Cisco Systems (CSCO) invests in new technologies for its data communications business by funding hundreds of smaller innovators and buying the most successful technologies that emerge, limiting the amount of risk inherent from the technology R&D process, says Ronald L. Altman, SVP and Senior Portfolio Manager at Anchor Capital Advisors LLC.
“Somebody comes into John Chambers’ office and says, ‘I have a great idea, I think I can build the business that’s going to be half a billion dollars or billion dollars,’ and he says, ‘How much money do you need and let’s see the business plan.’ If Cisco likes it, they put him in a separate company, they fund it, and they’ve got a hundred of these. If the company succeeds, they’d buy it. So they take a limited risk, and it’s a great venture capital pool that they can use to augment the products that they develop internally,” Altman said.
Altman says CSCO trades below the average value of a S&P 500 company, and he adds that Cisco is more of a software company than a hardware company, a distinction visible in the company’s gross margins.
“You can’t get 60%-plus gross margins in the hardware business. What you’re really looking at in Cisco is millions of lines of code buried in application-specific microprocessors inside their box. As long as the demand for data continues to grow and it grows at a very high rate, Cisco is a great play. Demand keeps growing and the distribution of that data keeps increasing. Cisco still has a very positive future,” Altman said.
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BJ’s Restaurants (BJRI) has a robust growth pipeline in the U.S., and with its cash flow generation and positive same-store sales is seeing significant long-term growth opportunities, says Scott M. Swanson, Partner and Senior Equity Analyst at Crowell, Weedon & Co.
“[BJ’s] ended the year with about 130 locations, and management at the company has stated numerous times in the past that they believe that they could operate over 400 locations in the U.S. based on the comparable-sized restaurants that they are opening today, and so that wouldn’t even include perhaps a smaller footprint or a smaller prototype that they could look at in the future,” Swanson said.
BJRI has the financial capability to increase its unit growth, as the company is generating sufficient cash flow to fund the openings and looks to continue opening locations at a rate of about 11% to 12% a year, thus generating significant earnings growth, says Swanson.
“With positive same-store sales in excess of 2% to 3%, they should be able to generate earnings growth in excess of 15%, so I think that BJ’s has a long growth runway ahead of them that should last for several years,” Swanson said.
Buffalo Wild Wings (BWLD) maintains one of the highest unit growth rates among restaurants with more opportunities to expand toward from coast to coast, and BWLD displays a competitive advantage through its higher profitability per square foot, says Nick Setyan, Senior Equity Analyst for Wedbush Securities.
“In terms of Buffalo Wild Wings, the longer-term context there is they have probably the highest unit growth rate on the company side in restaurants,” Setyan said. “Their cash-on-cash returns are increasing, which is always a metric that I look to, as they expand to the West Coast and East Coast. They can maintain 20% unit level EBITDA profitability on just $300 a square foot in sales.”
Because BWLD can maintain profitability at lower prices than its competitors, BWLD is able to penetrate areas that are up to 60% below state median income levels while still performing at or above system averages, Setyan says.
“BJ’s Restaurants (BJRI) needs almost $1,000 a square foot in sales to maintain 18% profitability. Applebee’s and Chili’s need something in the neighborhood of $400 to $600 in sales to maintain those types of profitability metrics. Buffalo Wild Wings can do it with only $300 in sales per square foot,” Setyan said. “So the longer-term growth opportunity because of that, in my opinion, is still quite big as they can get to above 2,000 units.”
Krispy Kreme Doughnuts (KKD) changed management, and the company is now implementing a turnaround strategy to increase store traffic and to reinvigorate the brand, says Will Slabaugh, Vice President and Equity Research Analyst at Stephens Inc.
“Krispy Kreme has been our best idea for 2013 and continues to be. I think there is still a lot of upside to both estimates and valuation,” Slabaugh said. “I think this story is still in the early innings of really turning the brand around and becoming a high-class growth story. I think it’s going to raise a lot of eyebrows if you start to see domestic units accelerating at a much faster pace.”
Slabaugh says traffic is already growing for KKD, and it seems to continue. He says not many analysts follow this stock anymore, but he continues having the name as one of his favorites in QSR.
“The past few quarters have provided a traffic growth of over 6%, over 8%, and I think a lot of that traffic growth is continuing into this current quarter, so that’s been extremely impressive. It’s an old brand, but it’s one that has been really reinvigorated recently, and I think you will see a lot more unit growth out of that company going forward,” Slabaugh said.
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Chipotle Mexican Grill (CMG) engages in a domestic unit-growth strategy while maintaining pricing power and expanding into new types of operations which enhance profit margins, all while leading in newer consumer trends such as a more transparent supply chain and ingredient integrity, says Sharon Zackfia, Partner and Group Head-Consumer at William Blair & Company, L.L.C.
“I still think Chipotle has a fairly open-ended growth path ahead of it, with the opportunity to still triple its U.S. restaurant base. And, maybe most important for near-term sentiment, it seems likely that Chipotle will take a price increase this summer. Chipotle historically has seldom seen any price resistance from consumers,” Zackfia said. “A price increase would bolster margins and same-store sales trends, which should help earnings growth accelerate into the back half of 2013.”
Chipotle‘s growth strategy also includes catering, which has a higher profit margin than its restaurant burrito business. Zackfia says catering is a way for CMG to increase sales in a way that doesn’t affect the front line, and which may put analysts’ worries about throughput maximum down.
“Catering for Chipotle is pretty much a back-of-house operation, whereby Chipotle will prepare chafing dishes of ingredients and customers will then, at home or at the office, customize their burritos or tacos themselves, because customization is a key element of Chipotle‘s success,” Zackfia said. “In addition, catering is obviously going to be a high average ticket, which could help bolster unit-level productivity and same-store sales, so that’s a bit of a positive wildcard as it rolls out this year.”
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The Cheesecake Factory (CAKE) is paying down all of its debt and generating excess free cash flow that is going back to shareholders as share repurchases and dividends, and it is gearing up make a large imprint internationally, says Scott M. Swanson, Partner and Senior Equity Analyst at Crowell, Weedon & Co.
“With more limited capital spending needs, the company is generating a lot of excess free cash flow now. Most of that’s going back to shareholders in the form of either share repurchase and/or dividend, so with modest expansion rate, with improving operating margins and with a declining share count, they’re able to drive pretty good earnings per share growth,” Swanson said.
The Cheesecake Factory is also on the cusp of an attractive international opportunity by licensing its brand to different parties abroad, thus driving pure profit that will drop straight to the bottom line, says Swanson.
“Although it’s early days, the restaurants that have opened in the Middle East have exceeded their sales expectations, so it looks like a big opportunity for them,” Swanson said. “First was the Middle East, now they’ve announced South America, Mexico, and I think it’s reasonable to assume that at some point down the road there will probably be an Asian presence or a European presence. So it’s a real nice upside, I think, to the earnings growth as we look out over the next several years.”
Red Robin Gourmet Burgers (RRGB) is poised to return to its historical status as a high-return-on-capital, high-profit-growth company and gain market share as new management implements new marketing strategies, says Bryan C. Elliott, Senior Equity Analyst with Raymond James & Associates, Inc.
“If [management is] successful in doing that through some of the brand repositioning and merchandising and marketing changes that we expect to see over the next few months — broadening the menu, new creative on TV — if they are successful at those things, it can begin to see strong comp sales and higher store cash flow margins,” Elliott said.
The new strategy’s success could then create a high-enough return on the cost of building a new unit that will justify accelerating expansion, which Red Robin has been successful at in the past, says Elliott.
“Red Robin is a very differentiated brand that, when well managed, has historically gone out and captured a lot of market share in new markets. And unit growth stories — companies that are able to open new units and sustain strong results on a per-store basis — are increasingly rare in the U.S. and thus are selling at high valuations,” Elliott said.
Sonic Corporation (SONC) would be under pressure if the federal minimum wage were to rise, creating significant labor-cost increases at a majority of its stores for this quick-service restaurant and perhaps stunting its appetite for expansion, says Sharon Zackfia, Partner and Group Head-Consumer at William Blair & Company, L.L.C.
“Sonic has done a good job turning around its same-store sales trends over the past year, but I’m a little concerned that a higher minimum wage could not only create margin pressure at Sonic‘s company-owned restaurants — half of which are in the state of Texas, which has the federal minimum wage — but could also perhaps impede appetite for franchisee development,” Zackfia said.
SONC‘s large exposure to Texas creates potential margin pressure. Moreover, Zackfia says the restaurant segment with some of the highest exposure to the minimum-wage is QSR, a segment which may have more problems passing through the increased labor costs to the consumer.
“Sonic has been at 3,500 locations, give or take, for three or four years now, and I was hoping to see an inflection in development in the not-too-distant future, and the minimum-wage discussion creates more concern on that front,” Zackfia said.
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Starbucks Corporation (SBUX) remains unusually stable and is posting strong same-store sales over last year, and she expects the favorable trends in the coffee bean market and the company’s growth initiatives in other hot beverages and food to result in continued growth for this coffee giant, says Sharon Zackfia, Partner and Group Head-Consumer at William Blair & Company, L.L.C.
“I think Starbucks stands out as a name that will likely be another strong performer in 2013. Starbucks has had some of the strongest same-store sales performance in the industry, which is notable because it has 18,000 restaurants and it is posting all-time-high average unit volumes in the U.S. It’s a strong testament to the brand and labor and throughput initiatives that Starbucks can be at all-time-high average unit volumes and still lead the industry in same-store sales growth.”
Zackfia says Starbucks sales continue to remain healthy, and the company currently has tailwinds which would help accelerate earnings growth for the company into 2014. She also says the companies initiatives with new accretive brands would result in double-digit growth.
“Commodity costs continue to become favorable in the coffee market, and that’s now a multiyear tailwind through 2015. And some of the initiatives that Starbucks is investing in during fiscal 2013 will turn more accretive in 2014, including La Boulange, Evolution Fresh and Teavana, so I think there’s unusually high visibility on Starbucks’ ability to continue to grow earnings at a 20% or greater clip, which is unusual for a company of its size and market cap,” Zackfia said.
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Western Alliance Bancorporation (NYSE:WAL) improves credit quality, with profitability expected to follow in the coming couple of years, allowing this Southwestern bank to continue growing while having exposure to upside in their loan portfolio, says Brett Rabatin, Managing Director, Equity Research, at Sterne Agee & Leach, Inc.
“I continue to like Western Alliance. It’s a bank headquartered in Phoenix that has exposure to Vegas and California, and they have what I consider two catalysts of continued strong growth in their loan portfolio, so they should have topline revenue improvement,” Rabatin said.
Rabatin says California has had strong loan growth, although it’s dependent on which verticals the bank participates. He also says WAL is cleaning up its Nevada exposure, and the company has a promising future in the coming years.
“They’re also getting their Vegas operation cleaned up, and so as credit quality continues to improve, profitability should actually be stable to improving over the next two years, which is going to be somewhat unique in the environment, so I still think that’s a name where people are underestimating the earning power of the franchise a year or two from now,” Rabatin said.
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