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Struggling Restaurants that May Serve Up

By George Putnam, III
The Turnaround Letter
www.turnaroundletter.com

Diners may seem like a fickle group – one day everyone flocks to Restaurant X as the place to eat, only to quickly replace it with the next fad, Restaurant Z. The reality is different, though¬ – most people like to go to their regular restaurant again and again (that is how the chains grew so large in the first place). It’s only when the restaurants basically tell their customers “please don’t come here anymore” by offering unappealing food, poor service, higher prices and tired surroundings that the customers look elsewhere.

As a result, the formula for a turnaround is generally straight-forward: stop turning off your regular customers. Entice them back with an offering worth taking. A number of restaurant companies have successfully turned around their businesses: Darden Restaurants (parent company of Olive Garden), Wendy’s and Burger King are recent examples.

Listed below are several restaurant turnaround stocks. They have well-known franchises, reasonable balance sheets and attractive valuations. Several have new management teams. Macro headwinds like rising wage costs and aggressive competition from grocery stores may be offset by steady economic growth. With some patience, these stocks might serve up some tasty returns for investors.

Bloomin Brands (BLMN) – This $4.3 billion (sales) company owns well-known brands like Outback Steakhouse and Carrabba’s Italian Grill. It has over 1,300 locations in 48 states and over 200 locations in 48 states and over 200 locations in Latin America and Asia Pacific. The shares are down nearly 40% from their prior highs. While profit growth at its small international segment (12% of revenues) is cooking along nicely, the domestic operations have been weak, with 4Q16 traffic down 6.4%, dragging down overall margins by over a percentage point. To help rebuild traffic, management is being more aggressive about closing underperforming stores, opening new locations and remodeling others. Menu improvements, a new rewards program and better service are also part of the plan. The high capital spending will eat into near-term free cash flow, but if the changes work, Bloomin Brands could return to favor.

Brinkers (EAT) – Brinkers, founded in 1975, owns the Chili’s and Maggiano’s Little Italy chains, with 1,600 locations in 31 countries. Sales in 2016 were over $3 billion. Like many restaurant groups, Brinkers saw its same store sales decline 3.1% in its most recent quarter, driven by weak industry trends as well as some sloppy execution by the company. Management appears to be well aware of these issues, and efforts to address them are underway, including some changes to the management team. Slower spending on new unit growth is bolstering Brinker’s healthy free cash flow, which helps maintain the 3.1% dividend yield and service its debt.

Del Frisco’s Restaurant Group (DFRG) – Based in Texas, Del Frisco’s owns 54 high-end steakhouse chains: Del Frisco’s Double Eagle Steak House, Sullivan’s Steakhouse, and Del Frisco’s Grille. After rising above 28 in 2014, the shares have declined 36% and aren’t much above their 2012 IPO price of $12.75. Weak performance led to a new CEO in November, a strategic review and many changes to the management team. The plan going forward: tighten manager accountability, streamline costs, improve service and utilize better technology. With no debt and only modest declines in same-restaurant sales, the company has plenty of runway to implement its changes.

Dine Equity (DIN) – Owner of the iconic IHOP (International House of Pancakes) and Applebee’s chains, Dine Equity, with over 3,700 locations, is one of the world’s largest full-service restaurant companies. The shares are down over 50% from their highs and are trading at the same price as they were ten years ago. The company faces a number of headwinds, including unappealing menus, high prices and poor in-store execution, along with franchisee issues and high turnover in the senior management ranks. While daunting, these issues are fixable. Because the company is nearly 100% franchised, its capital spending requirements are low, but it needs to redirect funds from dividends and share repurchase back to franchisees to help upgrade its offerings. With investors legitimately worried about the operating problems, the company is ripe for real change, either internally or externally driven. It might not take that much for a new management team to revive the brand and bring investors back to the table.

Fiesta Restaurant Group (FRGI) – Based in Dallas, the Fiesta Restaurant Group owns 342 Pollo Tropical and Taco Cabana fast casual chains across the southern United States and 29 locations internationally. Like other struggling restaurants, “PT” and “TC” have suffered from falling sales and profits due to weak execution and strong competition as well as higher labor and other costs. The outlook was grim enough in February that a strategic sale process was terminated for lack of interest. However, a respected new CEO just joined the company, and a successful industry veteran was added to the board. With the shares trading 65% below their 2015 highs, positive cash flow and very low debt, Fiesta Restaurant Group looks attractive.

Red Robin Gourmet Burger (RRGB) – After an impressive rebound in 2015, this Denver-based chain of over 500 restaurants in the United States and Canada has lost some of its edge, pushing its shares down by 40% from their peak. To help recover from the weak 4Q16 same-restaurant sales decline of 4.3%, the company is more aggressively focusing on the basics as well as expanding its take-out, delivery and catering programs. Cash flow priorities include debt paydown and share repurchases, along with location remodeling. Competition is notoriously aggressive, but a recent CEO change plus the addition of two restaurant veterans to the board bodes well for the future.

Editor’s Note: Edited by George Putnam, III for over 30 years, The Turnaround Letter, a monthly newsletter, focused on “troubled” companies poised for a rebound. The Turnaround Letter has had the longevity and proven track record necessary to gain the confidence of thousands of investors and industry experts. The 10.6% annualized return (as of 4/31/17) on his Turnaround Letter stock recommendations over the last 15 years makes The Turnaround Letter one of the top-performing investment newsletters for that period of the approximately 200 on the market today. For more information on this newsletter visit www.TurnaroundLetter.com.

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