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Investment Conclusion
Portillo’s (NASDAQ:PTLO) reported strong F4Q2021 financial results. Revenues for the period increased significantly based on higher transaction values and shift in product mix towards premium priced items. However, margins were negatively impacted by cost inflation associated with commodities and labor. Nevertheless, counter to industry trends, despite some shortage of front-line staff, all of the firm’s restaurants were fully operational during the fourth quarter. PTLO’s Spicy Chicken Sandwich launched in March last year continued to be a customer favorite, garnering substantial sales, despite the strong competitive market surrounding the product. The company entered two new territories during the period, opening one store each in Westfield, Indiana, and Madison, Wisconsin, ending the year with a footprint of 70 restaurants.
Over the next few quarters, driven by: growth in same-store sales and incremental sales derived from the five new restaurants launched last year and the seven expected to open this year, we expect the strong momentum in retail sales experienced over FY2021, to continue. However, the margin contraction evidenced over F4Q2021, is also likely to persist, due to lingering inflationary pressures related to labor and commodities. In addition, PTLO anticipates investing significantly in developing its employee base, in order to prepare talent for leadership roles in potential restaurants. Management indicated that they will continue to price their products below market rates, and focus on operating leverage to mitigate the margin shortfall. Therefore, it appears likely that PTLO might be unable to generate profits over the near-term. Nevertheless, after adjusting for non-cash items, cash flow from operations will possibly expand on a year-over-year basis, in our opinion.
Longer-term, PTLO’s focus on sustaining existing strong customer demand, by expanding: same-store sales and the number of restaurants, will ensure growth in earnings and free cash flows, in our judgment. Same-store sales growth will be derived from menu innovation, digital sales, and the loyalty program. In regard to new unit development, the company has committed to a target growth rate of 10% every year, with an objective of developing a footprint of 600 domestic restaurants. We expect the number of new units launched every year to exceed planned targets, as the popularity of its brand, forces PTLO to rapidly expand the footprint, to benefit from the considerable customer demand. In addition, given the clamoring for its product across the U.S., we believe PTLO is being overly conservative with regards to the number of restaurants it can successfully operate within the country. The firm is likely to keep adding stores even after its footprint expands to 600, in our assessment.
Given the scenario, PTLO appears well-positioned for substantial revenue growth over numerous years. Consequently, due to revenue leverage from sharply higher sales, restaurant operating margins are likely to expand, as marginal costs per dollar of sales decrease. Additional leverage will be derived from a decrease in commodity prices from current levels, and economies of scale related to the digital platform, advertising, and corporate fixed costs. As a flow through of significantly higher sales and margin expansion, we anticipate boosts in: profits and free cash flows, over the long-term.
Considering that F4Q2021 results have only reinforced our secular outlook on PTLO, we remain constructive on the company. PTLO appears well positioned to meet and exceed the estimates for growth in revenues and operating cash flows factored into our 10-year Discounted Cash Flow model. Therefore, we’re maintaining our 1-year Price Target of $30/share. Reiterate Buy Rating. (Please go through our initiation report “Portillo’s: Solid Business With Potential For Significant Growth” for our long term opinion on the stock).
Key Takeaways From The Fourth Quarter
F4Q2021 Results Summary. For the quarter, revenues of ~$139 million (+17.2% compared to F4Q2020), missed consensus estimates of ~$139.5 million, and earnings per share came in at ($0.52), below analyst projections of ($0.48). On a year-over-year basis, same-store sales advanced by 10.3%. Net loss for the period was ~$33.8 million vs. a net income of ~$4.89 million during the previous year’s same quarter. Restaurant level: adjusted EBITDA expanded to ~$35 million (~+1.3% compared to F4Q2020), while adjusted EBITDA margin declined by 400 bps on a year-over-year basis to ~25.2%. During the fourth quarter, the firm generated operating cash flows of ~$42.9 million, and free cash flows of ~$8.7 million.
For FY2021, PTLO reported: ~$535 million in revenues representing a year over year growth of ~17.5% and a net loss of $13.4 vs. a net income of ~$12.3 million over FY2020. In addition, for the period, on a year-over-year basis, same-store sales increased by ~10.5%, and restaurant level: adjusted EBITDA expanded by ~16.5% to ~$142 million, and adjusted EBITDA margins decreased by 20 bps to 26.6%.
Focused On Expanding Sales Not Margins. Given inflationary pressures, PTLO experienced margin contraction over F4Q2021. However, the momentum in revenues the firm has been witnessing over recent quarters continued. Considering that the company’s business objective is to be a volume player rather than a cost leader, the current business dynamics are favorable. PTLO’s strategy is to provide flavorful abundant meals at a reasonable price, particularly during economic crises or amidst cost inflation related to commodities, including gas. Their goal is to take market share from competitors by being a sanctuary for customers when prices are rising around them.
PTLO desires to increase margin dollars rather than margin percentages. In alternate terms, the firm deliberately prefers being a relative price laggard, pricing its products below that of the competition, and increasing menu prices by rates below the inflation rate. Management is of the opinion that the current margin pressure is idiosyncratic, while winning customer loyalty has favorable long-term implications for the business. Consequently, the firm is likely to continue to experience margin compression until inflation headwinds subside, and commodity prices stabilize closer to prior levels.
New Unit Development Goals Remain On Track. PTLO launched its Joliet, Illinois restaurant in February, plans to open its St. Petersburg, Florida location in April, and add another five restaurants during the second half of the year.
Amongst the restaurant launches planned for FY2022, one of primary importance is the Dallas location which represents the firm’s first foray into the Texas market. PTLO Dallas is located on the north side of the city within the Grandscape complex, which forms part of an invite-only real estate development, called The Colony. The project is five minutes from Toyota’s North American headquarters, a massive office complex in Plano and Frisco. Given the large addressable population the development will likely provide PTLO Dallas, the business appears well-positioned to succeed.
PTLO Dallas appears to be the company’s flagship store within the Dallas-Fort Worth region, which will be rapidly infilled with additional locations, to create brand awareness and fulfill customer demand. Management has indicated that it considers the Dallas-Fort Worth market as being of similar size to its Chicago market, where the firm has ~30 stores, within the metropolitan area.
Eyeing Labor Leverage Through Improvement In Productivity. PTLO recently updated its point of sales platform. The new system permits employees to process transactions within the restaurants, at the drive-thrus, and from long customer queues, using the same digital platform. The initiative reduces the time required to train new employees and improves restaurant throughput. In addition, the firm has deployed efficiency enhancers, such as pop and lock boxes instead of boxes that had to be constructed in stores, precut bread instead of bread that had to be cut and packaged, and precut and trimmed sausages instead of having to cut the ordered sausages and trim them on the premises. Considering the productivity benefits, PTLO’s is utilizing less labor hours even as it is paying more for labor. Overall, the objective is to derive operating leverage, in order to improve margins, rather than depending predominantly on price hikes to mitigate the effects of inflationary pressures on profits.
Contrary To Industry Trends, PTLO’s Staffing Challenges Appeared Limited. The company recently hired scores of front-line workers to staff its recently launched restaurants. A team of 100 was hired for a new store opened in Joliet, Illinois, and another 120 were brought on to support a new restaurant scheduled for launch in St. Petersburg, Florida, in April. The significant traction PTLO is experiencing with bringing on new talent is driven by initiatives the firm has implemented over the prior year to encourage potential employees to apply for jobs at its restaurants.
During F2Q2021, the firm allocated substantial funding towards team member pay, benefits, training, and talent development, which reflected in ~20% year-over-year growth in employee wages over F4Q2021. The employee rewards package includes free shift meals, extra pay on key holidays, flexible scheduling, and a more affordable health care program. PTLO is committed to promoting from within and has implemented leadership development training, which resulted in an internal management promotion rate of ~80% during FY2021. Therefore, unlike most industry participants, the company has not suffered from curtailed operating hours during the pandemic.
Launched First Off-Premise Only Restaurant. On February 1, PTLO opened its first dedicated pick-up restaurant in Joliet, Illinois. The outlet is a fraction of the size of a typical PTLO restaurant and does not include a dining room. Designed as a drive-thru, the restaurant includes a third drive-thru lane for customers that utilize the company’s digital platform to place orders and make payments. Although the restaurant is substantially smaller in size, it is generating considerable sales driven by take-out orders, third party delivery orders, and catering orders. Management appeared excited about the low capital expenditure associated with the project and the outsized sales being generated. Therefore, it appears likely that PTLO might launch numerous similar stores to benefit from the initiative.
Balance Sheet Appears Strong. At the end of F4Q2021, the company had a restricted cash and cash equivalents balance of ~$39.3 million and long-term debt of ~$316 million on its balance sheet. In regard to additional funding, PTLO has available for use, a remainder of $45 million on a revolving credit facility, it secured in March 2020. Given these factors, we believe that the firm is appropriately funded to operate effectively and execute on its footprint growth targets.
Bottom Line
PTLO’s popularity appears well-set to keep growing, as based on reviews, legacy customers can’t have enough of it and new customers rave excitedly about it. There are scant examples of companies with runaway customer demand (like PTLO) that have not turned wildly successful over the long-term. Our advice is to not confuse the trees for the woods. The current margin challenge will be overcome over time. PTLO’s future remains rosy, and could get rosier, as the business evolves. We view the stock as a home-run for investors with elongated time horizons.
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