Monday, October 13, 2014

BJRI Another Manufactured Surprise in the 3Q -- Look for $0.15 or $0.02 better

In the second quarter, conservative guidance helped create a positive EPS surprise.   Investors should expect more of the same in the third quarter.  Lower than guided labor and operating expense should lead to $0.02 upside though traffic was likely sluggish.   Ignoring the gamesmanship, management deserves credit for cutting operating expense and controlling labor costs.   To deliver a real turnaround, BJRI must deliver traffic and sales growth to leverage its high fixed cost structure.  

With the stock trading at 39x forward four quarter earnings, the market appears to be giving BJRI a lot of credit for either a margin turnaround or resumed growth.   Neither of those things have happened but management is making progress on margins.   BJRI’s third quarter restaurant level EBITDA margin should be up 70bp to 17%.   That is still 300bp below the company’s 2010-2011 3Q margin, but it is at least moving in the right direction.    

Flat SSS in the the third quarter would also be an improvement from -1.7% in the prior quarter.   Same store sales  are likely to turn positive in the fourth quarter as BJRI benefits from a 2% price increase and laps a 2% headwind from mix—0% traffic growth plus 2% price plus 0% mix impact = ~2% SSS.    An easy comparison is not a turnaround, but the direction here also beats the alternative.

In a best case scenario BJRI might restore its restaurant level EBITDA margins in 2015 to 19%.  If so, BJRI would make more or less $1.35 (I am looking for $0.98 in 2015). This would still be 140bp below its peak 2011 margin (also a 53 week year).  At that point, the margin turnaround would be more or less in the rearview mirror.    Investors would just need to guess the right multiple to apply to its 10% planned unit expansion and whether shares outstanding will decline going forward and, if so, how quickly.   Without traffic growth and material positive SSS, it would be hard to get too excited about anything beyond 20-25x.   The current price equals 26x our ballpark for post-turnaround earnings.    BJRI traded at much higher multiples pre-meltdown but it also grew EPS at a 25% CAGR back then.   The company’s traffic building plans—app ordering, cheaper items, faster table turns—sound okay though not too inspired.   Seeing is believing on this front.

How to manufacture a surprise

BJ’s CFO Greg Levin gives specific line-item guidance for the upcoming quarter as part of 
each quarterly conference call.   Obviously, this has a big impact on expectations.   After reporting the first quarter, he stated, “I'm expecting labor to be in the mid to upper 35% range in the second quarter, and that's based on our current sales trend.”    Labor came in at 35%.   At the time of that guidance, April sales were running  -1.5% to -2.0% and the final number for the quarter, -1.7%, was right in the middle of that range. The 75bp pickup from labor, relative to Levin’s guidance, added almost $0.04 to second quarter EPS.   Regarding operating expense Levin said, “During the second quarter, I'm expecting total operating and occupancy costs to be in the range of $25,000 a week. Included in this number is about $2,400 per week or $4.7 million in marketing spend.”  Operating expense equaled $24,000 a quarter including $4.8 million in marketing.   This added almost $0.05 to second quarter EPS.   Thus, the $0.06 positive surprise reported in the second quarter was maybe not as exciting as the stock’s 11% jump that day would suggest.   Conservative guidance is a smart tactic for any CFO.  Levin has been giving conservative guidance for a while and the sell-side has elected to play along.   

The more important point is that BJRI held labor per operating week flat on top of 2% decline in the prior period.  Excluding marketing, operating expense fell 5% per operating week.   This was the same as in the first quarter so it wasn’t a surprise per se, but it is still outstanding.   Bottom line, the company’s EBIT margin was down 60bp year-over-year; a big improvement from down 210bp in the first quarter.   We expect a year over year rise in EBIT margin in the third quarter.

Another positive surprise in the third quarter--$0.15 or $0.02 better

BJRI has less wiggle room in the seasonally weak third quarter but it looks like management's guidance has set the company up for another positive EPS surprise. I am looking for $206.6 million in revenue with a flat comp.   The flat comp is an improvement.  Not coincidentally, BJRI’s first recent negative comp was in the third quarter last year.  BJRI will benefit from 60bp more price than in the last quarter.   A two percent price benefit should offset a two percent negative impact from mix.   The latter stems from the company’s roll-out of lower priced items like the $6.95 Brewhouse burger. 

According to management, the July 4 shift from Thursday last year to Friday this year (when the units would be busy anyway) resulted in a negative first week comp of -5%.   Away from the calendar shift, July comps were flat to slightly positive.   Management was looking for flattish comps for the overall quarter.  According to BlackBox, the overall restaurant industry SSS improved to 2.2% in September from 2.1% in August and 0.5% in July.   Traffic remains slightly negative. With recent more favorable industry trends, there could be room for modest upside.    

The Street must think so since the consensus revenue estimate is $208.5MM or $1.9MM above my number.  Given the timing of the three unit openings in the quarter, it seems likely that operating weeks will come in very close to management’s guidance of 1960.   The consensus revenue estimate implies average weekly sales of $106,383 (more or less flat year over year) versus my $105,404.   I assume AWS growth will lag SSS growth by 50bp as was the case in the prior two quarters.  

Lower-than-guided expenses should again outweigh weak sales.  Management forecast labor in the “low 36%” range.  This guidance implies an uptick in labor per operating week though this has been flat year to date.   Assuming a continuation of this positive trend, I am looking for labor at 35.9%.   This difference would add a little more than a penny to EPS.
Greg Levin guided operating expense including marketing at $24,000 per week.  Marketing spend is expected to total $4.7MM.   Ex-marketing, this suggests that operating expense would be flat quarter to quarter at ~$21,500.   Given lower volume in the third quarter relative to the second, operating expense per week typically turns lower.   Assuming this remains true, I look for another 5% year over year decline in non-marketing operating expense which would put overall operating expense at $23,548.   The apparently modest difference is worth $0.02 relative to expectations.

Adding it up, the third quarter should be another at least semi-manufactured positive surprise much like the prior quarter.    There should also be plenty of real year over year progress in expense control—labor and non-marketing operating expense—but not much to get excited about on the top line.   A real surprise would stem from traffic growth and that seems unlikely.    

If you think the market is likely to again reward BJRI for a positive surprise, get ready.

Another 3Q key—share count   

Management repurchased 300,000 shares in the second quarter but its fully diluted shares rose anyway given prior option grants.   Since reporting the second quarter, the board approved an incremental $100MM share repurchase.  An actual reduction in diluted shares outstanding in the third quarter would be a decent milestone.

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