Portillo’s: Buying Beef and Stock (NASDAQ:PTLO)

Portillo (NASDAQ: PTLO) shares have fallen 40% year-to-date and are actually down 55% over the previous 12 months. Traders fled the inventory after a disappointing first-quarter earnings report, considerations about shopper spending and continued promoting by non-public fairness agency Berkshire Companions (unaffiliated of Berkshire Hathaway) after the IPO.

​​​​​​Whereas the Q1 numbers had been underwhelming, at in the present day’s worth I see a slight basic flaw in Portillo inventory (mentioned under) and assume buyers are lacking some vital positives, together with:

• Loyal buyer base in Chicago, offering some aggressive insulation ought to worth competitors enhance
• Operational enhancements via kitchen reconfiguration and the power to cut back retailer prices via kiosks
• Restaurant growth continues in Sunbelt markets – new eating places optimized to enhance return on capital
• The tip of the non-public fairness cover is coming as Berkshire Companions is at the moment on the backside 20% possession (vs. 60+% at IPO).

Whereas I used to be adverse on Portillo’s on the finish of 2022 (at 20 shares) and impartial earlier this 12 months at 14, under $10 a share I’m a purchaser of the inventory (and scrumptious Italian beef sandwiches). I see near-term progress potential of 60% and 130% (32% annualized) by 2027.

Newest outcomes and the close to future

As proven above, same-restaurant gross sales had been barely adverse in 1Q24 as optimistic pricing was greater than offset by comparable transactions, which declined 3.2% quarter-on-quarter. Whereas the outcomes had been disappointing, it is value noting that Portillo’s is not alone, as a number of restaurant chains reported weak outcomes final quarter, together with Starbucks ( SBUX ) , which posted -7% attendance and -3% gross sales on the similar retailer, and Wall Avenue favourite Cava ( CAVA ), which had a -1.2% decline in visitors, contributing to softer-than-expected 2.3% progress in retailer income. Equally, Darden’s ( DRI ) Olive Backyard’s largest chain additionally posted adverse comparable gross sales (-1.6%) and transactions (-2.6%). Nearly all eating places are going through stress as customers tighten their belts as a consequence of years of inflationary pressures which have squeezed family budgets, and we’re prone to see additional easing within the close to time period.

For the foreseeable future, Portillo’s can be at a slight drawback to its restaurant friends with regards to transactions/similar shops as a result of 55% of Portillo’s areas (and 70% of income) are in Illinois, which has a declining inhabitants. Total, I anticipate -1 to 0% same-store transaction progress over the following couple of years (and 0-3% same-store income progress) till extra Sunbelt areas enter the corporate base and bolster transactions.

Having stated that, Portillo’s has achieved a sensible job of managing profitability in a troublesome atmosphere, with restaurant-level EBITDA margin down simply 0.4% year-over-year and general EBITDA margin up. Furthermore, as described under, there are alternatives for operational enchancment that ought to assist protect margins even in powerful circumstances for corporations.

Alternatives for enchancment

Portillo’s has giant eating places, an intensive menu, and a reasonably complicated operation. Traditionally, it had an unnecessarily lengthy “manufacturing line” (100+ toes in some areas), which each elevated capital and working prices (much less throughput per worker) and slowed service. Not solely is the corporate addressing this subject by constructing smaller, extra environment friendly new shops (47-65 foot manufacturing strains and a $1 million discount in capital expenditures), however it’s upgrading many present eating places to enhance effectivity and throughput.

I see the introduction of ordering kiosks as a notable potential upside for Portillo’s. The advantages are quite a few and embrace: decrease labor prices, elevated order accuracy, and quicker service occasions. The corporate is testing kiosks in California, and I hope to roll them out to all areas inside the subsequent few years.

It’s also vital to emphasise that Portillo’s has tremendously improved the method of opening new eating places. From 2015 to 2021, the corporate struggled to develop as a result of it did not have the infrastructure (devoted new retailer opening groups) to correctly open eating places, and there have been many challenges alongside the best way (extremely lengthy strains, poorly skilled staff and in some instances 90 minutes ready!). Attributable to its scale, Portillo’s was in a position to put money into new restaurant opening groups, which considerably improved the opening course of and elevated buyer and worker satisfaction.

Evaluation

At $9.72 a share, after debt, Portillo’s is value simply over $1 billion, roughly the value at which Berkshire closed it in 2014 (when it had simply 40 areas, in comparison with 86 in the present day).

Portillo’s trades at simply 10x 2024e EBITDA (and 9x 2025e EBITDA), a major low cost to different progress restaurant chains. Whereas I discover the valuations of Cava (100x 2024e EBITDA and 80x 2025e EBITDA) and Kura Sushi (KRUS) at 60x 2024e EBITDA to be euphoric, Shake Shack (SHAK), which I contemplate the perfect comparable, is now buying and selling at 21x 2024e EBITDA ( and ~17.5x 2025e EBITDA).

By optimizing restaurant codecs and considerably enhancing the restaurant opening course of, Portillo’s elevated its unit progress targets. Furthermore, as the corporate expands into markets like Phoenix and Dallas, it’s going to profit from improved promoting scale and logistics/distribution. ​​​​​​Whereas the corporate can be weighed down by its big footprint in Chicago, I consider administration’s aim of low-to-mid-teens EBITDA progress is achievable. So I feel an EBITDA a number of of 13 occasions is affordable, implying a good worth of $16 per share in 2025 or 60% progress. What’s extra, if Portillo’s proves its progress mannequin, we may see a a number of of as much as 15x (which might nonetheless be a giant low cost for the sector), which might imply a price of $23 (32% annualized) by 2027.

Dangers

• As talked about above, customers are tightening their belts with regards to spending at eating places, and it is doable that this may result in additional declines in same-store gross sales.
• Portillo’s web debt to EBITDA is 3 occasions. Whereas I consider this degree of leverage is manageable, the steadiness sheet may develop into stretched if working outcomes meet expectations.
• Portillo’s is a small-cap inventory with a market cap under $800 million. Small-cap shares have considerably underperformed large-cap shares over the previous few years, and it is doable that this pattern will proceed.

Conclusion

Whereas sluggish shopper spending has dampened the near-term outlook, I feel the medium-term image for Portillo’s is fairly brilliant. Because the inventory is buying and selling at a deep low cost to my estimate of truthful worth, I took a place within the inventory.