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Restaurant insiders dine off the value menu
These 6 regional chains are selling cheap, have good growth prospects and offer a fresh take on casual dining. And company officers at each are buying.
By Michael Brush
Given the challenges that face our nations restaurants, its a wonder anyone is buying their stocks.
Thanks to the Atkins Diet fad, for example, many eateries are being forced to change their menus, always a risky venture. Prices for the basics -- beef, chicken, pork, cheese, milk and butter -- are up a shocking 20% to 100% in the past year. And gasoline prices remain high, pressuring families to cut back on splurges like a meal out.
Despite these looming obstacles, shares of the big restaurant chains are up nicely in the past 12 months, thanks to investor enthusiasm about the economic recovery and speculation about what it may do for consumer spending. Restaurant stocks look pretty pricey now, considering the Fed is poised to start raising interest rates and economic growth may cool off.
So its no surprise to find insiders dumping literally millions of dollars' worth of shares of each of the nation's blue-chip restaurant chains, including Applebee's (APPB, news, msgs), McDonald's (MCD, news, msgs), CKE Restaurants (CKR, news, msgs), Pizza Hut and Taco Bell parent Yum! Brands (YUM, news, msgs), Panera Bread (PNRA, news, msgs), Outback Steakhouse (OSI, news, msgs) and Cheesecake Factory (CAKE, news, msgs).
Beneath the surface, though, you see exactly the opposite trend at six of our nations small, regional restaurant chains: Mexican Restaurants (CASA, news, msgs), Rubio's Restaurants (RUBO, news, msgs), BUCA (BUCA, news, msgs), BJ's Restaurants (BJRI, news, msgs) (formerly Chicago Pizza & Brewery), Pizza Inn (PZZI, news, msgs) and Famous Dave's of America (DAVE, news, msgs).
At these chains, insiders have been steadily buying in recent months, often adding to already sizeable personal holdings. Are they lousy investors missing the big-picture trends that have encouraged insiders at the dominant restaurant chains to sell? Or are they onto something?
We checked in with most of the regional chains where insiders are buying, as well as the money managers who own them and the Wall Street analysts who cover them. And it looks as if the insiders are onto something. Here are four basic reasons insiders are buying shares:
Valuations are low
Much of the money flowing into the stocks of regional restaurant chains is coming from investors who love beaten-up value plays. One of them is David Nierenberg, who calls his Camas, Wash.-based Nierenberg Investment Management the D-Cubed Family of Funds. Those three Ds stand for Davids Dirty Dogs -- or the small, beaten-up stocks he hunts down as a contrarian investor. Our mission is to shave those dogs and decide which have intrinsic merit, and build large positions, says Nierenberg.
Nierenbergs record is impressive. Three of the four stocks hes purchased as an insider advanced on average anywhere from 34% to 115% in the six months after he bought, according to Thomson Financial. One of those is Mexican Restaurants, a tiny regional chain based in Texas. Mexican Restaurants has gone up 34% on average in the six months following a purchase by Nierenberg, says Thomson. Nierenberg, a company director, recently bought $172,000 worth of the stock to put in a new investment vehicle, even though he already owns 30% of the shares. (All told, insiders hold 54% of this stock.)
One of the main reasons Nierenberg has adopted this dirty dog is that it looks dirt cheap. The restaurant trades at an enterprise value (EV)-to-cash-flow ratio of four. (EV is market cap plus debt, minus cash.) Thats well below the typical take-out valuation for a public restaurant. They're normally taken private when their EV/cash flow ratio falls as low as 6.5.
Rubios and Buca also look to be promising and inexpensive contrarian plays, says Bob Costomiris, a value investor who manages the Strong Small Company Value fund (SCOVX), which holds shares of both.
Rubios, famous for its tasty fish taco, operates restaurants in six western states, with a large majority in California. Buca serves Southern Italian immigrant cuisine in a family style format in restaurants called Buca di Beppo and Vinny Ts of Boston. Theyre scattered around the county, with a concentration in California, Florida and Massachusetts.
Both chains have an enterprise value of less than half their sales, another value metric for restaurants, says Costomiris. That looks cheap, because restaurants regularly trade for about twice this much or more, he says. Rubios also has a dollar per share in cash, which isnt bad for a $7.50 stock.
Buca looks like a very dirty dog indeed. It trades for almost $4 below its book value of $8.98. True, that book value may come down if Buca closes more restaurants, which it might. And interest costs may soon go up. The company may be forced to renegotiate the terms of its debt, as it is about to violate loan agreements.
With problems like these, its no wonder that Wall Street analysts have negative ratings on the stock, or that the financial press loves to beat up on it. As a contrarian investor, thats just what Costomiris wants to see. Nothing has gone right for this company for at least several years, says Costomiris. But we think the restaurant concept is a good one. They do a good job of delivering a pretty unique Italian experience.
Buca, like each of these value plays, has some changes in the works that might boost valuations over the next one or two years. Well get to those in a moment.
Improving sales
Across the board, diners have been going out to these small restaurant chains quite a bit more since late last year. BJs Restaurants, which operates under the names BJ's Restaurant and Brewery, BJs Pizza and Grill and BJs Restaurant & Brewhouse, is a good example. (Despite the corporate name, this chain has no restaurants in Chicago; its based in Southern California.) This restaurant chain posted impressive same-store gains of 7.7% in the first quarter, among the highest in the industry. (Same-store sales, or comps, are a measure of sales trends in outlets open more than a year.)
Rubios turned in 4% same-store gains in the quarter ending March 28, the highest in its last 10 quarters of growth. There is definitely a resurgence in the industry, says Sheri Miksa, Rubios president and chief operating officer. Higher sales helped Rubios post record earnings of 6 cents per share in the first quarter.
Thanks to a stronger regional economy around Houston and a new marketing drive, same-store sales at Mexican Restaurants moved out of the negative territory and improved by 2% in the first quarter. Pizza Inn also saw sales grow by 2%.
To be sure, this years numbers look good in part because business was so bad in the first quarter of last year due to lousy weather and consumer caution before the Iraq war. But the rest of this year should be healthy at most of these regional restaurant chains. BJ's Restaurants, for example, expects 3% to 4% growth throughout the year.
Room to grow
Another reason sales are so strong for these regional chains is that so many small, independent restaurants closed down during the economic crunch. Casual dining, the segment where these six restaurant chains operate, saw the number of outlets shrink by more than 2% last year.
Many of these regional chains are poised to fill the gap. BJ's Restaurants, for example, is on the cusp of a national expansion campaign. It plans to open 200 restaurants over the next several years -- on a base of 31 outlets. We look for 20% unit growth annually over the next five years, says Robert Curran, who handles investor relations for the company. This aggressive national expansion campaign probably explains why insiders (including Chief Executive Paul Motenko) purchased an additional $200,000 worth of stock since March, even though they already hold about 44% of the shares of this company.
Rubios has opened a dozen restaurants in the last 18 months. Because of the quality of its signature fish taco and other Mexican-style offerings, Costomiris thinks the chain can expand even more. The nation may have passed the saturation point for burger joints long ago, he says, but I do not believe we are oversupplied in fish tacos. So, at the end of the day, this is a growth company because they can take this thing national.
Pizza Inn is opening scores of new restaurants, even as it closes less efficient ones. That may explain in part why two Pizza Inn board members purchased about $32,000 worth of the stock in early June. The companys chief executive, general counsel and finance chief together own 1.15 million shares out of some 10 million shares outstanding.
Famous Dave's is improving margins by closing down less profitable restaurants and opening more than enough new franchises to offset the difference. It has more than 95 locations and agreements to open around 160 franchises. Since March, insiders including Chief Executive David Goronkin and finance chief Diana Purcel, have bought $178,000 worth of their companys stock. This is an astute group of buyers, as their holdings in Famous Dave's typically go up anywhere from 38% to 60% in the six months after they buy, according to Thomson Financial.
Menu changes
Tinkering with a menu is always dicey. Restaurants risk alienating loyal customers, and theres no guarantee new offerings will be a hit with new customers.
But three of the regional restaurant chains where insiders are buying have just introduced new menus after receiving positive feedback in test markets. So theres reason to think the changes will help sales growth.
Rubios is making a play for the fast-food customer with its new fresh and affordable menu. Aside from Carnitas Street Tacos for $1, Rubios offers Taco Meal Deals, or combination meals for $3.99, a price designed to compete with the $5-$6 meals offered by the fast food burger chains. There is really an opportunity to come in between fast food and fast casual with a menu that is a mix of both, says Miksa. Rubios just rolled out the new menu across the entire chain at the start of June. For the Atkins crowd, it includes low-carb lettuce tacos and chicken salad.
In Texas, Mexican Restaurants recently tweaked its menu to introduced more value offerings and make its dishes more appealing to the Hispanic community.
Finally, Buca is branching out from its large portions geared for family and group gatherings, reducing its reliance on special occasions and large parties. Last November, it began experimenting with a Buca small menu for couples and smaller groups. The menu change has worked, helping to turn 10% declines in comps into positive sales trends at many restaurants. And it has reversed negative trends in other restaurants, even if they arent yet back in the black. The new menu was rolled out in the whole chain in March, and it just might help turn the chain around.
Interim Chief Executive, co-founder and board member Pete Mihajlov may think so, at least. Near the end of May, he purchased $20,800 worth of the stock, even though he already owned 169,000 shares, or about 1% of the outstanding stock.
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