BJ’s Restaurants (BJRI) is a casual dining restaurant chain headquartered in Huntington Beach, CA. The idea has previously been written up three times, most recently as a short in 2012. Back then, BJRI was an overvalued concept beginning to expand outside of its core markets. Today, the multiple has contracted, but many of the same headwinds (and many new ones) appear likely to constrain growth going forward.
BJRI now operates in 25 states, with approximately 70% of restaurants in four states (CA, TX, FL, OH).
Our short thesis is based on the following:
1.Negative comps (and increasing reliance on price)
Like many mall-based restaurants, BJRI has seen comps turn negative, despite raising price 2-3% on an annual basis. After a fairly steady 2.5-3% increase in pricing in recent years, in 2Q16 price only rose 2.0%.
While price rebounded by +2.8% in 3Q16, we question the ability to continue taking price at these levels. 2-3% appears reasonable, but given the continued crowding of the casual dining space, promotional activity has created a more difficult environment. As a result, BJRI has increasingly increased its promotional cadence. CEO Greg Trojan on the 3Q16 earnings call highlighted our concerns about where BJRI sits relative to competitors.
“While our frequency of discounting is up approximately 30% versus last year, we remain well on the lower end of the spectrum relative to our category, both in terms of frequency and depth.”
While the BJRI concept is fine, it doesn’t appear to be significantly differentiated enough from peers to remain on the low end of the promotional spectrum without ceding share.
While we admire the discipline BJRI has shown on the pricing front, we question the ability to remain disciplined as traffic continues to deteriorate. Traffic has been increasingly challenged, culminating with the (6.2%) traffic comp in the most recent period.
The traffic trends shouldn’t be surprising given that BJRI relies so heavily on mall traffic. But the company rarely discusses its reliance on malls, outside of a quick comment buried in its 10Q:
“Our business is subject to seasonal fluctuations. Additionally, our restaurants in the Midwest and Eastern states, including Florida, are impacted by weather and other seasonal factors that typically impact other restaurant operations in those regions. Holidays (and shifts in the holiday calendar), severe weather, hurricanes, tornados, thunderstorms and similar conditions may impact restaurant sales volumes seasonally in some of the markets where we operate. Many of our restaurants are located in or near shopping centers and malls that typically experience seasonal fluctuations in sales. Quarterly results have been and will continue to be significantly impacted by the timing of new restaurant openings and their associated restaurant opening expenses. As a result of these and other factors, our financial results for any given quarter may not be indicative of the results that may be achieved for a full fiscal year.”
We were surprised to see so little discussion in conference calls about mall-based traffic, when it appears ~70% of locations are mall-based (mostly in mall parking lots).
3.Slowing store openings
Given the challenges with comps and competitive pressures, BJRI has recently announced plans to slow its store openings. From the Q3 call:
“But as we look to the restaurant openings for 2017, we plan to slow our growth to help navigate the challenging macro environment. While we have not yet finalized our planning for next year, we are anticipating a range of 10 to 15 new restaurant openings. We are slowing the pace of growth to focus even more of our enterprise resources on building sales. In times like these where the sales headwinds are blowing fiercely, we are choosing to point more weapons at growing sales in existing restaurants versus opening more restaurants, much like we did during the 2008 and 2009 down cycle.”
Texas appears particularly challenged, with no openings planned in 2017.
Interestingly, the company was touting its robust new store opening performance as recently as the beginning of 2016. In many ways, we admire how quickly management has recognized the changing landscape and slowed openings. They also seem to have left room to slow openings further.
4.Newer stores lower SSS when entering the comp base
The decision to slow new store openings leads us to believe that recent openings have been challenged. Unfortunately, they still have to watch recently opened stores enter the comp base in coming quarters. These do so with a negative effect on overall comps even before we take into account that recent openings have caused BJRI to slow new openings. From the 1Q16 call (emphasis is ours):
“Question – Jeff Farmer:Thanks.I'm just following up on an earlier line of questioning.It looks like over the last three years, you guys have opened up something like more than 25 restaurants outside of California, Texas, Florida, so those core markets for you.As a group, are those units entering the comparable store base as a headwind or a tailwind assumed from sales?
Answer – Greg Levin:There has been really no change in our discussion on that, Jeff, in the sense that when newer restaurants come into the comp base they come in negative.I will tell you right now, the class of 2014, it came in negative.I don't know what the exact hit was on a comp sales, in the past we've talked about it being around 50 basis points and looking at the trend it looks pretty consistent.”
-The company will begin comping over favorable food deflation in the coming quarters. Some analysts are already calling for a reversal in the deflationary trend.
-With ~33% of stores located in CA, wage inflation is a likely headwind, especially in light of the increasingly promotional environment limiting the ability to raise price.
There are several risks to our thesis:
-If casual dining or mall traffic rebound suddenly, BJRI should be a significant beneficiary.
-The company has repurchased over $240M of stock since initiating a repurchase plan in 2014. With a relatively clean balance sheet, they could continue to repurchase stock.
-There has been recent speculation about M&A in the casual dining space. Given the growth challenges facing BJRI, we doubt they make an attractive target, but debt is still cheap and if comps rebound, unit economics are attractive. QSR recently announced an agreement to acquire Popeye’s (PLKI) for ~28x 2018 EPS, although we note PLKI has a large franchise component.
Overall we believe it is unlikely that comps will return to positive territory given the headwinds facing the company, and continued lower estimate revisions will cause the stock to re-rate lower.
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I do not hold a position with the issuer such as employment, directorship, or consultancy. I and/or others I advise hold a material investment in the issuer's securities.