BJ'S RESTAURANTS INC BJRI S
July 14, 2011 - 1:25am EST by
devo791
2011 2012
Price: 55.51 EPS $1.06 $1.27
Shares Out. (in M): 28 P/E 52.4x 43.7x
Market Cap (in M): 1,529 P/FCF Negative FCF Negative FCF
Net Debt (in M): 0 EBIT 42 51
TEV: 1,481 TEV/EBIT 35x 29x
Borrow Cost: NA

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Description

BJ's Restaurants is a casual dining restaurant chain with 108 units in the US.  The company has performed very well over the past few years, which has resulted in it receiving a staggeringly high valuation.  While there are a number of high multiple stocks in the market, what makes the short case for BJRI unique and compelling is that when you consider what the company is -- a mid-stage restaurant chain -- it has no hope of being worth anywhere near the current price even under the most optimistic scenarios.

BJRI is currently valued at 35x this year's EBIT and 52x this year's earnings.  While some companies have the economic characteristics that make it possible for them to potentially live up to the expectations embedded in these valuations, a mid-stage restaurant chain simply does not.  I believe that fair value for BJRI today is $20.  If we give the company the benefit of the doubt and model a flawless unit expansion over the next decade BJRI is worth around $27 today.  With a current price that is double this valuation, the company is a compelling short.  BJRI is not just priced for perfection, it is priced for perfection times two.

BJRI cannot ever be worth anything close to 52x earnings because it is bound to the economics of restaurants.  These apply as follows:

1) Restaurants are generally very capital intensive, with decent but unspectacular returns on capital.  

BJRI targets around a 25% pre-tax ROI on new units.  The company has performed well, however, and I believe in reality they are tracking closer to a 29% pre-tax ROI on new units, or 20% after tax.  When you incorporate the incremental overhead needed to support new units (around 3% of revenues), you get to around a 17% after-tax ROI at their current high-performing levels.  While growth can certainly create some value with these ROIs, the value creation is relatively moderate, especially when compared with businesses that do not require any capital to grow.

2) Growth has to be "slow" and steady, partly because of the large capital requirements associated with expansion and partly because of the operational focus needed to execute on it.  

In BJRI's case, this means they can drive around 11% unit growth annually.  This obviously slows the value creation (they can't double the business in only a few years).  It also means that revenue growth is limited to being "only" low double digits each year.

3) The company's unit level performance is so exceptional there's arguably no room to improve upon it anymore; it can only get worse from here.

Right now they are serving 1200 guests per day and turn their tables 4.4x.  To put those figures in perspective, casual dining restaurants generally top out at 600 - 700 guests per day and 3 - 3.5 table turns.  Restaurant units obviously have a limited capacity and I believe that BJRI is approaching their limits.  You can see some of these figures in their investor presentation here:
http://phx.corporate-ir.net/External.File?item=UGFyZW50SUQ9OTgxNjF8Q2hpbGRJRD0tMXxUeXBlPTM=&t=1

Strong comps and improving unit margins have been a driver of overall company margin expansion over the past few years.  Both of these are increasingly unlikely beyond this year due to the company's essentially "maxed out" performance metrics.  The absence of high comps and consequent margin expansion going forward are a potential catalyst for the stock to decline closer to its intrinsic value.  Furthermore, because operating performance is so exceptional right now, there is also the possibility that unit margins actually decline by a point or two for any number of reasons (increased competition, waning popularity, operational miscues, poor site selection, etc.).  Meaningful unit margin declines back to where they were just a few years ago would likely result in a significant correction in the share price.

4) Because the company already has over 100 units, there isn't a lot of G&A leverage left for the company to drive margin expansion.

The company has gone from 3.8% EBIT margins in 2008, to 4.7% in 2009, to 6.1% in 2010, to an expected 6.9% in 2011.  Part of this has been driven by improved unit margins as discussed above, with the balance driven by G&A leverage.  With over 100 units, however, the bulk of the G&A leverage has already played out for the company.  G&A will be roughly 6.3% of revenues this year.  Incremental G&A going forward should run at around 3% of revenues and I have modelled G&A at full roll-out at 4.3% of revenues.  This leaves only 200 bps more margin to capture over the next 10 years, accreting at around 20 bps per year.  If they are able to get G&A down to 4.3% of revenues as I have assumed, it will be quite the feat.  PF Chang's stands at 6.6%, Cheesecake Factory is at 5.8%, and the very mature Brinker is at 4.8%.

5) Because the company already has 108 units, there isn't that much unit expansion left.

The company believes they can get to 300 units of "various site types and sizes", an important caveat to note.  I would be surprised if they could build much more than 200 units with the same economics of their existing restaurant base, so they are probably actually half way to saturation.  I suspect that they are contemplating some smaller formats with unknown economics to get them beyond 200 units.  For comparison, PF Chang's bistros hit a wall at 200 units and Cheesecake Factory seems to be hitting a wall at 150 units.  I have given them the benefit of the doubt, however, and modelled out their expansion to 277 restaurants, all with the current format and unit economics.

Valuation

I modelled out what I believe is a very aggressive, best-case scenario for the company.  It runs until 2020 when the concept will essentially be fully rolled out.  My assumptions are as follows:
  • Unit growth from 108 units today to 277 units in 2020.  Unit growth will therefore be around 9 - 11% annually.  As mentioned above I'm skeptical that they can get to this many units with strong economics in place.
  • Revenues per average unit increasing from $5.3 M last year to $6.5 M in 2020 (a 22% increase).  Bear in mind that they target $4.5 - $5.5 M on new units, and that this $6.5 M is an average across the entire 277 unit base.  Realistically revenues per unit are likely to decline as the company expands into new geographies and fills out their mature markets.
  • Unit margins increasing from 19.5% last year to 20.0% in 2020.  Realistically unit margins are likely to decline as the company expands into new geographies and fills out their mature markets.
  • G&A as a % of revenues declining from 6.7% of revenues last year to 4.3% of revenues in 2020.  This is probably a bit of a stretch too, and a 4.8% figure more in line with Brinker is more realistic.
  • A discount rate of 9.0%.
The model gets you to $164 M in EBIT, $113 M in net income, and $4.10 in EPS in 2020.  What's really incredible is that the current price is 9.1x EBIT *10 years from now* when the concept is fully rolled out, and 13.5x earnings.  If you do a DCF with that 9% discount rate you get a $27 - 28 per share present value.  Also, if you assign the company a low growth multiple of 13 - 14x earnings in 2020 you get $55 per share for its price 10 years from now, which is coincidentally the same as the share price today.  In other words, even with this staggering assumed performance over the next decade the short still wouldn't lose money 10 years from now.

In conclusion, BJRI is worth around $20 per share today, and even if you assume a flawless rollout over the next 10 years of their restaurant concept with arguably aggressive, unrealistic assumptions it's still only worth around $27 per share.  With a current share price that is double this valuation, the stock is a compelling short. 

Catalyst

Comps eventually moderate, or maybe even decline.
Some of the new geographies don't live up to the high expectations set by the existing unit base.
Unit expansion hits a wall sooner than the company expects.  
21% of revenues come from alcohol, which suggests they run a large bar business.  Bar business at restaurants is often fickle.
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    Description

    BJ's Restaurants is a casual dining restaurant chain with 108 units in the US.  The company has performed very well over the past few years, which has resulted in it receiving a staggeringly high valuation.  While there are a number of high multiple stocks in the market, what makes the short case for BJRI unique and compelling is that when you consider what the company is -- a mid-stage restaurant chain -- it has no hope of being worth anywhere near the current price even under the most optimistic scenarios.

    BJRI is currently valued at 35x this year's EBIT and 52x this year's earnings.  While some companies have the economic characteristics that make it possible for them to potentially live up to the expectations embedded in these valuations, a mid-stage restaurant chain simply does not.  I believe that fair value for BJRI today is $20.  If we give the company the benefit of the doubt and model a flawless unit expansion over the next decade BJRI is worth around $27 today.  With a current price that is double this valuation, the company is a compelling short.  BJRI is not just priced for perfection, it is priced for perfection times two.

    BJRI cannot ever be worth anything close to 52x earnings because it is bound to the economics of restaurants.  These apply as follows:

    1) Restaurants are generally very capital intensive, with decent but unspectacular returns on capital.  

    BJRI targets around a 25% pre-tax ROI on new units.  The company has performed well, however, and I believe in reality they are tracking closer to a 29% pre-tax ROI on new units, or 20% after tax.  When you incorporate the incremental overhead needed to support new units (around 3% of revenues), you get to around a 17% after-tax ROI at their current high-performing levels.  While growth can certainly create some value with these ROIs, the value creation is relatively moderate, especially when compared with businesses that do not require any capital to grow.

    2) Growth has to be "slow" and steady, partly because of the large capital requirements associated with expansion and partly because of the operational focus needed to execute on it.  

    In BJRI's case, this means they can drive around 11% unit growth annually.  This obviously slows the value creation (they can't double the business in only a few years).  It also means that revenue growth is limited to being "only" low double digits each year.

    3) The company's unit level performance is so exceptional there's arguably no room to improve upon it anymore; it can only get worse from here.

    Right now they are serving 1200 guests per day and turn their tables 4.4x.  To put those figures in perspective, casual dining restaurants generally top out at 600 - 700 guests per day and 3 - 3.5 table turns.  Restaurant units obviously have a limited capacity and I believe that BJRI is approaching their limits.  You can see some of these figures in their investor presentation here:
    http://phx.corporate-ir.net/External.File?item=UGFyZW50SUQ9OTgxNjF8Q2hpbGRJRD0tMXxUeXBlPTM=&t=1

    Strong comps and improving unit margins have been a driver of overall company margin expansion over the past few years.  Both of these are increasingly unlikely beyond this year due to the company's essentially "maxed out" performance metrics.  The absence of high comps and consequent margin expansion going forward are a potential catalyst for the stock to decline closer to its intrinsic value.  Furthermore, because operating performance is so exceptional right now, there is also the possibility that unit margins actually decline by a point or two for any number of reasons (increased competition, waning popularity, operational miscues, poor site selection, etc.).  Meaningful unit margin declines back to where they were just a few years ago would likely result in a significant correction in the share price.

    4) Because the company already has over 100 units, there isn't a lot of G&A leverage left for the company to drive margin expansion.

    The company has gone from 3.8% EBIT margins in 2008, to 4.7% in 2009, to 6.1% in 2010, to an expected 6.9% in 2011.  Part of this has been driven by improved unit margins as discussed above, with the balance driven by G&A leverage.  With over 100 units, however, the bulk of the G&A leverage has already played out for the company.  G&A will be roughly 6.3% of revenues this year.  Incremental G&A going forward should run at around 3% of revenues and I have modelled G&A at full roll-out at 4.3% of revenues.  This leaves only 200 bps more margin to capture over the next 10 years, accreting at around 20 bps per year.  If they are able to get G&A down to 4.3% of revenues as I have assumed, it will be quite the feat.  PF Chang's stands at 6.6%, Cheesecake Factory is at 5.8%, and the very mature Brinker is at 4.8%.

    5) Because the company already has 108 units, there isn't that much unit expansion left.

    The company believes they can get to 300 units of "various site types and sizes", an important caveat to note.  I would be surprised if they could build much more than 200 units with the same economics of their existing restaurant base, so they are probably actually half way to saturation.  I suspect that they are contemplating some smaller formats with unknown economics to get them beyond 200 units.  For comparison, PF Chang's bistros hit a wall at 200 units and Cheesecake Factory seems to be hitting a wall at 150 units.  I have given them the benefit of the doubt, however, and modelled out their expansion to 277 restaurants, all with the current format and unit economics.

    Valuation

    I modelled out what I believe is a very aggressive, best-case scenario for the company.  It runs until 2020 when the concept will essentially be fully rolled out.  My assumptions are as follows:
    The model gets you to $164 M in EBIT, $113 M in net income, and $4.10 in EPS in 2020.  What's really incredible is that the current price is 9.1x EBIT *10 years from now* when the concept is fully rolled out, and 13.5x earnings.  If you do a DCF with that 9% discount rate you get a $27 - 28 per share present value.  Also, if you assign the company a low growth multiple of 13 - 14x earnings in 2020 you get $55 per share for its price 10 years from now, which is coincidentally the same as the share price today.  In other words, even with this staggering assumed performance over the next decade the short still wouldn't lose money 10 years from now.

    In conclusion, BJRI is worth around $20 per share today, and even if you assume a flawless rollout over the next 10 years of their restaurant concept with arguably aggressive, unrealistic assumptions it's still only worth around $27 per share.  With a current share price that is double this valuation, the stock is a compelling short. 

    Catalyst

    Comps eventually moderate, or maybe even decline.
    Some of the new geographies don't live up to the high expectations set by the existing unit base.
    Unit expansion hits a wall sooner than the company expects.  
    21% of revenues come from alcohol, which suggests they run a large bar business.  Bar business at restaurants is often fickle.

    Messages


    SubjectRE: Agree with your thesis
    Entry11/16/2011 10:53 AM
    Membertombrady
    Cgn or Devo,
     
    Great write-up. I also see Bj's as inappropriately "high-flying" for a midscale pizza chain, which is what the company is at its core. Granted near-term sales initiatives can always lead to temporarily pumped-up comps, this company has set itself up to disappoint investors, likely sooner rather than later.

    My follow-up: I've looked into the Company management's "Equity Incentive Plan" in the most recent Qs and K. All I've found is details on a 2005 Incentive Plan that replaced the 1995 Incentive Plan, and was amended most recently in 2010. I've seen no mention of any related management lock-up.
     
    Cgn, could you give more disclosure surrouding this so-called lockup aspect of the thesis?

    Thanks.
     
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