The Habit Restaurants (“Habit” or “HABT”), a growing burger chain with 195 locations, is an attractive long. Habit shares are down nearly 50% since May as the restaurant sector has been under pressure from an unfavorable promotional environment. Prior to Q3’17, Habit posted 54 consecutive quarters of SSS growth and investors were enamored with what appeared to be one of the more attractive growth stories in the restaurant category. However, as SSS slowed down amid strong competitive and discounting pressure, Habit’s stock went from nearly $20/share in May to $9.65/share today, representing 6.9x 2018E EBITDA and 7.9x 2019E FCF. At 7x EBITDA, HABT is among the cheapest growing restaurant stocks in the market. While SSS has declined slightly in the last quarter and is forecasted to decline by ~1% in Q4, Habit’s results were better than most of the comps and trades at a significant discount to the overall industry. Given the growth opportunity (current base is only 195 stores), attractive unit economics and low menu price point, Habit should trade at a significant premium to the restaurant sector which currently trades at 9-11x EBITDA. Shares are worth at least $17/share, implying 15x 2019E FCF and more than 75% upside.
HABT’s stock appears cheap regardless of valuation methodology. Shares are down ~50% since the 2018 high of ~$20/share as expectations for SSS were too high coming into 2017. While SSS has indeed faced pressure over the last 2-3 quarters, Habit performed better than most of the industry. In fact, peers like Shake Shack continue to trade at premium valuations despite printing negative comps over the last three quarters.
Many small restaurant chains are also struggling with declining SSS yet stocks like SHAK still trade at a significant premium. With SHAK, investors place a high value on the growth opportunity, attractive unit economics and brand awareness. While Habit shouldn't necessarily trade at SHAK’s valuation, the discount to the industry seems very severe, especially relative to chains like FRGI which has seen SSS decimated over the last year. With just 195 stores, attractive unit economics (discussed more below) and an ambitious store growth plan, Habit arguably should trade significantly higher than some of its small restaurant peers.
By taking the base of the 195 stores today as well as the 50 or so they plan to open for the next two years, Habit could generate $27 million of FCF, $36 million of EBITDA and $455 million of revenue on a run-rate basis. Nearly all of Habit’s capex over the last few years have been for growth. Habit generates significant free cash flow with nearly $20 million over the last twelve months (excluding growth capex). Including new stores over the next two years, Habit could generate up to $30 million (the model below shows $27 million but could be higher under the new tax proposals) of FCF. On $27 million of FCF, Habit trades at just 7.9x.
Attractive Unit Economics
Habit benefits from attractive unit economics, an important factor for a growing restaurant chain. On average, Habit spends between $750-$810k of capex for each new store. Today, Habit stores on average generate about $1.9 million revenue and new restaurants generate $1.5 million by year 3 of opening. Restaurant contributions have historically ranged between 20% to 22% but the illustrative example below assumes 18%. With increased labor costs, especially in states like California where most of Habit’s stores are located, contribution margins may decline. However, even with contribution margins of 18%, Habit generates 33-42% ROI on each new store.
Significant growth opportunity
With a base of only 195 locations, Habit has a significant growth opportunity, particularly in the East Coast where Habit has been expanding (Habit is targeting 25% of new locations for East Coast and 75% in California and surrounding western states).
Store locations as of 03/31/2017:
While management has a vision of potentially opening 2,000+ units, that forecast is probably overly optimistic. The restaurant space is intensely competitive but given where the stock trades today, Habit doesn’t need to get to 2,000 or even 1,000 for the story to work. With its extremely attractive unit economics, Habit could successfully at least double its store presence over the next 5-7 years.
Low average check size
Habit has an average check size of $8.50 ($7.95 shown below as of March 2017), significantly lower than other burger chains like Shake Shack, Five Guys and smashburger. Despite the price increases over the last few quarters (pricing was higher by 2.5% in Q3, 1.5% in Q2, 2.2% in Q1, 2.7% in Q4), Habit remains significantly cheaper than competing burger concepts. This gives Habit potentially some space to further increase prices, especially important as Habit is seeing wage pressure.
High Yelp Ratings
Habit has generally high ratings on Yelp. Obviously Yelp isn’t the best indicator for how much consumers like a restaurant but a random sample of highly reviewed locations provides another helpful data point. On average for the 15 random locations we looked up (targeted locations through CA as well as locations in East Coast with highest # of reviews), we found that Habit had a Yelp rating not too far off from In-N-Out, the beloved burger chain and a primary competitor in California.
At $9.65/share, Habit’s valuation is attractive and the discount to peers should narrow, given the SSS performance of the last few quarters relative to peers, growth prospects, attractive unit economics, and pricing increase potential. While Habit has a big presence in California, the menu and brand has national appeal as Habit serves burgers, a proven concept that works globally. At this point, investors seem to have priced in a worst case scenario, and it shouldn't take much for the stock to re-rate higher over time as the store base continues to grow.
Appendix: Business Overview
Habit has broad consumer appeal and a balanced mix of revenue from lunch and dinner
SSS historically strong. Habit saw 52 straight quarters of SSS through Q4’16
Strong historical financial performance and growth
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.
Continued successful expansion of store base
Higher AUVs and contribution margins from increase in locations with drive-thrus