As my colleague Peter Romeo pointed out yesterday, Chili’s had a pretty good quarter, at least if you look at its topline numbers.
The casual dining chain generated same-store sales and traffic growth, something that’s been painfully difficult for the sector for some time. The numbers easily bested Wall Street estimates.
So why did Chili’s parent Brinker International’s stock get punished yesterday, falling 11%?
The answer lies in margins. As Peter noted, restaurant operating margins shrunk by 250 basis points, to 12.4% from 14.9%. That was an acceleration from the previous quarter. And it clearly spooked investors worried that casual dining chains could be setting themselves up for problems down the road because of the takeout trend.
It’s not an unfounded concern—indeed, it represents a challenge for such chains going forward. Thinner casual dining margins might become more commonplace as the companies replace more profitable dine-in customers with less profitable takeout customers.
As Chili’s results have demonstrated, takeout is providing casual dining chains with a rare opportunity to generate traffic and get customers coming back. To-go sales at Chili’s rose 20% and now represents 12% of the chain’s business.
And as our friends at TDn2K noted, takeout is a huge driver of traffic growth today. The simple fact is that customers right now are increasingly less likely to eat their food inside a restaurant.
The problem, however, is that casual dining chains like Chili’s, Applebee’s and others were built to serve customers inside, where they theoretically order drinks and alcohol that yield higher profit margins than the burgers or ribs on the menu.
The restaurants are frequently stand-alone buildings near heavy shopping areas. Chili’s, for instance, averages 3,200 square feet compared to a 2,500-square-foot average for the traffic-heavy McDonald’s, according to Technomic Ignite data.
Takeout is a different business. The orders can be larger, which helps, but they don’t include drinks—though chains such as BJ’s Restaurants have been working on beer and wine delivery. That removes those profitable items from the equation.
If delivery is involved, then those orders are even less profitable because the chains have to pay fees to providers like DoorDash, Uber Eats, Postmates or Grubhub.
There are two other issues: Many casual dining chains, and Chili’s was sure one of them thanks to its three-for-$10 offer, have pushed value offers to generate customer traffic. And the chains have been selling their real estate and leasing them back, which pressures store margins further by burdening them with leases.
All of that said, it’s also possible that the market overreacted to the thinner margins. Stephen Anderson, analyst at Maxim Group, rates Brinker International a Buy and says that most of the margin compression from last quarter came from one-time factors and not a real trend to lower profits.
He believes profits will remain stable but added in a note that, “we do not rule out the potential for a return to margin expansion” next fiscal year.
Maybe. But the shift of traffic toward more takeout and delivery is clearly putting pressure on management teams at casual dining restaurants, as well as fast-casual chains initially designed to serve dine-in customers.
Addressing that differential will be the new normal.
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