We recently downgraded our recommendation on Brinker International Inc. (EAT), a leading casual dining restaurant company in the world, to Neutral from Outperform, as its major brand Chili’s continues to face challenges in improving comparable restaurant sales. During the third quarter of 2011, comparable restaurant sales fell 0.3% at Chili's due to drop in guest check average and capacity.
Moreover, we remain cautious regarding stiff competition and cost inflation, which are expected to temper fourth quarter 2011 results, with 92% of the commodities currently contracted for 2011. The company also expects food cost to expand 100 basis points (bps), as a percentage of sales, in 2012 due to rising commodity costs. Brinker continues to face significant inflationary pressure due to a hike in beef prices. Furthermore, we believe the sluggish traffic growth and consumer spending will likely restrict Brinker’s revenue growth in the near term.
However, Brinker is repositioning its Chili’s brand and is undertaking several initiatives to offset its declining sales momentum and deliver more sustainable and stable growth. Chili's revamped its menu in an attempt to regain customers and build loyalty with new items and reintroduced and improved classics. In January 2011, Chili’s launched a new value-oriented lunch combo, with prices ranging from $6 to $8, in the core menu to position itself favorably against other fast-casual restaurants. Chili's has also rolled out the new Happy Hour program that includes specially priced drinks and menu items. The company has also added two course meals for $20 permanently to in its menu, in order to combat the three course meals for $20 program introduced prior year, which was more margin dilutive. Moreover, Brinker continues to focus on product-based promotions like day parts initiatives to attract the attention of casual diners, rather than offering discounts. The company, in order to induce customer loyalty, remains connected with its guests through social media programs and emails, which in turn is expected to drive top-line growth going forward.
The company reiterated its goal of delivering net margin growth of 400 bps and also expects to double its EPS by 2015. To achieve the target, Brinker is undertaking major cost-saving initiatives at Chili’s, which include disciplined cost management, successful implementation of team service and labor cost savings initiatives. The company also started the phase one of the kitchen equipment retrofit program relating to new kitchen processes effort in late second quarter 2011. Through this, Brinker expects to optimize kitchen labor component and improve cost of sale by reducing food waste. Further, management conceded that the second phase of the program, related to the new cooking equipment initiative, has been expanded to 15 units and an aggressive roll out is expected in the beginning of fiscal 2012. The company has introduced the new point of sale and back office systems in 24 restaurants and plans to launch them in all Chili’s and Maggiano’s restaurants during the first quarter of 2012. The company also plans to remodel its restaurants; the first remodeled unit was opened in Oklahoma where the guest response has been positive. Currently, Brinker intends to extend the re-image program to four additional markets, which are geographically dispersed, at reduced cost. Subsequent to this re-imaging program, the company plans to re-image 60 more restaurants.
Additionally, the company’s strategy to close underperforming stores, shift to franchised operation, focus on international expansion in order to diverse its operations from the over-supplied domestic market and enhancing shareholder value looks promising for its business.
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