Chuy's Restaurants Expected to Grow Over Long Term

Chuy’s Holdings long term growth

Chuy’s Holdings (CHUY, Financial) was founded by Mike Young and John Zapp in Austin, Texas in 1982.

Chuy’s owns and operates 64 full-service Tex-Mex restaurants across 14 states serving authentic, made from scratch dishes. It is now growing steadily outside of Texas, adding 10 new restaurants per year.

Ownership history:

Goode Partner LLC acquired 98% of shares of Chuy’s in 2006 with eight restaurants at that time. Chuy’s completed its IPO at $13.00 per share on July 27, 2012. Since then, Goode Partner has reduced its holding to less than 5%. Its current top institution holders include Fidelity and Eagle Asset Management, holding 13.86% and 10.09% of its common shares as of July 31.

Young and Zapp became co-chairman of the board of directors in October 2013. The current CEO Steve Hislop has served in the top executive role since July 2007. Of the seven board members, six have decades of experience in the restaurant industry.

Restaurant style:

Chuy’s restaurants have a common decor, but each location is unique in format, offering an "unchained" look and feel. Chuy’s believes its restaurants have an upbeat, funky, eclectic, somewhat irreverent atmosphere, while still maintaining a family-friendly environment.

Current performance:

As of Aug. 31, the company operated 64 restaurants in 14 states. Chuy’s is expected to open 10 more restaurants per year. From fiscal year 2007 to 2015, the company’s annual revenue growth rate is about 19% to 23%.

On Aug. 4, Chuy’s reported its fiscal second quarter results. Revenue increased 19.1% and same store sales increased 3.2%, while net income soared 55.9% without outstanding debt.

Competitors:

Chuy’s top competitors include Texas Roadhouse (TXRH, Financial), Chili’s under Brinker International (EAT, Financial) and BJ’s Restaurant (BJRI, Financial). The competitors’ market shares have reached a mature level around $2 billion to $3 billion, while Chuy’s market cap is only around $556 million.Â

Comparison:

Chuy’s main advantage is its small size, strong balance sheet and durable long-term growth plan. Its current growth strategy, however, is mainly driven by unit expansion. Thus its capital expenditure as a percentage of sales is on a higher level of around 14% and free cash flow per sales is -1.96%. Its competitor Texas Roadhouse has more mature market share and is able to manage capital expenditure in the single digits with positive free cash flow.

Chuy’s same store sales increased by a modest 1% to 3% per year, while its competitors are managing around 3% to 8% per year, which would be a critical ratio to watch for future earnings growth.

Conclusion:

The current P/E, P/B and P/S level suggests the whole restaurant industry has reached an extreme overvalued level, and the downside risk is extremely high. For the long term horizon, Chuy’s is a good growth candidate to be considered, due to its strong balance sheet, small capital market size and strong expansion strategy. Texas Roadhouse has grown by three times within 10 years, and it’s reasonable to expect Chuy’s may have similar or higher growth potential in the following decade. I will wait until the next downturn to see if free cash flow turns positive, P/E hits around 15 Â and P/B reaches around 2 to trigger a buy position.

Notes:

CHUY = Chuy’s

CMG = Chipotle

TXRH = Texas Roadhouse

BJRI = BJ’S Restaurant