Brinker International (EAT): Casual Dining Headwinds, Optimistic Estimates & Above Average Multiples

Leading Independent Investment Research, Morningstar, Inc.

Morningstar

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Morningstar, Inc.

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Thematic (Sector/Industry)

United states Consumer discretionary / Thematic (Sector/Industry)

On the surface, there would appear to be challenging times ahead for the restaurant industry, with year over-over traffic declines across much of the industry and rising labor costs on the horizon. However, we believe it would be shortsighted for investors to overlook this category, as there are a number of compelling operators that are redefining the way consumer discretionary companies adapt to constantly evolving consumer expectations regarding value, convenience, health, and technology. Our analysis starts with the fast-casual restaurant category, which is not only changing consumers' expectations regarding restaurant experiences, but also influencing how the market values restaurant concepts and forcing traditional quick-service and casual-dining chains to reinvent themselves. However, one of the more underexplored developments in the restaurant space thus far in 2016 is a bifurcation within the fast-casual category, with a class of chains thriving but several other players aspiring to be the "next Chipotle" finding success more difficult (not to mention Chipotle's own struggles). We've spent 2015 and 2016 getting to know many of the up-and-coming privately held fast-casual players to gain a better understanding of what attributes restaurant concepts must have to develop an economic moat and drive traffic in today's environment. We then examined our restaurant coverage to see where we can locate similar traits and, more importantly, where the market may not be giving restaurant chains enough credit. We believe the market may be underestimating the changes that several players in our restaurant coverage have made to adapt to these trends, including <a href="https://www.smartkarma.com/entities/7641" target="_blank" data-smartkarma-citation="entities:7641:1">Starbucks Corp (SBUX US)</a> and <a href="https://www.smartkarma.com/entities/8104" target="_blank" data-smartkarma-citation="entities:8104:1">Panera Bread Co (PNRA US)</a>, both of which trade at a significant discount to our respective longer-term DCF-driven fair value estimates of $63 and $250.Analyst: R. J. Hottovy, CFA

On the surface, there would appear to be challenging times ahead for the restaurant industry, with year over-over traffic declines across much of the industry and rising labor costs on the horizon. However, we believe it would be shortsighted for investors to overlook this category, as there are a number of compelling operators that are redefining the way consumer discretionary companies adapt to constantly evolving consumer expectations regarding value, convenience, health, and technology. Our analysis starts with the fast-casual restaurant category, which is not only changing consumers' expectations regarding restaurant experiences, but also influencing how the market values restaurant concepts and forcing traditional quick-service and casual-dining chains to reinvent themselves. However, one of the more underexplored developments in the restaurant space thus far in 2016 is a bifurcation within the fast-casual category, with a class of chains thriving but several other players aspiring to be the "next Chipotle" finding success more difficult (not to mention Chipotle's own struggles). We've spent 2015 and 2016 getting to know many of the up-and-coming privately held fast-casual players to gain a better understanding of what attributes restaurant concepts must have to develop an economic moat and drive traffic in today's environment. We then examined our restaurant coverage to see where we can locate similar traits and, more importantly, where the market may not be giving restaurant chains enough credit. We believe the market may be underestimating the changes that several players in our restaurant coverage have made to adapt to these trends, including Starbucks Corp (SBUX US) and Panera Bread Co (PNRA US), both of which trade at a significant discount to our respective longer-term DCF-driven fair value estimates of $63 and $250.Analyst: R. J. Hottovy, CFA

Lessons From the Next Generation of Moats in the Fast-Casual Restaurant Industry