Brinker (EAT) Initiated at Neutral

We recently initiated our coverage on Brinker International, Inc. (EAT), one of the world’s largest casual dining restaurant operators, with a Neutral rating. Brinker operates under two brand names – Chili’s Grill & Bar (Chili’s) and Maggiano’s Little Italy (Maggiano’s) – and is the second largest casual dining restaurant in revenue after its close competitor Darden Restaurants, Inc. (DRI). In beginning of the month the company divested another division — On The Border Mexican Grill & Cantina (On The Border).

Third Quarter Result Disappoints

Brinker International’s third-quarter 2010 adjusted earnings of 37 cents per share fell short of the Zacks Consensus Estimate of 41 cents. The earnings were hit by adverse weather conditions and costs related to the roll-out of the new menu at Chili’s.

Total revenue slipped 7.8% to $713.4 million reflecting a 4.2% decline in comparable-restaurant sales and a 5.3% fall in restaurant capacity following the sale of 21 restaurants to a franchisee and closure of 19 restaurants since third-quarter 2009. Adverse weather negatively impacted comparable-restaurant sales by about 90 basis points.

By restaurant concepts, comparable-restaurant sales fell 5% at Chili’s Grill & Bar but rose 1.9% at Maggiano’s driven by improving traffic.

During the quarter, one company-owned and eight franchise restaurants were opened (or acquired), and twelve company-owned and five franchise restaurants were closed (or sold).

Estimates’ Trend

The Zacks Consensus Estimates for Brinker International’s fourth quarter and full-year 2010 earnings has remained fairly stable at 47 cents and $1.22 per share, respectively over the last 30 days, representing annualized growth rates of (10.3%) and (15.3%). This implies that analysts do not foresee any upward and downward pressure on the stock.

Neutral Recommendation

We believe Brinker is in a favorable position based on its idea of repositioning the brand for more sustainable and stable growth, menu improvements, cost effective measures, and strong financials.

Brinker International is one of the few casual dining chains expanding strategically even in this sluggish economic environment. Brinker International is focused on global expansion in both new and existing markets through development agreements with new and existing franchisees and joint venture partners. Global expansion allows further diversification from a saturated domestic market and will enable the company to build strength in a variety of markets and economic conditions.

Additionally, Brinker International’s growing percentage of franchise operations in domestic and international markets will help improve margins as royalty payments positively impact the bottom line. Brinker International’s free cash flow remains in a comfortable position attributable to lower unit capital expenditure that resulted from capacity contraction. The company increased the quarterly dividend by 27% to 14 cents per from 11 cents per share, which is effective from the fourth quarter fiscal 2010.

However, considering the sluggish economic recovery, high unemployment rate, reduction in disposable income, increasing input costs related to beef and chicken as well as stiff competition, we are compelled to harbor concerns about Brinker International. Moreover, Chili’s brand renewal process may lead to the risk of disappointing guests and increase capital expenditure.

Brinker International is slated to release its fourth quarter and full-year 2010 results on Aug 12, 2010. We currently have a short-term Sell rating on Brinker International.

BRINKER INTL (EAT): Free Stock Analysis Report
DARDEN RESTRNT (DRI): Free Stock Analysis Report
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