about 2m shares at about $46 per share and in 2014 the Company repurchased about 2.8m shares at about $35 per share.  Diluted shares outstanding have been declining from about 29m at the end of 2013 to about 22m currently.  We expect further declines over the next few years.

We believe BJRI is attractive at current prices trading at 1.1x revenues, 8.5x LTM EBITDA, and a 9% unleveraged FCF yield.  We believe BJRI is a cash-generating machine which over time will enable the business to build significant shareholder value.  We define FCF as cash from operations (LTM $138m) less maintenance capital expenditures (LTM $40m - our assumption at about 4% of revenues).  Over the past five years, BJRI has grown revenues, adjusted EBITDA, and cash from operations by close to 10% per annum.  BJRI has a “Ft. Knox” balance sheet with net debt of about $160m or 1.1x LTM EBITDA.  While we recognize BJRI operates in a competitive industry with traffic issues which is currently undergoing a shakeout, we believe BJRI is one of the stronger competitors and is well-positioned to survive and take significant market share in casual dining over the next several years.

Over the past six years, the Company has generated cumulative cash from operations of about $630m or about 60% of the current enterprise value (EV).  Due to the Company’s attractive negative working capital business model, over the past six years BJRI’s cash from operations has been larger than adjusted EBITDA every single year.  The highly cash-generative business model has enabled BJRI to substantially grow its restaurant base and concurrently repurchase a large percentage of total shares with little leverage.  Further, BJRI’s business model is somewhat recession resistant, as evidenced by its strong cash flows and adjusted EBITDA during 2008 and 2009.

We believe if BRJI stabilizes its results and grows its base of restaurants, investor perception could improve.  Our model is based on stable comp store sales, an increase in restaurant units of about 5% to 6% per year, leverage of operating expenses, and significant share repurchases.  We believe BJRI could add 40 new units or more from 2017 to 2019.  We believe BJRI could achieve $165m in adjusted EBITDA by 2019 and trade for 10x adjusted EBITDA or an EV of about $1.65b.  Based on net debt of about $150m and 20m diluted shares outstanding, we believe BJRI stock could trade for about $75 per share, or about 65% higher than the current price of $45 per share.

Casual Dining Industry / Competitive Position

While the casual dining industry overall is mature and traffic volumes have been declining for several years, it is also very large and BJRI has been taking share.  Many of the larger casual dining companies have heavily penetrated footprints and limited opportunity to increase units while unit growth has been a major driver of BJRI’s revenue growth.  Larger players are more dependent on comp store sales performance to drive revenue growth.  We are encouraged that BJRI has successfully opened new units in smaller markets (see New Restaurant Openings).  BJRI has repeatedly stated it is earning excellent cash on cash returns in these new restaurant units.  Because these new openings are in small markets (many with populations of around 50,000), this would seem to validate the large potential market in the U.S.  

We believe BJRI offers differentiation with its “casual plus” dining experience versus larger casual players such as Applebee’s, Chili’s, and Ruby Tuesday’s.  BJRI’s restaurants appeal to a younger demographic as compared to some of these older and larger concepts.  We expect BJRI to continue to take share in casual dining over the next three years both in comp store sales outperformance and new unit growth.  If BJRI can stabilize its comp store sales performance in 2017 and return to a more aggressive growth mode for new units, its multiple could be much higher.  

While recent comp store sales trends have been weak, we believe the competitive environment could improve a bit.  We believe negative comp store trends could continue for the next few quarters for BJRI but we are looking out two or three years to a potentially larger company with stabilized comp store sales.  BJRI has slowed new openings significantly for 2017 to 10 units to try to improve comp store sales.  It sales building initiatives announced on the Q4 2016 conference call included: (1) slow roasting oven technology to produce large proteins like prime rib, turkey, chops, etc. with high quality at price points well below competitors which have been rolled out to all stores; (2)  improved speed of service and increased attachment through new technology with handheld ordering devices which also have been rolled out across its entire system; (3) an improved value proposition through Daily Brewhouse Specials which offer food and beverage specials on selected nights to drive value-conscious traffic; and (4) growth in the off-premise business through take-out and delivery, where BJRI’s off-premise averages about 5% of total sales as compared to 10% for competitors.

Although these initiatives are not fully implemented (expected H2 2017), the Company has already shown some stabilization in Q1 2017, with comp stores sales starting down 2.5% early in Q1 but ending Q1 down 1.3% for the entire quarter and trending close to flat in April.  While we certainly would not take this improvement as a given, it is encouraging, even before the full sales building program is deployed.

BJRI comps have been negative the last few quarters but they have continued to out-perform the industry, both in traffic and comp store sales.  Unit sales continue to be near the top of the industry and restaurant unit margins at 18% to 20% are also near the top of the industry.  The Company continues to achieve excellent returns on new restaurants as system-wide restaurants averaged cash on cash returns of close to 30% in 2015 and 2016.  BJRI also has retention rates for employees that are significantly better than the industry for both hourly and manager levels.  The Company has grown sales and EBITDA over the past several years - from 2011 to 2016 total revenues grew close to 10% per year and adjusted EBITDA grew close to 12% per year.  Comp store sales performance in 2016, while negative at -1.6%, was significantly stronger than most of the other major players.

BJRI’s results for 2016 outperformed almost all major competitors in casual dining – Applebee’s comp store sales were -7.2% for Q4; Ruby Tuesday’s were -4.1%; Chili’s were -3.3%; Red Robin were -4.3%; as compared to BJRI -2.2%.  We expect several larger competitors to close restaurants in 2017 reducing industry capacity.  Further, BJRI has been adding restaurants in smaller, less competitive markets and has not opened a new restaurant in the heavily penetrated Texas market for some time.  We expect BJRI to emerge from the casual dining industry shakeout over the next few years in a strong position.  Consider that Applebee’s has 2,050 units, Chili’s has 1,530 units, and Ruby Tuesday has 613 units which together are more than 20x BJRI’s units.  We believe these larger players have marginal units in their huge footprints which are likely to be closed over the next few years.

BJRI restaurants are located across the U.S. with largest concentrations in California (62); Texas (34); and Florida (20).  The Company has 8 restaurants in Ohio, 6 restaurants in Arizona, 5 restaurants in Colorado and Nevada, and 4 restaurants in Virginia and Washington.  BJRI leases almost all its stores.  The average restaurant size had been about 8,500 square feet but in 2014 the Company developed a smaller prototype with about 7,400 square feet.  The net cost for BJRI’s restaurants had been about $4.5m net of tenant allowances but the new prototype reduced this investment to about $3.6m.  The average sales volume for new restaurants at maturity is targeted to be about $4.5m with four-wall restaurant cash flow margins of about 18% to 20%.

Strategic Plan / Activists

In February 2013, Greg Trojan became CEO of BJRI.  He was previously CEO of Guitar Center from 2010 to 2012 and House of Blues Entertainment prior to that.  He has led a program to drive improved same store sales, grow the restaurant base, and reduce expenses over the past four years which has been successful.  The key differentiators for BJRI include: (1) a value-oriented $25 restaurant experience for $15; (2) menu variety; (3) occasion variety; (4) higher quality food; (5) a high energy, contemporary atmosphere; and (6) craft beer.  

The strategic plan under Trojan was successful in improving comp store sales results and reducing operating expenses and improving operating profit margins from 2013 to 2015.  Since early 2014, the “Project Q” program has enabled it to reduce costs through a wide range of programs and significantly increase restaurant operating margins and adjusted EBITDA margins.  Project Q has focused on eliminating unnecessary kitchen complexity; expanding kitchen capacity for menu enhancements; improving cost of sales; improving kitchen labor efficiencies; and improving guest throughput.  Employees have provided over 1,500 Project Q ideas of which about 350 have been implemented.   Project Q and cost saving initiatives have helped improve restaurant level margins by 200 to 300 basis points.  Adjusted operating margin has also improved over the same period.

In 2013, an activist group led by Luxor acquired close to 15% of total shares and got three seats on BJRI’s Board.  Since this time, BJRI has aggressively repurchased its shares and diluted shares outstanding has declined from about 29m at year end 2013 to about 22m at present.  We believe the activist group is laser focused on reducing total shares outstanding to drive long-term shareholder value and this is likely a good thing.

Marketing and Advertising

The Company spent 2.2%, 2.3%, 2.2%, and 2.3% of revenues in 2013, 2014, 2015, and 2016 on marketing related expenditures.  However, it notes that depending on the operating conditions for casual dining restaurants, it may decide to increase or decrease its marketing expenditures beyond current expectations.  Marketing expenditures generally takes the form of limited television for those markets where BJRI has enough penetration, as well as print, radio, digital, and social media programs.  The Company also uses its loyalty program, BJ’s Premier Rewards, to engage with its customers and monitor their frequency and purchasing behavior.

Seasonality

The Company business is not especially seasonal, as indicated by the chart below, which shows quarterly revenues and operating income.

Strong Cash Generative Business Model and Attractive FCF yield

BJRI has a highly cash-generative business model.  The Company’s cash from operations has exceeded adjusted EBITDA in every year since 2008, largely due to the favorable negative working capital business model.  Over the past six years, cumulative cash from operations was $630m or about 60% of today’s enterprise value.  In 2016, BJRI generated $138m of cash from operations with about $106m of capital expenditures, of which we believe about $40m (or 4% of revenues) are maintenance expenditures (see Comparable Spreadsheet).  We estimate 2016 FCF at $90m to $100m or about a 9% unleveraged FCF yield.  BJRI expects to add 10 restaurants in 2016 at a cost of about $3.6m per restaurant.  

We believe the Company has good long-term prospects for growth in revenues, adjusted EBITDA, and FCF.  Over the past five years, BJRI has grown total sales, adjusted EBITDA, and cash from operations by about 10% per annum.  We believe as BJRI expands its restaurant base by 5% to 6% per year, FCF could grow significantly in the next few years.  Importantly, BJRI earning high cash on cash returns on its new restaurants (close to 30%) even in the current difficult environment for the casual dining industry.  These strong cash-on-cash returns should drive continued growth in BJRI’s cash from operations over the next few years, assuming comp store sales remain stable.   

High Cash on Cash Returns on New Restaurants

In 2015 and 2016, BJRI system wide restaurants averaged cash on cash returns of close to 30% on its new restaurants.  BJRI’s smaller format (7,400 square feet versus 8,500 square feet) restaurants typically cost about $3.6m after TI allowances.  Unit volumes run about $4.5m to $5m with restaurant level cash flow margins of 18% to 20% which results in a 25% to 30% cash on cash return.  We believe these are extremely attractive returns in the current low growth, low interest rate environment.  In a U.S. economy with 10-year treasury rates of about 2.5%, if the Company can generate nearly 30% cash on cash returns on new unit investments, that is a valuable business model.  BJRI has reduced the cost of new units from $4.5m which has increased new unit investment returns and enabled the Company to enter smaller markets.  We believe cash from operations and FCF could grow substantially over the next several years if the Company can maintain this performance.

Solid Competitive Position Casual Dining Segment

The casual dining segment of the restaurant industry is mature but very large at almost $100b.  There are many chains which are already quite large (e.g., Chili’s and Applebee’s) with limited opportunities for growth.  We believe the Company has a solid and well-established casual-plus competitive position in the casual dining restaurant industry with a superior meal and environment for a similar value as larger competitors.  The Company seeks to offer a $25 meal experience for $15 and this value orientation should resonate in the current environment.  We also believe BJRI restaurants are attractive to younger customers relative to many other casual dining concepts.  We believe over the next few years there could be significant retrenchment in the casual dining industry.  Most players have reduced the pace of new openings and several could see significant reductions in restaurant units.  We note that recently the CEO of Dine Equity (DIN) resigned with weak comp store sales at Applebee’s.  We note also that Ruby Tuesday (RT) is another heavily stored concept with weak financial results that could see significant downsizing.  BJRI is in a relatively stronger position in the casual dining segment with its limited units (190 restaurants) and success in entering smaller new markets, of which there are many left across the U.S.  We would not be surprised to see one of the stronger players try to acquire BJRI given its strong cash flow and relatively attractive growth opportunities.

Substantial Revenue Growth Potential Through Expansion of Chain

We believe BJRI has a significant runway for growth as it has expanded into several new markets in recent years with good results.  BJRI cites the potential for up to 425 restaurants in the U.S. and possibly many more.  Unlike mature casual dining restaurant chains, BJRI has an opportunity to drive revenues through expanding its restaurant base over time.  New restaurant units continue to perform well with strong cash on cash returns.  BJRI has only 190 restaurant units as compared to mature chains like Applebee’s with 2,030, Chili’s with 1,596 units, and Olive Garden with 844 restaurant units.  Over the past few years, BJRI has grown its restaurant units by close to 10% per year and we believe the Company will be able to continue on a 5% to 6% per annun growth trajectory for several more years.  Over the next five years, we believe BJRI could become a much larger company, with substantially more units.

Recession-Resistant Business Model

BRJI achieved strong financial results in 2008 and 2009 with adjusted EBITDA growing and solidly positive cash from operations generated.  While the Company’s business model is not recession-proof, we do believe it is recession-resistant, given its lower price point, its strong value proposition to consumers, and the fact that people will continue to celebrate special events and eat out, even in a recession.  We believe this performance through a very difficult economic period speaks strongly to the strength of BJRI’s business model and its attractive niche for consumers.

Improved Profit Margins Since Early 2013 - Attractive Long Term Business Model

CEO Greg Trojan arrived at BJRI in early 2013 and under his Strategic Plan adjusted EBITDA margins have increased more than 200 basis points.  A major driver of these improved profit margins has been the Project Q initiative, which has focused the Company on reducing costs and improving efficiencies to increase profitability and cash generation.  Consequently, BJRI has adjusted EBITDA margins which are among the highest in the restaurant industry.

The Company’s long term business plan is to grow revenue through both restaurant growth (8% to 10% per annum) and modest comparable sales growth (1% to 2% per annum) while reducing costs through Project Q and operating cost saving strategies and leveraging both G&A expense and D&A expense to drive improved restaurant level cash flow margins (19%+) and EPS growth which exceeds revenue growth.

Top of Mind Awareness Opportunity

BJRI has an opportunity to drive brand equity and awareness in both legacy and newer markets.  The Company’s top-of-mind awareness is significantly below larger mass casual restaurant chains like Chili’s and Applebee’s.  BJRI is increasing its spending on marketing and advertising to take advantage of this lag in awareness.

Activist Representation on Board Disciplines Capital Allocation

There is strong activist Board representation on BJRI’s Board, with significant share ownership.  Luxor and PW Partners have a significant position and Board representation.  BJRI has been aggressively repurchasing shares over the past few years and we believe this major share repurchase program is being driven, in part, by these activist investors.  We believe this large share repurchase program of close to 25% of total shares outstanding over the past few years is helping to drive long term shareholder value.  We believe BJRI has been intelligent about its capital allocation decisions, including the recent decision to slow new restaurant expansion in order to stabilize and grow comp store sales.

Attractive Upside Potential

In 2016, BJRI generated adjusted EBITDA of about $130m and cash from operations of about $138m.   We believe BJRI can grow revenues and adjusted EBITDA based on stable comp store sales, stable gross margins, and SG&A expense leverage.  We believe BJRI can expand its restaurant base by 5% to 6% per annum on average.  

We believe BJRI could achieve adjusted EBITDA of close to $165m by 2019 with about $150m net debt on its balance sheet.  We believe BJRI could reduce total shares outstanding to about 20m by year-end 2019.  We believe BJRI could have an enterprise value (EV) of about $1.65b based on 10x adjusted EBITDA.  Based on about 20m total common shares outstanding, BJRI would have a share price of about $75 per share (65% higher than current price).

“Ft. Knox” Balance Sheet Enables Value Creation

BJRI has a “Ft. Knox” balance sheet with a net debt position of about $160m at Q1 2017 or about 1.1x LTM adjusted EBITDA.  BJRI recently arranged a new $250m credit line facility, giving the Company significant additional liquidity for organic growth and share repurchase opportunities.  We believe BJRI could generate close to $100m of FCF (defined as cash from operations less maintenance capital expenditures) per annum, which can be invested in new restaurants and share repurchases.  We think BJRI could end 2019 with significantly more restaurants and significantly fewer total shares outstanding.

Conclusion and Target Price

Based on 10x our estimated EBITDA of $165m for 2019 with $150m net debt and about 20m diluted shares outstanding, we believe BJRI could have a market cap close to $1.5b or $75 per share or more versus $45 per share today (+65%).  If BJRI continues to execute and its casual dining restaurants perform as we expect, we think our target price can be achieved.  Further, we believe BJRI has a solid competitive position with a good platform for growth and we believe BJRI could prove an attractive acquisition to a strategic or private equity acquirer.

1. 14 weeks in 2016.

Catalysts

1. Low valuation with a 9% unleveraged FCF yield and 8.5x Adjusted EBITDA and 1.1x revenue for business with good long-term growth potential.

2. Steady reduction of total shares outstanding from 23m at year-end 2016 to 20m or less by year end 2019.

3. Growth in units and stable comp store sales results in increased market share in casual dining industry.

4. Continued high cash on cash investment returns in new stores helps drive higher cash from operations and adjusted EBITDA over the next several years.

5. Projected adjusted EBITDA of $165m or more by 2019.

6. Improved and stabilized performance in comp store sales trends (low single digits).

7. Growth in adjusted EPS from 2016 to 2019 due to modest comp store sales, new unit growth, operating expense leverage, and reduction in diluted shares outstanding.

8. Possible acquisition of BJRI by a strategic or financial purchaser.

9. Increased analyst recognition of BJRI’s improved, more consistent business model.

Risks

1. The U.S. economy declines, including the restaurant industry, which is driven by consumer spending.

2. Recent comp store sales results have been weaker and could get worse before they improve.

3. The restaurant industry is highly competitive with significant new entry in markets like Texas (which has a large concentration of BRJI restaurant base).

4. The casual dining segment of the restaurant industry has struggled with customer traffic in recent quarters and this trend could continue and be a headwind for BJRI.

5. BJRI is unable to improve its adjusted EBITDA margins and/or grow its revenues as we expect.

6. Misallocation of capital into a poor acquisition.  

7. We are defining FCF as cash from operations less maintenance capital expenditures and including non-cash stock comp and some other add-backs which some investors would not want to include.

Disclaimer

Disclaimer:  We own shares of BJRI.  We may buy or sell these shares at any time without notice.  The information in the write-up is believed to be correct as of the date written but VIC members should do their own verification of this information and analysis of this potential investment.  We undertake no obligation to update this write-up if new information arises at a future date.

Catalyst

see above