Fitch affirms Brinker International's IDR, bank credit facility and senior unsecured notes at BBB-; outlook stable
May 15, 2014
– Fitch Ratings has affirmed the ratings of Brinker International, Inc. (Brinker; NYSE: EAT) as follows:
--Long-term Issuer Default Rating (IDR) at 'BBB-';
--Bank credit facility at 'BBB-';
--Senior unsecured notes at 'BBB-'.
The Rating Outlook is Stable.
At March 26, 2014, Brinker had approximately $845 million of total debt.
KEY RATING DRIVERS:
Investment Grade Credit Statistics
Brinker's ratings reflect Fitch's expectations that total adjusted debt-to-operating EBITDAR will stay in the 3.0 times (x)-3.5x range and that operating EBITDAR-to-gross interest expense plus gross rent can be maintained around 4.0x. The ratings also reflect Fitch's belief that free cash flow (FCF) can approximate $100 million or more annually. For fiscal 2013 and 2014, Fitch projects that total adjusted debt-to-operating EBITDAR will be 3.1x and 3.2x, respectively, and that operating EBITDAR-to-gross interest expense plus rent will be roughly 4.0x. Fitch expects annual FCF to average $125 million through 2015.
On-going Financial Strategy
Brinker's cash flow priorities include investing in capex to support operating initiatives, satisfying $25 million of annual term loan amortization payments, and maintaining at least $50 million of cash. The firm is also returning cash to shareholders by targeting a 40% dividend-to-earnings per share payout ratio and buying back stock. Brinker's Board of Directors increased its quarterly dividend 20% to $0.24/share and share repurchase authorization by $200 million in early fiscal 2014.
Brinker expects improved FCF and additional debt capacity as EBITDA grows to enable over $1 billion of share buybacks over the next five years. The company is committed to maintaining investment grade credit statistics but is using a combination of FCF and incremental debt to fund share repurchases. Fitch views Brinker's strategy related to share repurchases as moderately aggressive but expects the firm to pull back on buybacks if operating earnings weaken.
Strength of Chili's Brand
At March 26, 2014, Brinker operated or franchised 1,563 Chili's Bar & Grill (Chili's) and 45 Maggiano's Little Italy restaurants. Of the firm's 1,608 units, 55% were company-operated and 45% were franchised. Chili's is a leader in casual dining with more than $4.0 billion of system-wide sales globally based on the brand's average unit volume of $3 million. Chili's is experiencing about 2% unit growth annually with expansion mainly overseas and via franchisees and joint ventures. At March 26, 2014, 18% or 299 of Brinker's restaurants were in foreign markets, up from 14% at the end of fiscal 2010.
Menu enhancements, better service, and re-imaging are increasing customer satisfaction at Chili's while differentiating the brand in an intensely competitive environment. Brinker has broadened Chili's menu to include pizza, flatbreads, lighter calorie items, and fresh Mexican options. The firm is on track to have 75% or about 600 of Chili's company-owned units reimaged by the end of fiscal 2014 and 100% complete in early calendar 2015. The system-wide installation of tabletop devices is also helping to improve the guest experience and has the potential to increase average per person check.
Well-Articulated Sales Drivers
Fitch views Brinker's long-term goal of 3%-5% revenue, inclusive of 2%-3% same-store sales (SSS) growth, as achievable assuming pricing in the 1%-1.5% range, a modest benefit from mix, and flat to slightly positive traffic. SSS have been positive for nine of the past 12 quarters with SSS being 0.7% for both Brinker and Chili's in the quarter ended March 26, 2014, despite the negative impact of weather.
Menu innovation, value offerings, effective marketing, remodeling, and utilizing To Go and Delivery as additional sales channels should support future SSS growth. New items such as Guacamole Live, launched in the June 2014 quarter, are being added to Chili's Fresh Mex menu platform and the brand continues to provide variety under its existing two for $20 and starting at $6 lunch combo platforms.
Significant Margin Improvement
Brinker continues to make significant progress on its 2010 goal of 400 basis points of margin improvement, reporting an operating margin of 9.6% in fiscal 2013 versus 6.4% in fiscal 2010. Fitch believes Brinker can achieve this objective by fiscal 2015. Margin expansion is being driven by kitchen upgrades, labor efficiency, and higher margin menu items. Brinker expects commodity inflation for 2014 to approximate 1%-2% and at the end of the fiscal third quarter, was 46% contracted through calendar 2014 or the first half of fiscal 2015.
Liquidity, Maturities, and Covenants:
Brinker's liquidity is supported by its FCF generation and $250 million revolver expiring Aug. 9, 2016. FCF for the latest 12 months (LTM) was $137 million or 4.8% of sales. At March 26, 2014, the firm had $65 million of cash and $192 million of revolver availability. Maturities of long-term debt, excluding capital leases, are limited to the $25 million annual term loan amortization payment through fiscal 2016. During 2017, the outstanding balance on the term loan and revolver become due.
Brinker's credit facility includes a Minimum Adjusted Coverage Ratio test of 1.5x and a Maximum Debt-to-Cash Flow limitation of 3.5x. Maximum Debt-to-Cash Flow is defined as consolidated debt plus 6 times rent divided by EBITDA plus rent. Minimum Adjusted Interest Coverage is defined as EBIT plus rent divided by interest expense plus rent. The firm has ample cushion under these covenants. Fitch estimates that these ratios were 3.1x and 2.7x, respectively, for the LTM ended March 26, 2014.
Brinker's $250 million 2.6% notes due May 15, 2018 and $300 million 3.88% notes due May 15, 2023 include a Change of Control Triggering Event provision. Negative covenants restrict Brinker's ability to incur debt secured by liens and to engage in sale lease back transactions. At the fiscal year ended June 26, 2013, Brinker owned the land and building for 189 of its company restaurants and the building for 541 of its company units.
Future developments that may, individually or collectively, lead to a positive rating action include:
--Total adjusted debt-to-operating EBITDAR (defined as total debt plus 8.0x gross rent-to-operating EBITDA plus gross rent) maintained below 3.0x;
--Consistently strong SSS, due to positive traffic, operating income growth and continued margin expansion;
--Sustained annual FCF (defined as cash flow from operations less capex and dividends) of more than $100 million with a FCF margin to sales in the low to mid-single digit range.
Future developments that may, individually or collectively, lead to a negative rating action include:
--Total adjusted debt-to-operating EBITDAR sustained above 3.5x;
--Persistently negative SSS performance, due to declining traffic, at Chili's and margin declines;
--Meaningfully lower FCF due to operating income declines, higher capital expenditures, and/or a more aggressive dividend policy;
--Debt-financed share repurchases concurrent with weaken operating trends.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (August 2013);
--'U.S. Restaurant FAQ: Inquiring Minds Want to Know' (March 2014);
--'Rating Restaurant Companies: Sector Credit Factors' (February 2014);
--'2014 Outlook: U.S. Restaurants - Shareholder Demands to Rise, Even as Market Share Battle and Cost Pressures Continue (December 2013).
Applicable Criteria and Related Research:
Corporate Rating Methodology: Including Short-Term Ratings and Parent and Subsidiary Linkage
U.S. Restaurant FAQ: Inquiring Minds Want to Know (Highlights from First-Quarter 2014 Discussions with Investors)
Rating Restaurant Companies (Sector Credit Factors)
2014 Outlook: U.S. Restaurants (Shareholder Demands to Rise, Even as Market Share Battle and Cost Pressures Continue)
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