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What I'll Be Watching When Chuy's Holdings Reports Earnings

2017 has already been a long year for Chuy's Holdings (NASDAQ: CHUY) shareholders, with the stock down around 27% year-to-date. Two consecutive quarters of negative comparable sales growth, along with a couple of analyst downgrades, helped send shares to fresh two-year lows in June. With the company set to report its second quarter results on August 3, here are the items I'll be monitoring to see whether the Tex-Mex chain can get things back on track.

CHUY data by YCharts

It's all about comps

You hate to boil earnings report success down to a single metric, but if Chuy's turns in strong comparable restaurant sales growth numbers, the market would probably forgive a lot of other, less positive results. Chuy's take on Tex-Mex cuisine had shown remarkable resilience over the past several years -- with 25 consecutive quarters of comps growth through late 2016.

Image source: Getty Images

But in Q4 2016 and Q1 2017, Chuy's comps fell 1.1% and 0.7%, respectively, as increases in the average guest check couldn't overcome declining customer traffic. While this phenomenon was certainly not unique to Chuy's, the bad news is that trends don't appear to be improving much. According to Black Box Intelligence, average restaurant traffic fell 3.1% in the second quarter, while average comps fell 1%.

Chuy's most recent guidance is for full-year comps growth of 0.5% to 1.5%. It's worth noting that Chuy's comps began decelerating last year in Q2, so Chuy's will begin lapping those weaker results with this report, and year-over-year comparisons should get even easier later in the year. 

What to watch for: Any positive number would be a welcome sign that things may be turning around, though that may not be realistic given current conditions. At a minimum, investors will want to see Chuy's outperform the industry averages and maintain its current guidance. On the other hand, the stock could tumble if management is forced to lower full-year comps guidance after a third consecutive quarter of weakness.

Margins under pressure

Chuy's restaurant-level operating margins have historically been strong, averaging 19.3% in 2016. However, the last two quarters have also seen margins shrink year-over-year due mostly to higher labor costs, and new restaurant inefficiencies as Chuy's continues to expand into larger, more expensive markets.

To help preserve its margins, Chuy's has created a four-tiered approach to menu pricing, which should help it standardize margins across geographies while still offering the value the chain is known for. Locations in larger cities that have higher expenses for things like occupancy costs or wages will simply charge diners a little more to make up the difference.

What to watch for: Continued margin compression. Analysts have cited rising costs as factors in their recent downgrades. While Chuy's target for restaurant-level operating margin is 15% to 16.5%, the company has regularly been able to manage margins well above that figure, and investors should hope that continues.

Long-term success depends on store growth

At the end of 2016, Chuy's had 80 stores, with around half of those in its home state of Texas. But Chuy's has ambitions to double its store count in the next three to five years by growing its number of locations at an annual rate of 15% to 20%. This year, the company will open 12 to 14 new stores, while entering three large markets crucial to its longer-term growth. Chuy's recently celebrated the opening of its first Denver-area restaurant, with openings in the Chicago and Miami markets planned later this year.

Citing confidence that its restaurant concept will keep resonating with diners, even in the face of declining comps, Chuy's isn't about to dial back on its pace of expansion. In fact, Chuy's CFO Jon Howie recently commented that he believes the potential exists for a total of 350 to 450 stores in the U.S.

What to watch for: Any updates about how Chuy's newest stores are performing, and whether the new market openings are still on schedule. Additionally, committing to the higher end of its new store guidance (14 stores) would be a strong sign that Chuy's plans to stay aggressive with expansion.

Investors have given Chuy's the cold shoulder lately, but if the company can show some signs of life on the comps front while maintaining margins and steadily increasing its store base, it would go a long way toward assuaging fears that this growth story is broken.

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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.