Buy-Rating For Brinker International (EAT), Industry Expert Defends Contrarian Call
July 26, 2010 - The Wall Street Transcript has just published Restaurant Report offering a timely review of the Restaurants sector. This Special Report contains expert industry commentary through in-depth interviews with public company CEOs, Equity Analysts and Money Managers. Please find an excerpt below.
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Chris O'Cull is part of the consumer team at SunTrust Robinson Humphrey, Inc., where he concentrates on the restaurant sector. Previously he served in various executive roles, ranging from finance to marketing, at O'Charley's Inc. Prior to O'Charley's, he was an Analyst covering the restaurant industry at Morgan Keegan & Company and SunTrust Equitable Securities. Mr. O'Cull has been voted an Institutional Investor All-America Research Team "Best Up-and-Comer."
TWST: Broadly speaking, where do you focus your attention in the restaurant space these days?
Mr. O'Cull: Our coverage is evenly split between casual dining and fast food stocks. Our "buy" recommendations are with companies where we believe there is a good margin of safety, and where we believe a turnaround plan could lead to better performance. Some of our recommendations are viewed as contrarian calls because there is not a clear catalyst.
TWST: In these times, is scale a remarkably important aspect of a company in this industry?
Mr. O'Cull: It is. McDonald's (MCD) has done an excellent job of flexing its advertising muscle by supporting product ideas that are priced aggressively to drive trial and frequency. The fact that smaller fast food chains are offering similar types of products with better quality and priced almost as aggressively - and are struggling to generate similar demand - speaks to the importance of advertising level.
TWST: Where are you pointing investors now? What are some of your favorite stories these days?
Mr. O'Cull: Some of our favorite stories are names like DineEquity (DIN), Jack in the Box (JACK) and Wendy's/Arby's Group (WEN). Those are our favorite stories right now.
TWST: What about Jack in the Box?
Mr. O'Cull: Jack in the Box is a company that has seen quite a bit of sales pressure from its exposure to California and Texas; unemployment has really affected the Jack in the Box brand in both of those states. The company has a very innovative menu, offering more variety than any of the fast food burger chains, and we believe they are going to be able to drive broad appeal over time. And as the economy improves in those states, we think you'll see Jack in the Box gain share. In addition, Jack in the Box should be able to continue selling their company-owned stores to franchisees, which would result in better margin, better free cash flow and the ability to accelerate development of the brand across the country. For longer-term investors, Jack in the Box is a company that has significant expansion opportunity, especially once we get through this recession.
TWST: Any other companies you are favorable on right now?
Mr. O'Cull: Wendy's and Brinker (EAT) are our other "buy"-rated stocks. We believe the Wendy's brand turnaround has gone well. Management is achieving its key objectives of improving the Wendy's restaurant margin and realizing G&A savings following the merger. Wendy's has done a great job of improving its performance over the past couple of years despite the recession. The challenge with the Wendy's/Arby's Group is Arby's. Arby's is a brand that has seen significant top-line pressure and margin erosion. In our opinion, it was not positioned well going into the recession. Management is making menu adjustments by offering an everyday value menu and premium products at Arby's. We think they'll be successful with the turnaround at Arby's. We recently upgraded WEN, and we continue to recommend the shares.
TWST: What about Brinker International?
Mr. O'Cull: Brinker definitely fits in the contrarian category. The company jettisoned On the Border as well as Macaroni Grill, so now the focus is turning around the Chili's brand, which has struggled with same-store sales for several quarters. The "buy" rating on Chili's reflects what we believe is very good valuation given the significant cash flow. The company is essentially investment-grade profile, and we project it will generate roughly $200 million a year in free cash flow to be used to pay dividends and repurchase stock. We expect new concept leadership to improve Chili's sales and margin performance, but this performance will probably build slowly with the current economic backdrop.
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