Description

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Recommendation: Long Del Frisco’s (NASDAQ: DFRG) - $25 PT

Investment Thesis

Del Frisco’s is an owner and operator of restaurants with three main brands that focuses mainly on the high-end and ultra-high-end restaurant space. Its marquee brands are Del Frisco’s Double Eagle Steakhouse, Del Frisco’s Grille, and Sullivan’s Steakhouse. The company has seen steady growth and is aiming to continue growing at a steady clip. The company presently operates 47 restaurants, with several more scheduled to open this year. DFRG has performed very poorly during the recent market turmoil despite having essentially no dependency on any of the macro or economic factors that are believed to have caused the recent sell-off. Some of this can be attributed to the unfortunate timing of a somewhat weaker earnings report for the most recent quarter near when the market volatility began. In my view, this recent earning miss was due to a few noisy events that don’t have any long-term impact on the long-term economics of the business. While DFRG is largely tied to the macro performance of the U.S. economy, the U.S. economy has been performing very well; further, I view it as very unlikely that turmoil in the financial markets can drive the U.S. into a recession. While DFRG is somewhat tied to the financial markets / M&A volumes due to its focus on high-end business meals, it has enough geographic diversity to mitigate those factors. Further, DFRG’s Grille is less sensitive to the economy because it is more affordable. One thing that makes DFRG unique is that such a large percentage of its revenues come from beverage sales: 34% in the Double Eagle Steakhouse, 35% in the Grille, and 33% in Sullivan’s. This insulates DFRG to some extent from the recent volatility in beef prices and food prices more generally. DFRG is a unique collection of brands with proven unit economics and ample opportunity to continue growing in the U.S. for the foreseeable future; I view DFRG is as attractively valued, especially relative to where some of the other restaurant peers with worse prospects trade.

Financial Summary:

Management Team:

§  Management team has broad and diverse experience in the restaurant space, with substantial experience running high-end chains.

§  Management team has a demonstrated ability to execute on the market opportunity

Risks:

§  Macro volatility / U.S. economy issues – view any material impact on the U.S. economy from market turmoil as unlikely, but such a scenario would be bad for DFRG

§  Issues with new store growth / selection of new locations

§  Food price volatility – can have a severe impact on restaurants given it can’t always be passed on to consumers – mitigated by DFRG’s strong exposure to beverage sales

§  Minimum wage hike – unclear how many of DFRG’s employees make minimum wage but a national minimum wage hike would likely negatively impact DFRG

§  Tied to a relatively small unit base compared to larger restaurant peers – due to business model focused on high auv’s, issues in any given city can materially impact earnings – e.g., Baltimore issues affecting the Baltimore restaurant

Catalyst

Catalysts:

§  Continued U.S. economic growth and increasing consumer confidence – Del Frisco’s depends on people feeling comfortable enough to spend amply on fine dining

§  Continued unit growth and strong execution of business plan

§  Optimization of the capital structure – company currently has no debt and could use debt to increase its growth rate