Among the many features found in each week’s edition of Value Line’s Selection & Opinion is a list of the seven best and worst performing industries over the past six weeks. These rankings can be found on the inside back cover of Selection & Opinion. The 1,700 stocks in the Value Line universe are currently divided among roughly 100 industries. Notably, for the purposes of calculating these results, the performance of each stock is equally weighted to the others in its industry (i.e., irrespective of market capitalization).
Our latest Industry Price Performance rankings cover the period from October 7th to November 18th, a very good stretch for the market. Equity prices slumped in late September and early October, but have since rallied strongly, lifting many of the market benchmarks to record levels. The S&P 500 Index, for instance, rose 5.5%, while the broader Value Line Arithmetic Index advanced 7.6%. In this environment, the utility industries that had been prominently featured in our rankings earlier this fall were surpassed by other, more dynamic groups on our best-performing list. (Even so, the share prices of most utilities have still outperformed the market over this stretch.) Most notably, the Air Transport industry has soared above the pack, rising 20.6% amid declining fuel costs and easing fears about the impact of Ebola on international travel. The rest of the top seven were tightly bunched, with Restaurant, Paper & Forest Products, Publishing, Office Equipment & Supplies, Retail / Wholesale Food, and Biotechnology all advancing between 12.2% and 13.5%.
In looking for investment ideas among the seven best-performing industries, we are taking a closer look at Brinker International (EAT), one of the nation’s leading operators of casual-dining restaurants. Its primary chain, Chili’s Grill & Bar, was founded forty years ago and now has about 1,265 stores in the U.S. and another 300-plus in international markets. Franchisees own and operate about one-third of the domestic units and almost all of the overseas locations. The company has also developed or acquired a number of other concepts over the years, though it has sold off most of these over the past decade, including Corner Baker and On the Border. Brinker still owns and operates the Maggianio’s chain of 48 Italian restaurants.
The stock market’s enthusiasm for Brinker International extends back much further than the six weeks that encompass our latest Industry rankings. Indeed, its shares have outperformed the broader market over the past one-, three-, and five year periods, with returns typically coming in among the best in the restaurant space. Driving these gains has been a successful, but rather unglamorous business model that has helped to lift share net from $1.18 in fiscal 2010 to $2.71 in fiscal 2014. (Years end on the last Wednesday in June.) Since selling off most of its secondary brands, the emphasis at the Chili’s chain has been on improving existing operations rather than opening new locations. In fact, the number of Chili’s stores in the U.S. has declined by about 30 since the start of the decade. (International restaurants have increased 50%, to nearly 310 over the same stretch.) In that time, though, operating margins have widened by about 350 basis points, as the company has rolled out a variety of productivity enhancing initiatives, such as investing in new point-of-sale systems and installing upgraded kitchen equipment.
Meanwhile, Brinker has also made returning excess cash to shareholders a high priority. Since the start of the decade, the restaurant operator has more than doubled its dividend, while shrinking its share base by more than a third. This strategy has been aided by the paucity of new-store development, which has held down capital spending and provided ample free cash flow. The company has also been using borrowed funds to support its stock-buyback program. In fact, with the shrinking equity base, long-term debt now accounts for more than 90% of total capital, though healthy coverage ratios indicate that this leverage isn’t putting a strain on finances.
Looking ahead, we think EAT shares are a good selection for momentum-oriented investors. Strong gains on the bottom line should help to underpin support for this equity. Earnings rose 16% last fiscal year and look poised for a similar advance in fiscal 2015. Expanding margins and a declining share base will likely remain key elements of Brinker’s playbook, though we also see room for more contributions from rising same-store sales. Chili’s comps have risen less than 1% in each of the past two fiscal years. A dreary environment for casual-dining chains appears to be largely responsible for this weakness, with the chain outperforming the category over this stretch. The steady performance of the domestic economy should help to encourage more people to dine out, and management’s target of 1%-2% comp growth this fiscal year looks quite reasonable. In fact, the chain posted a solid 2.6% gain in the September quarter, again surpassing most of its casual-dining peers. Moreover, to win over customers, Chili’s appears intent on maintaining its emphasis on products, rather than pricing, which should also help with margins. With this in mind, the chain has already revamped its line-up of Mexican offerings and burgers, and it plans to launch a new product platform later this fiscal year.
That said, long-term investors will need to proceed more cautiously, perhaps looking to buy on dips in the share price, which is currently flirting with its 52-week high. On the positive side, the company still sees room for further margin expansion, and its strong track record on this score gives it considerable credibility. Still, top-line growth will likely need to become a bigger component of the growth strategy in the years ahead, and the lack of progress on this front seems to warrant a note of conservatism that isn’t necessarily reflected in the current valuation. The recent P/E ratio of 18.1 is equal to that of the broader market, but the stock typically trades at a discount of 10% or so.