Valuation multiples are driven by perceived growth, risk and uncertainties, and investors’ willingness to pay. There are various multiples available to value a company. We are choosing the forward PE ratio due to the high visibility in earnings of Brinker International (EAT). Forward PE ratio is calculated by dividing current share price with forecasted EPS for the next 12 months.
EAT’s valuation multiple
Since 4Q15, the PE multiple of the company has been declining, possibly because investors are worried about the decline of same-store sales growth. Although some of the losses in traffic were offset by an increase in menu prices, this is only temporary. In a highly competitive market like restaurants, continued increases in menu prices likely won’t work well. Also, a decline in EBITDA margins due to an increase in labor wages might suggest that investors are more pessimistic about future earnings.
As stated earlier, Brinker International (EAT) has taken several measures to stem the decline of traffic at its restaurants. It is yet to be seen what kind of effects these measures will have on same-store sales growth. Also, the campaign to increase the minimum wage to $15 per hour for restaurant employees is a cause of concern. The company’s current share prices may have already factored in future earnings per share of $3.6 for fiscal 2016, an increase of 15.5% from its 2015 EPS. If the company fails to meet these expectations, the stock could face selling pressure, which could bring its PE multiple down.
Alternatively, you can gain exposure to the restaurant industry by investing in the iShares U.S. Consumer Services ETF (IYC), which has holdings in McDonald’s (MCD), Starbucks (SBUX), and Yum! Brands (YUM).