Despite recent struggles with falling customer traffic, heading into Chuy's Holdings' (NASDAQ: CHUY) second-quarter earnings report, the Tex-Mex chain was still guiding for positive full-year 2017 comparable-restaurant sales growth numbers. That's looking a lot less likely after the company last week reported another quarter of sliding comps and lowered its full-year guidance to boot. The company also said it plans to slow its rate of new store growth through the end of 2018. Investors didn't react well to the report, sending shares to fresh 52-week lows.
Continue Reading Below
Comps continue heading in the wrong direction
Chuy's has now reported three consecutive quarters of comps declines. For Chuy's, comps measure how sales are doing at locations open at least 18 months.
In the second quarter, comps fell by 1%, worse than the 0.7% decline it experienced in Q1. That latest comps number breaks down into a 2.4% decline in weekly traffic, partially offset by a 1.4% increase in the average guest check.
This isn't a Chuy's-specific issue, as the entire industry has been struggling with lower customer traffic for a while now. For context, the comps number matched the 1% decline the industry saw on average in Q2. That's of some concern, because up until now, Chuy's had been outperforming this average. However, looking at customer traffic in isolation, we see the results weren't as bad as the industry average, which declined 3.1% for the quarter.
Now that Chuy's is halfway through the year, it's looking like a pretty tough road back to positive full-year comps in 2017. The company reduced its full-year guidance for comps growth to a range of minus 1.5% to plus 0.5%. And July was not a promising start to the third quarter, with management saying comps were down around 2% for the month. One possible silver lining over the next couple of quarters is that Chuy's will begin lapping some pretty weak comps from the slowdown that began about this time last year -- Q3 2016 comps growth was 0.3%, and Q4 2016 comps were down 1.1%.
Continue Reading Below
Store-level margins are getting squeezed
Similar to the past couple of quarters, restaurant-level operating margin fell again, to 19.1%, down from 21% last year. Chuy's is seeing pressure on a number of fronts, including labor cost inflation, higher commodity costs, higher occupancy costs in its newer, larger markets, and -- given the large number of new stores its opened recently -- a bunch of new restaurants that just haven't achieved normal margin yet.
If this is where margin levels are going to be for a while, the 19% range still seems pretty healthy, given that the company's blended restaurant-level margin target for new and mature stores is 15% to 16.5%. But it's definitely something to keep an eye on, as Chuy's expects continued inflation for wages and food costs this year and plans to keep adding stores in pricier markets such as Chicago, Miami, and Denver next year.
Decelerating the pace of expansion
Chuy's finished 2016 with 80 stores. The company had planned on opening 12 to 14 new restaurants in 2017. However, in light of the continued traffic slowdown and uncertainty around future comps, Chuy's says it will now open only 12 new units this year -- which would still represent 15% annual store growth.
The bigger potential hit to the investment thesis is that Chuy's is going to pump the brakes on its rate of store growth next year -- saying it will open between eight and 12 new locations in 2018. Assuming a base of 92 stores at the end of this year, that guidance represents annual store growth of 9% to 13% in 2018 -- a significant decrease from the "high teens" rate management has been targeting for the past few years.
Is slowing store growth now the right move?
On one hand, opening new restaurants aggressively is causing additional pain on the bottom line, as those restaurants naturally need a few years to ramp up to healthy store-level margins. On the other hand, the investment thesis pretty much relies on the company's rapid expansion to drive gains in revenue and earnings over the coming years. The company made the tough call and says that until it has greater visibility into a comps recovery, a more cautious approach makes sense.
There were a couple of references on the call to exploring ways to use the company's healthy balance sheet to "create shareholder value." The implication seems to be that Chuy's is considering a stock buyback, a special dividend, or some other action to make shareholders more amenable to the reduced store-growth plans. While it appears that the comps situation won't improve dramatically anytime soon, I'll be interested to see what tricks management has up its sleeve to try to keep investors on board.
10 stocks we like better than Chuy's Holdings
When investing geniuses David and Tom Gardner have a stock tip, it can pay to listen. After all, the newsletter they have run for over a decade, Motley Fool Stock Advisor, has tripled the market.*
David and Tom just revealed what they believe are the 10 best stocks for investors to buy right now... and Chuy's Holdings wasn't one of them! That's right -- they think these 10 stocks are even better buys.
Click here to learn about these picks!
*Stock Advisor returns as of August 1, 2017
Andy Gould owns shares of Chuy's Holdings. Andy Gould has the following options: short October 2017 $30 puts on Chuy's Holdings. The Motley Fool owns shares of and recommends Chuy's Holdings. The Motley Fool has the following options: short October 2017 $30 puts on Chuy's Holdings. The Motley Fool has a disclosure policy.