Bloomin' Brands: Valuation Remains Appealing, But There Are Still Near-Term Uncertainties

Summary

Bloomin' Brands (NASDAQ:BLMN) owns and operates a chain of casual dining restaurants via a self-operated and franchised model worldwide. The business has gone through its ups and downs, making multiple changes and improvements during the pandemic period, especially its off-premises presence and in-store operations. Readers may find my previous coverage via this link. My previous rating was a buy, advocating a small pilot position as I believed BLMN's valuation was too cheap relative to its history while the business was improving. I am reiterating my buy rating and recommending a small position to take advantage of the valuation situation.

Financials/Valuation

Unlike the last time I wrote about BLMN, the valuation is now slightly more expensive at 9.3x forward PE (vs. 7.7x previously). Nonetheless the upside remains attractive if it grows as I expected. My growth estimates are quite conservative in that I expect the 3Q23 SSS guidance to be the growth rate for the entire of FY24 as BLMN balances the reduction in pricing benefits while volume gradually recovers. The business should see a recovery to normalized growth of low-single digit to mid-single digits growth. I also expect margin to be impacted in FY24 due to the Brazil VAT situation but recover in FY25 (as discussed below).

I continue to have the expectation that BLMN will eventually rerate back to 14x, as that is where it traded before COVID struck. Also, relatively speaking, when compared to other casual restaurant peers (such as Dine Brands Global, Brinker International, Texas Roadhouse, etc.), BLMN is also trading at an unjustified discount, despite having lower debt and a similar growth profile. As a result, from a valuation standpoint, BLMN remains appealing. That said, a small position continues to be my recommendation to take advantage of this valuation situation, but leave room to size up if the stock dips due to the uncertainties I mentioned below.

Comments

For the short term, I zeroed in on SSS and margins from BLMN 2Q23 results. First, on SSS, the second quarter's blended comps of 0.8% were up from the second quarter of last year's -0.4%, thanks in large part to strong performance at both Outback and Carrabba's, with respective comps of 0.6% and 3.5%. While this is a positive development, I think my initial recommendation to buy a pilot position is going to help investors tide over 3Q23 as the 3Q guide is calling for 0.5 to 1.5% SSS, which is flat compared to 3Q22. I believe this might disappoint some investors, who are likely to expect ongoing improvement at the headline level. After dissecting the SSS drivers, it appears that the weak SSS guide was caused by the normalization of pricing benefits despite the fact that volume (traffic) is still on the rise. Pricing is forecast to continue its decline from the current 7% to 7.5% down to the 4% to 4.5% range by year's end. Specifically, management is hinting at this without factoring in any additional price hikes. So, if management wants to push the envelope, they can still do better than this guide. However, I believe it is critical to highlight management's observation that traffic outperformed the industry by 110 basis points in the second quarter. Put together, the near-term might see some stock price volatility as investors digest the idea of a weak improvement in SSS but an improvement in traffic (more important than pricing over the long term, in my opinion).

BLMN did well in terms of margins as well, with RLM (restaurant-level margins) at 16.4% thanks to lower COGS as inflation slowed to 2.8% from the high single digits that had been expected. As inflation slows down, I anticipate a positive margin trend. It's important to keep in mind that operating cost inflation is still relatively high, hovering around the 8% mark. Importantly, I expect BLMN to see cost savings from all the hard work they have put into increasing productivity with tools like server handhelds and more energy-efficient grills. These savings should drive further margin improvement and an improved dining experience. The logical reasoning here is that, for instance, more efficient grills will reduce the need to recook, thereby reducing overall time spent on the grill, which increases the time available to attend to guests. Cycling back to the point of high inflation, suppose it persists, management does have room to increase pricing further, so I think margin should be relatively sturdy in the near term and improve eventually.

Finally, for readers who might not be aware, the Brazil VAT tax will resume in the fourth quarter, which will have a negative impact on EBIT by $6 million. Management has forecasted a $30 million impact on the top line for the first three quarters of FY24. As the corporate tax rate in that country returns to 34% and BLMN laps the 2Q23 benefits, the company will incur an additional $10-$12 million in tax expense and a $15 million hit to EBIT. Hence, we should see a one-off step down in earnings expectations to reflect this.

This will reduce our fourth quarter operating income by approximately $6 million. Given the impacts of the Q2 tax upside and the Q4 tax downside largely offset, this new legislation should not impact our ability to attain our 2023 full year EPS guidance. Source: 2Q23 earnings

Overall, while I am positive about the business recovery, I continue to recommend a small position as the visibility to recover is still not as clear as I want it to be. The volatile SSS movement over the next 2 quarters, the possibility of higher than expected inflation, and Brazil's VAT impact are all uncertainties that need to go away before investors and consensus can better model the business. Until then, it is likely that the stock will remain volatile.

Risks

BLMN's business ultimately relies on consumer traffic into the stores. As such, any events that lead to a steep or prolonged decline in traffic will decimate any hopes for recovery. This was especially well illustrated during COVID. Aside from a pandemic, a prolonged recession that reduces consumer discretionary income will also hurt BLMN's business given that the food it offers is more expensive than typical fast food restaurants like McDonald's.

Conclusion

BLMN presents an appealing investment opportunity, with a historically undervalued stock and ongoing positive developments in its business operations. This is especially when compared to its peers in the casual dining restaurant industry. While short-term uncertainties, such as the modest SSS growth projection for 3Q23 and the normalization of pricing benefits, may lead to stock price volatility, there are promising signs, including outperforming industry traffic and improving restaurant-level margins. BLMN's efforts to enhance productivity and efficiency should further bolster margins in the face of inflation. It's important to note the impact of the Brazil VAT tax, which could temporarily affect earnings. Overall, I recommend a small position until visibility improves regarding SSS trends, inflation, and the VAT tax's impact. Until then, some level of stock volatility may persist.