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Upgrading Del Frisco’s To ‘3’ After 30% Decline – Del Frisco’s Restaurant Group (NASDAQ:DFRG)

Upgrading Del Frisco's To '3' After 30% Decline - Del Frisco's Restaurant Group (NASDAQ:DFRG)

We weren’t shy again in Might about expressing our doubts over the timing of the choice by Del Frisco Restaurant Group (DFRG) to make a $325 million acquisition of Barteca Restaurant Group shortly after deciding that they might promote their underperforming Sullivan’s Steakhouse idea. Since then buyers have fled DFRG in droves, with the inventory now buying and selling under $12 per share, versus $16.95 the day earlier than the Barteca deal was introduced.

DFRG knowledge by YCharts

That 30% drop in simply two months has gotten our consideration and we now consider the inventory is attractively priced given how busy administration can be over the approaching quarters. We subsequently are upgrading the shares from “2” to “3” this week. Under we provide a number of causes for the scores change.

Enterprise Mannequin

Del Frisco’s targets the excessive finish eating phase, with a concentrate on wonderful service and visitor expertise. The top result’s larger common checks, which may make for stronger margins than most different ideas. Contemplate the slide under, offered by the corporate throughout its announcement of the Barteca deal:

Supply: Barteca acquisition company presentation

With such excessive unit volumes and mid to excessive 20’s EBITDA margins, DFRG is giving itself a big cushion to climate close to-time period enterprise challenges, akin to visitors weak spot throughout a recession, or a short lived spike in meals prices. When margins are above common to start with, it’s merely simpler to face up to short-term shocks to what you are promoting, and stay worthwhile, as a result of there’s extra margin for error.

Sentiment

Given the investor response to the Barteca deal (inventory down >30%), the bar has been reset decrease for the corporate going ahead. Provided that we weren’t impressed with the deal both (the worth paid was wealthy and shopping for two chains whereas making an attempt to promote one looks like lots to deal with at one time), the inventory worth decline has allowed us to get extra snug with the shares at present costs, as they’re already discounting a lot of the considerations. Because the inventory has come down, the enterprise itself stays the identical, which frequently makes for a superb contrarian funding alternative.

Valuation

We discovered DFRG’s inventory worth to be at greatest pretty priced earlier than the Barteca deal, so once they paid a big worth for the corporate (2.5x 2017 income of $127.9 million, in response to the press launch) we felt much more uneasy concerning the valuation. That has all modified now.

At $11.65 per share, DFRG now trades under the corporate’s IPO worth of $13 again in 2012, and about as little as it has ever fetched during the last six years. Utilizing our EBITDA estimate for 2018 of $37M, DFRG’s valuation comes to only 7.2x EV/EBITDA, under that of the business as an entire (~eight.0x), and much under the place excessive finish chains like Ruth’s Chris (RUTH) sometimes commerce (9.0x-12.0x).

With out Barteca, we estimate truthful worth of $13-$15 per DFRG share conservatively (8x-9x EV/EBITDA). Given the cautious nature of this deal, we really feel that assuming zero earnings accretion signifies that the shares nonetheless have 10-20% upside to truthful worth. Because the deal will get built-in and monetary aims for the mixed firm come into focus for 2019 and 2020, we might very nicely improve that vary.

Danger/Reward Outlook

When a inventory loses one-third of its worth, it typically provides buyers a margin of security even when there are considerations concerning the firm’s trajectory. DFRG’s core enterprise supplies robust unit economics and money stream, at a worth that we really feel is is unlikely to go a lot decrease, assuming the present enterprise tendencies proceed. A sub-7.0x EV/EBITDA a number of for a excessive finish, excessive quantity, excessive margins chain doesn’t appear warranted over the long run. We, subsequently, see minimal down from right here, barring a recession.

Administration would argue that the Barteca deal will permit them to comprehend operational synergies and develop at greater charges over the long run, which can be true, however for now we’re assuming no incremental shareholder worth creation from the deal. We will do that, and demand that it bolsters our case for an improve as we speak, as a result of there want be no profit for the inventory to be a strong worth on the at present depressed worth.

That stated, we really feel there are a number of upside catalysts, together with a valuation bump after the mud settles and the corporate can show that each one of their ideas are performing nicely. Any synergies from the Barteca deal would supply different catalysts to the upside for the inventory. No matter how the Barteca deal works out, we expect buyers as we speak will earn cash at present costs.

Disclosure: I/we’ve no positions in any shares talked about, and no plans to provoke any positions inside the subsequent 72 hours.

I wrote this text myself, and it expresses my very own opinions. I’m not receiving compensation for it (aside from from Looking for Alpha). I’ve no enterprise relationship with any firm whose inventory is talked about on this article.

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