Josh Moore, Brad Bolte, James Hall, Tanner Swaringen, Tim Meyer 4/1/2014

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1 BRINKER INTERNATIONAL Financial Analysis Draft 3 Josh Moore, Brad Bolte, James Hall, Tanner Swaringen, Tim Meyer 4/1/2014

2 Table of Contents Liquidity Ratios... 3 Introduction... 3 Current Ratio... 3 Quick Ratio... 4 Inventory Turnover... 5 Inventory Days... 7 Accounts Receivable Turnover... 8 Accounts Receivable Days... 9 Cash to Cash Cycle Working Capital Turnover Conclusion Profitability Ratios Introduction Sales Growth Gross Profit Margin Operating Profit Margin Net Profit Margin Asset Turnover Return on Assets ( ROA ) Return on Equity ( ROE ) Conclusion Capital Structure Ratios Introduction Debt to Equity Times Interest Earned Altman s Z-Score Conclusion Growth Rates Introduction Internal Growth Rate Sustainable Growth Rate Page 1

3 Industry-Specific Ratios Introduction Company-Owned Locations Financial Analysis Conclusion Financial Forecasting Income Statement Dividends Forecasting Balance Sheet Statement of Cash Flows Restated Financial Statements Cost of Capital Estimation Cost of Debt Cost of Equity Backdoor Cost of Equity Weighted Average Cost of Capital (WACC) Appendix Appendix (1) Page 2

4 Liquidity Ratios Introduction Liquidity is the ability or quality of an asset that makes it easily convertible to cash. In general, liquidity represents more safety to companies and investors alike because it is easier for the holder of the asset to collect the cash value associated with the asset. On a company balance sheet, marketable securities and accounts payable are two examples of relatively liquid assets. In this analysis of liquidity ratios, we will looks at the current and quick ratios, inventory turnover, inventory days, accounts receivable turnover, accounts receivable days, cash to cash cycle, and working capital turnover. Current Ratio The current ratio, also known as the liquidity or cash asset ratio, is defined and calculated as the current assets divided by current liabilities. It is used to measure the firm s ability to pay current liabilities with current assets. A higher number is generally better. As evidenced below, Brinker s yearly current ratio was higher than the average of its peers until 2011, but it has since slumped below the mean. We believe this is due primarily to the firm selling its On The Border segment in The segment s efficient financials helped bolster the holding company s current ratio as a whole. Page 3

5 Current Ratio Average Brinker Brinker Restated Dine Equity Darden Buffalo Wild Wings Industry Current Ratio Brinker Brinker Restated Dine Equity Darden Buffalo Wild Wings Industry Figure 1. Quick Ratio The quick ratio, or quick asset ratio, is a measure of the firm s short-term liquidity. It is calculated as cash plus accounts receivable plus marketable securities, all divided by current liabilities. In contrast to the current ratio, the quick ratio measures the firm s ability to cover short-term obligations without using certain, less-liquid current assets, such as inventory. As you can below, Brinker has a very undesirable quick asset ratio over the past five years. Anything over 1 is what a company or analyst might consider as desirable. Since this ratio is far below 1 it is telling us that Brinker would be unable to cover its short term obligations. With a quick ratio as low as this one, there is increased risk involved in investing into this company. Page 4

6 Quick Ratio Average Brinker Brinker Restated Dine Equity Darden Buffalo Wild Wings Industry Quick Ratio Brinker Brinker Restated Dine Equity Darden Buffalo Wild Wings Industry Figure 2. Inventory Turnover Inventory turnover represents the number of times each company s inventory currently on hand is sold during a specified period. In general, a higher number is better, because the ratio is calculated as cost of goods sold divided by inventory. A higher number is better because it implies a higher amount of sales, whereas a lower number implies excess inventories. It should be noted that companies in this industry have higher than average inventory turnover levels because their food is perishable, and they move their inventory much faster than other companies in industries such as retail or technology. Brinker has been slightly increasing its inventory turnover each year for the past five years. When comparing Brinker to its peers it is maintaining a relatively consistent pattern matching its peers. As stated previously, the inventory Page 5

7 turnover in this industry is much higher than other industries due to the perishable inventory. In this industry it is common to see this ratio exceeding 100, which Brinker and its peers have done so over the past five years. In the last two years, Dine Equity has shrunk its inventory to zero, while its percent of franchised restaurants has risen to one hundred. That is why there are no inventory turnover statistics for Dine Equity over the past two years. Inventory Turnover Average Brinker Brinker Restated Dine Equity Darden Buffalo Wild Wings Industry Inventory Turnover Brinker Brinker Restated Dine Equity Darden Buffalo Wild Wings Industry Figure 3. Page 6

8 Inventory Days Inventory days, or days sales of inventory, takes inventory turnover one step further by taking the number of days in the period, usually 365 or 360, and dividing that by the inventory turnover. This new ratio measures the amount of time it takes the company to turn its inventory into sales. In general, a lower number is better because it means they are taking less time to turn their inventory into sales. Brinker is averaging an inventory day s ratio of 3.38 over the past five years. This tells us that Brinker is converting its inventory into sales every 3.38 days. This ratio shows a strong and short turnover rate which is needed in this industry due to the perishable inventory. If this ratio was to much higher for Brinker or its peers it would result in wasting inventory. Inventory Days Average Brinker Brinker Restated Dine Equity Darden Buffalo Wild Wings Industry Inventory Days Brinker Brinker Restated Dine Equity Darden Buffalo Wild Wings Industry Figure 4. Page 7

9 Accounts Receivable Turnover Accounts Receivable Turnover, or A/R Turnover, measures the company s efficiency in collecting credit revenue. It is calculated as net credit sales or total sales divided by average accounts receivable for a period. A higher number implies that the company s offered credit terms are leading to efficient accounts receivable collections. Comparing Brinker to its peer group has revealed fairly average accounts receivable turnover of While Brinker shows a healthy ratio, Buffalo Wild Wings has mastered their accounts receivable ratio resulting in very high efficiency. AR Turnover Average Brinker Brinker Restated Dine Equity Darden Buffalo Wild Wings Industry Accounts Receivable Turnover Brinker Brinker Restated Dine Equity Darden Buffalo Wild Wings Industry Figure 5. Page 8

10 Accounts Receivable Days Accounts Receivable Days, A/R Days or Days Sales Outstanding represents the average number of days between a sale and the associated collection of revenue. In all cases, a lower number is better because it implies that the company is receiving cash faster, which means its accounts receivable account is a more liquid current asset. Brinker has obtained an accounts receivable days of 0.21 in 2013, and an average over the past five years of Compared to Brinker s peer group they are sitting comfortably in the middle of the pack. In this industry many of its sales are transacted in cash making this ratio relatively low. AR Days Average Brinker Brinker Restated Dine Equity Darden Buffalo Wild Wings Industry Accounts Receivable Days Brinker Brinker Restated Dine Equity Darden Buffalo Wild Wings Industry Figure 6. Page 9

11 Cash to Cash Cycle The Cash to Cash Cycle, sometimes referred to as the Cash Conversion Cycle, is the aggregate number of days in the Accounts Receivable Days and Inventory Days ratios. It represents the number of days required for cash spent on inventory and other inputs to become cash gained from sales revenue. For the last five years, Brinker has maintained a relatively average number of days for its cash to cash cycle; however, the number has begun to fall below the average and is exhibiting a favorable downward trend. Cash to Cash Cycle Average Brinker Brinker Restated Dine Equity Darden Buffalo Wild Wings Industry Cash to Cash Cycle Brinker Brinker Restated Dine Equity Darden Buffalo Wild Wings Industry Figure 7. Page 10

12 Working Capital Turnover Working Capital Turnover represents the company s ability to fund its sales using its working capital. To clarify, working capital is current assets minus current liabilities. Working capital turnover is calculated similar to accounts receivable turnover and inventory turnover: it is sales divided by working capital. It is a relative ratio that should be compared to prior year s data. Based on Brinker s working capital turnover over the past five years it is steadily becoming worse. This unhealthy ratio of in 2013 represents that Brinker is unable to fund its sales using working capital. Working Capital Turnover Average Brinker Dine Equity Darden Bloomin' Brands Buffalo Wild Wings Industry Table Working Capital Turnover Brinker Dine Equity Darden Bloomin' Brands Buffalo Wild Wings Industry Page 11

13 Figure 8. Conclusion After rigorous analysis of Brinker s liquidity ratios many of their ratios are undesirable, representing an increased amount of risk involved in investing in this company. Given these low liquidity ratios, representing Brinker we can come to the conclusion that the margin for safety if significantly lower than the industry average. We will discuss Brinker s likelihood of going bankrupt with the Altman s Z-score later in this ration analysis section. Profitability Ratios Introduction Profitability ratios assess the extent to which a company s revenues exceed various measures of their cost. As a rule of thumb the higher this ratio is compared to its competitors the better shape the company is in. Profitability ratios are the most commonly analyzed ratios when an investor is doing a financial analysis. These ratios by themselves may not make sense at certain times. It is important to have a good overall understanding of the industry from where these ratios are being taken in order to complete the entire story that this analysis will provide. Sales Growth Sales Growth is the percentage change of sales from one year to the next. A higher number is considered to be the most desirable figure for this ratio. While it does not factor in the associated cost of revenue, it can be a useful statistic in measuring the firms growth or accumulation of the market share compared to its peer. Brinker s sales decreased from 2009 to 2011, but have since displayed an upward trend. The sales numbers are very volatile within this peer group, but Brinker s numbers are generally lower than the average. Page 12

14 Sales Growth Average Brinker % % - 3.4% 2.1% 0.9% -7.3% Brinker Restated -21.0% -12.4% 2.1% 0.9% 2.2% -7.6% - - Dine Equity 19.0% 8.9% 21.0% 24.6% 6.7% -4.4% Darden -5.0% -9.1% 6.6% 6.9% 3.8% -0.1% Buffalo Wild Wings 28.1% 27.6% 32.6% 21.7% 32.6% 27.5% Industry 1.2% 0.4% 3.4% 1.4% 9.2% 1.6% 40.0% Sales Growth 30.0% 20.0% 10.0% 0.0% -10.0% -20.0% -30.0% Brinker Brinker Restated Dine Equity Darden Buffalo Wild Wings Industry Figure 9. Gross Profit Margin Gross profit margin, also known as gross margin, is used to measure the profitability of a company. It is calculated as revenue minus cost of goods sold all divided by total revenue. Gross margins can vary greatly between industries. It is most useful when comparing profitability relative to the firm itself in prior years, or to its industry peers. The gross profit margin numbers are much more consistent than the sales growth percentages. Brinker s gross profit margin has remained consistent around Page 13

15 twenty percent higher than the industry average over the last five years. However, because Brinker s restated cost of goods sold is much lower than the original numbers and total revenue is unchanged, the gross profit margin becomes much higher over the past three years. Brinker s restated numbers are thirty percent higher, on average than their peers. Gross Profit Margin Average Brinker 72.1% 71.5% 17.3% 18.1% 19.0% 44.7% Brinker Restated 74.5% 71.5% 73.1% 72.7% 73.4% 72.9% Dine Equity 38.5% 39.7% 47.0% 57.5% 57.7% 45.7% Darden 21.9% 22.9% 24.0% 22.9% 22.1% 22.9% Buffalo Wild Wings 25.2% 26.1% 27.0% 24.2% 23.7% 25.6% Industry 46.4% 46.3% 37.7% 39.1% 39.2% 42.4% 80.0% 70.0% 60.0% 50.0% 40.0% 30.0% 20.0% 10.0% Gross Profit Margin 0.0% Brinker Brinker Restated Dine Equity Darden Buffalo Wild Wings Industry Figure 10. Operating Profit Margin Operating profit margin is the amount of earnings generated by each dollar of sales. This measure is calculated by dividing operating income by total revenue. The operating profit margin is especially informative when used in conjunction with the sales Page 14

16 growth. It is important to analyze and note the company s changes in efficiency relative to the changes in the sales growth. In 2009, many of these operating profit margins clustered in the ten to twenty percent range; however, as Dine Equity began restructuring its franchising model, the company generated much higher operating profits. The other firms within this peer group have maintained steady operating profit margins centers around thirteen percent. Operating Profit Margin Average Brinker 7.8% 10.4% 12.3% 12.8% 13.7% 10.8% Brinker Restated 2.4% 5.0% 7.0% 8.0% 5.4% 5.6% Dine Equity 20.4% 16.6% 26.8% 41.0% 38.4% 26.2% Darden 12.5% 13.2% 14.1% 13.7% 12.2% 13.4% Buffalo Wild Wings 14.3% 15.6% 15.6% 14.4% 14.7% 15.0% Industry 11.5% 12.1% 15.2% 18.0% 16.9% 14.2% Operating Profit Margin 45.0% 40.0% 35.0% 30.0% 25.0% 20.0% 15.0% 10.0% 5.0% 0.0% Brinker Brinker Restated Dine Equity Darden Buffalo Wild Wings Industry Figure 11. Page 15

17 Net Profit Margin The net profit margin, in contrast to the operating profit margin, is the firm s net income divided by sales. It represents the percentage of a company s bottom line, or net income that comprises total revenue. Similar to operating and gross profit margin, net profit margin best serves the financial analysis when compared to prior years or the margins of its peers. Brinker s net profit margin has remained about 1.2% below the industry average for the last five years. The only company to report a loss in net income during this time was Dine Equity in 2010, but they have since improved their business and posted the highest numbers within the sample set for the last two years. Net Profit Margin Average Brinker 2.2% 3.6% 5.1% 5.4% 5.7% 4.1% Brinker Restated 2.4% 5.2% 5.5% 6.0% 3.1% 4.8% Dine Equity 2.2% -0.2% 7.0% 15.0% 11.2% 6.0% Darden 5.2% 5.8% 6.4% 6.0% 4.8% 5.8% Buffalo Wild Wings 5.7% 6.3% 6.4% 5.5% 5.6% 6.0% Industry 3.5% 4.1% 6.1% 7.6% 6.1% 5.3% Net Profit Margin 16.0% 14.0% 12.0% 10.0% 8.0% 6.0% 4.0% 2.0% 0.0% -2.0% Brinker Brinker Restated Dine Equity Darden Buffalo Wild Wings Industry Figure 12. Page 16

18 Asset Turnover Asset turnover represents the dollar amount of revenue accumulated for every dollar of sales. In all cases a higher asset turnover ratio indicates that a firm is utilizing its assets more efficiently. Asset turnover is calculated by dividing sales by total assets. Generally, it is best when the asset turnover becomes larger because that means the company is generating more sales per dollar of assets. In essence, its assets are becoming more efficient. Within this group, Brinker, before the restatements, had the highest asset turnover levels, with a value thirty percent higher than the industry average in Most of these firms regressed slightly in 2010, but have since followed a very gradual increase of the last three years. Only Dine Equity s assets have become less-efficient relative to its total revenue. Asset Turnover Average Brinker Brinker Restated Dine Equity Darden Buffalo Wild Wings Industry Asset Turnover Brinker Brinker Restated Dine Equity Darden Buffalo Wild Wings Industry Figure 13. Page 17

19 Return on Assets ( ROA ) Return on Assets ( ROA ) indicates the percentage profit gained generated by a firm s total assets. It is calculated as the proportion of net income to the total assets. When firms increase their revenues, it is important to observe the relative changes to ROA. If sales are increasing but the ROA is decreasing then it may behoove the managers to slow down growth as they are becoming less profitable. In general, a higher ROA is best. Brinker s ROA was below the industry average before 2011, but it has since risen above the average at an increasing rate. Within this group, Buffalo Wild Wings emerged again as a clear front-runner with an average ROA over the five-year time period of 10.0%. Return on Assets (ROA) Average Brinker 4.1% 5.6% 9.5% 10.5% 11.2% 7.4% Brinker Restated 3.6% 6.6% 8.1% 9.5% 4.9% 7.0% Dine Equity 1.0% -0.1% 2.9% 5.3% 3.0% 2.3% Darden 7.4% 7.8% 8.8% 8.0% 5.9% 8.0% Buffalo Wild Wings 9.9% 10.1% 10.2% 9.7% 10.1% 10.0% Industry 5.2% 6.0% 7.9% 8.6% 7.0% 6.9% 12.0% Return on Assets 10.0% 8.0% 6.0% 4.0% 2.0% 0.0% -2.0% Brinker Brinker Restated Dine Equity Darden Buffalo Wild Wings Industry Figure 14. Page 18

20 Return on Equity ( ROE ) Return on equity, most commonly abbreviated as ROE, is the amount of profit comprised from the shareholder s equity. This ratio can be found by dividing net income by owner s equity. Return on equity best utilized when comparing the profitability of firms within the same industry. Shareholders equity is on facet of the firms funding of operations. If the net income is increasing while the stockholder s equity is remaining relatively constant, this will represent a firm best utilizing their equity invested. An increasing ROE represents increased the effectiveness of the shareholders equity. As evidenced below, all of the firm s within this group have exhibited drastic volatility in ROE. Brinker, for example mustered a 71.1% Return on Equity in 2012 due to a variety of factors including a $4B stock repurchase plan which greatly reduced the shares outstanding. The firm was showing a significant, nearly exponential growth in ROE until 2013, when the firm only a 0.9%. Dine Equity exhibited the most volatility from 2009 to 2011 as their ROE climbed from -83.5% in 2010, to 92.9% in % 100.0% 80.0% 60.0% 40.0% 20.0% 0.0% -20.0% -40.0% -60.0% -80.0% % Return on Equity Brinker Brinker Restated Dine Equity Darden Buffalo Wild Wings Industry Figure 15. Page 19

21 80.0% 70.0% 60.0% 50.0% 40.0% 30.0% 20.0% 10.0% 0.0% Return on Equity (without Dine Equity) Brinker Darden Buffalo Wild Wings Industry Figure 16. Conclusion Brinker s profitability ratios indicate that they are below the industry average for ROA, ROE, sales growth, gross margin, operating margin, and net profit margin. The only time Brinker exceeds the industry average is in asset turnover, which has increased steadily over the last five years. Capital Structure Ratios Introduction The capital structure of a firm describes the way in which its operations are being financed. Properly analyzing the capital structure ratios allows the analyst to understand where a firm is currently obtaining their funds. Firms will utilize different methods of funding depending on their current needs, and the cost of said funding. The most commonly analyzed capital structure ratio is the debt to equity, because this will demonstrate the extent to which a company is leveraged. There are three main capital structure ratios that will be analyzed in this section. These three ratios consist of debt Page 20

22 to equity, times interest earned, and the Altman s Z-score, which will be discussed in further detail below. Debt to Equity The Debt to Equity Ratio is a capital structure ratio that measures the firm s debt, or total liabilities, in proportion to total shareholders equity. In order to confirm the most universal truth of accounting, assets must always equal liabilities plus shareholders equity. The Debt to Equity Ratio describes the amount of leverage or debt that comprises that latter part of the equation. Analyst opinions vary regarding an ideal number for this ratio. For instance, a higher number indicates that the firm has been aggressive in financing its assets with debt, which has trade-offs. If the growth rate of the company is less than the cost of debt, then creditors benefit. Relative to its peer group Brinker is doing very well about not financing a majority of its assets with debt. Brinker has been able to obtain a debt to equity ratio of 0.34 while its peer group average is It is also important to point out that Buffalo Wild Wings has been able to finance all of its assets without seeking debt. Debt to Equity Average Brinker Brinker Restated Dine Equity Darden Buffalo Wild Wings Industry Debt to Equity Brinker Brinker Restated Dine Equity Darden Buffalo Wild Wings Industry Page 21

23 Figure 17. Times Interest Earned Times interest earned is useful when analyzing the proportion of interest that comprises operating income. It is the number of times a company can pay its interest expenses out of the earnings before interest and taxes account. Anything below one is considered to be undesirable and risky to potential investors. This ratio is attained by dividing earnings before interest and taxed by total interest payable. Over the past three years, all of the firms in this group, except Darden, have exhibited a strong upward trend in times interest earned. Their total revenues are beginning to cover a larger amount of the interest owed on outstanding debt. Because Buffalo Wild Wings is debt-free, it does not need to pay interest on any debt. Thus, the times interest earned ratio is undefined. Page 22

24 Times Interest Earned Average Brinker Brinker Restated Dine Equity Darden Industry Times Interest Earned Brinker Brinker Restated Dine Equity Darden Figure 18. Altman s Z-Score Altman s Z-score is a measure how likely a firm is to going to declare bankruptcy; it can also be thought of as the credit risk of the company itself. The standard rule to follow is: if the score is below 1.8 the company is expectedly heading toward bankruptcy, but if the score is above 3.0 the firm does not expect to go bankrupt at any time in the near future. The formula to calculate Altman s Z-score is below: Page 23

25 Source: supplychainshaman.com According to our calculations in the data below, only Dine Equity can be marked as nearing bankruptcy. Over the past five years, the Z-score has grown from 1.0 to 1.6, demonstrating a significant upward trend. The other firms in the industry have exhibited a similar trend, but they do not appear to be nearing bankruptcy. Altman's Z-Score Average Brinker Brinker Restated Dine Equity Darden Industry Altman's Z-Score Brinker Brinker Restated Dine Equity Darden Figure 19. Page 24

26 Conclusion As evidenced by the debt to equity ratio, the percentage of invested capital allocated to debt is generally lower in this industry, with the exception of Dine Equity, whom has seven times the amount of debt as they do equity, which may be negative affects their bankruptcy risk in the Altman s Z-score. For the most part, Brinker s capital structure numbers are on par with many of the statistics of the casual dining sector as a whole, despite the volatility within this small peer group. Growth Rates Introduction In this section, there are two relevant growth rates to be analyzed: internal growth rate and sustainable growth rate. The sustainable growth rate measures the level of growth attainable while receiving no outside additional funding. The internal growth rate is used to assess the ability to which a firm can grow by keeping its capital structure constant. Internal Growth Rate Internal growth rate is the level of a firm s growth rate without obtaining financing from outside sources. This ratio is very important for smaller firms and startup firms. If a firm is able to obtain a healthy internal growth rate is represents the ability of a company to grow with only its available assets. After analyzing Brinker s IGR over the past five years, there has not been a noticeable trend associated with this information. Brinker s five year average is consistent with its peer group average, which shows it is similar to the rest of its competitors. Page 25

27 Internal Growth Rate Average Brinker 8.6% 16.1 % 25.2 % 47.5 % 0.6% 19.6% Dine Equity 12.0% 92.9% 58.4% 4.6% 42.0% Darden 16.3% 16.4% 16.0% 11.2% 6.8% 13.3% Buffalo Wild Wings 16.1% 16.5% 17.5% 16.3% 32.6% 19.8% Industry 13.2 % 16.3 % 37.9 % 33.4 % 11.2 % 23.7% 100.0% Internal Growth Rate 80.0% 60.0% 40.0% 20.0% 0.0% Brinker Dine Equity Darden Buffalo Wild Wings Industry Figure 20. Sustainable Growth Rate Sustainable growth rate is the rate at which a company can grow while keeping its capital structure constant. This is also the growth rate of a firm without increasing or decreasing its current financing leverage. This rate will represent the ability of a firm to grow without borrowing more money. You could also consider this to be a rate of how efficient a company is operating. Brinker showed healthy growth rates from 2009 to In 2013 Brinker had a large decrease in their SGR which put them below the peer group average for For the purpose of displaying a graph with legible information, Page 26

28 we have capped the y-axis at 100% because only Dine Equity has shown a SGR with a rate higher than 100%, which was 304% in Sustainable Growth Rate Average Brinker 11.7% 21.5% 34.2% 61.9% 0.8% 26.0% Dine Equity 71.8% 0.0% 303.7% 121.6% 8.1% 101.1% Darden 21.6% 20.9% 20.9% 15.6% 9.3% 17.7% Buffalo Wild Wings 16.1% 16.5% 17.5% 16.3% 32.6% 19.8% Industry 30.3% 14.7% 94.1% 53.9% 12.7% 41.1% Sustainable Growth Rate 100.0% 90.0% 80.0% 70.0% 60.0% 50.0% 40.0% 30.0% 20.0% 10.0% 0.0% Brinker Dine Equity Darden Buffalo Wild Wings Industry Figure 21. Industry-Specific Ratios Introduction In many cases, there are certain characteristics about specific industries that make traditional liquidity, profitability, and capital structure ratios helpful, but incomplete. In this analysis, it is also important to analyze a firm s Company Owned Location ratio. This ratio helps to measure and diagnose certain differences between the structure of industry peers financial statements. Page 27

29 Company-Owned Locations The Company Owned Locations ratio is important in this industry because a restaurant holding company s franchising structure can have a significant impact on the financial statements. For example, Dine Equity is structured in such a way that they hold no inventory on their balance sheet, which means their current assets are, proportionally, much more liquid that their peers. Brinker s franchising structure is essentially the average of this peer group; however, the range within this group is so large considering Darden owns and operates 100% of their restaurants and Dine Equity is entirely franchised. The average percentage of company owned locations for the entire casual dining sector is 88.9% as of 2013 Q4. Compared to the entire casual dining sector, Brinker s company owned location percentage is relatively low. Company-Owned Locations Averag e Brinker 60.6 % 56.2 % 55.0 % 54.7 % 55.1 % 56.3% Dine Equity 12.3% 11.9% 9.1% 5.4% 1.0% 7.9% Darden 98.3% % % % % 99.7% Buffalo Wild Wings 35.2% 35.6% 35.4% 39.0% 42.8% 37.6% Industry 51.6 % 50.9 % 49.9 % 49.8 % 49.7 % 50.4% Page 28

30 120.0% Company Owned Locations 100.0% 80.0% 60.0% 40.0% 20.0% 0.0% Brinker Dine Equity Darden Buffalo Wild Wings Industry Figure 22. Financial Analysis Conclusion Brinker s current financial statements have shown us that, compared to its peers, is generally less liquid, less profitable, able to sustain less growth moving forward without adapting. Financial Forecasting Financial forecasting is essential to the valuation process. It is important to make educated assumptions using historical trends, ratios, the current economic environment, and industry related patterns. Using these methods will help us define the intrinsic value of the firm. Of course, the longer the forecasted period, the more unreliable the estimated numbers will become. Using the income statement, balance sheet, and statement of cash flows of Brinker International, we will forecast out the next 10 years of financial information. Page 29

31 Income Statement The first financial statement to be forecasted is the income statement. The income statement is important to forecast with logical assumptions because the numbers used in the balance sheet and statement of cash flows are pulled directly from it. The most important factor in forecasting the income statement is the sales growth figure. Future revenues are used in multiple ratios, including liquidity and profitability. As always, the current economic conditions must also me taken into consideration. Since we are slowly coming out of the housing recession, the sales growth rate has been adjusted to take this into account. Brinker International has been showing an increasing trend in sales over the past 5 years. We have continued this trend, but on a cautious basis, since the average consumer still seems hesitant about the economic future. We started with a sales growth of 2.4% in 2014 and continued the upward trend to a max of 17% in 2018 and finally settling down to 15% in 2019 and on. After the sales growth is projected, a common sized income statement can be created. A common size income statement reports line items as a percentage of revenues. Using this method, trends and patterns are easier to see and easier to forecast. We have continued Brinker International s upward trend and have forecasted their gross profit margin to rise steadily from 73% in 2014 to a maintenance amount of 75% in 2018 and on. This gives us a cost of goods sold of 27% in 2014 and a final number of 25% in 2018 and thereafter. We have also noticed a trend of Brinker lowering their restaurant expenses. We have continued this trend by forecasting these expenses as 23.5% in 2014 and slowly decreasing to 21.5% in 2019 and thereafter. Following the trend of lower expenses and increasing sales growth, we have naturally forecasted the operating income, earnings before taxes, and the net income, to continue this favorable trend. We started with an operating income of 10% in 2014 and gradually increased it to 13% in 2018 and thereafter. The earnings before taxes number was forecasted at 9% in 2014 and reached a max of 13% in 2019 and remaining at that rate. And finally we show net income increasing from 6% in 2014 to 7.3% in 2018 and maintaining at that rate. Again, with a long forecast period of 10 Page 30

32 years, unexpected factors could affect our projections. Using these forecasted income statement numbers, we can now forecast the balance sheet, statement of cash flows, and look at dividends. Page 31

33 As-Stated Income Statement (in thousands) Period Ending 30-Jun Jun Jun Jun Jun Jun Revenues 3,860, ,276, ,858, ,761, ,820, ,846, ,914,404 3,022,237 3,294,239 3,722,490 4,355,313 5,008,610 5,759,901 6,623,887 7,617,470 8,760,090 Cost of Sales 1,101, , , , , , , , , ,847 1,088,828 1,252,152 1,439,975 1,655,972 1,904,367 2,190,023 Gross Profit 2,759, ,352, ,042, ,019, ,050, ,087, ,127,515 2,206,233 2,437,737 2,754,642 3,266,485 3,756,457 4,319,926 4,967,915 5,713,102 6,570,068 Operating Costs and Expenses: Restaurant Labor 1,239, ,054, , , , , , ,116 1,054,156 1,191,197 1,393,700 1,602,755 1,843,168 2,119,644 2,437,590 2,803,229 Restaurant Expenses 922, , , , , , , , , , ,169 1,101,894 1,267,178 1,457,255 1,675,843 1,927,220 Depreciation and Amortization 147, , , , , , , , , , , , , , , ,404 General and Administrative 163, , , , , , , , , , , , , , , ,204 Other gains and charges 196, , , , , , Total operating costs and expenses 2,669, ,249, ,887, ,813, ,819, ,830, ,865,219 1,934,232 2,075,370 2,345,169 2,700,294 3,105,338 3,571,139 4,106,810 4,722,831 5,431,256 Operating Income or Loss 90, , , , , , , , , , , , , , ,271 1,138,812 Interest Expenses 45, , , , , , ,144 30,222 32,942 37,225 43,553 50,086 57,599 66,239 76,175 87,601 Other, net (4,046.00) (9,430.00) (6,001.00) (6,220.00) (3,772.00) (2,658.00) Earnings Before Taxes 48, , , , , , , , , , , , , , ,271 1,138,812 Income Taxes Expense 2, , , , , , Income from continueing operations 45, , , , , , , , , , , , , , , ,087 Income from discountinued operations, net of taxes 6, , , Net Income 51, , , , , , , , , , , , , , , ,487 Income Summary Common Shares Outstanding 101, , ,570 82,940 74,340 67,444 59,500 51,750 44,000 35,000 35,000 35,000 35,000 35,000 35,000 35,000 Dividends per Share Annual Dividends 42,554 44,933 47,738 46,446 47,578 53,955 52,360 51,233 47,960 40,950 43,750 43,750 43,750 43,750 43,750 45,500 Common Sized Sales Growth % % -3.40% 2.15% 0.90% 2.4% 3.7% 9.0% 13.0% 17.0% 15.0% 15.0% 15.0% 15.0% 15.0% Period Ending 30-Jun Jun Jun Jun Jun Jun-13 Revenues 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% Cost of Sales 28.5% 28.2% 28.5% 26.9% 27.3% 26.6% 27% 27% 26% 26% 25% 25% 25% 25% 25% 25% Gross Profit 71.5% 71.8% 71.5% 73.1% 72.7% 73.4% 73% 73% 74% 74% 75% 75% 75% 75% 75% 75% Operating Costs and Expenses: Restaurant Labor 32.1% 32.2% 32.4% 32.1% 31.6% 31.4% 32% 32% 32% 32% 32% 32% 32% 32% 32% 32% Restaurant Expenses 23.9% 23.9% 23.1% 23.7% 23.0% 23.0% 23.5% 23.5% 23.0% 23.0% 22.0% 22.0% 22.0% 22.0% 22.0% 22.00% Depreciation and Amortization 3.8% 4.4% 4.8% 4.7% 4.4% 4.6% 4% 4% 4% 4% 4% 4% 4% 4% 4% 4% General and Administrative 4.2% 4.5% 4.8% 4.8% 5.1% 4.7% 4.50% 4.50% 4.50% 4.50% 4.50% 4.50% 4.50% 4.50% 4.50% 4.50% Other gains and charges 5.1% 3.6% 1.0% 0.4% 0.3% 0.6% Total operating costs and expenses 69.1% 68.7% 66.0% 65.7% 64.5% 64.3% 64% 64% 63% 63% 62% 62% 62% 62% 62% 62% Operating Income 2.3% 3.1% 5.4% 7.4% 8.2% 9.0% 10.0% 10.5% 11.3% 12.0% 13.0% 13.0% 13.0% 13.0% 13.0% 13.0% Interest Expenses 1.2% 1.0% 1.0% 1.0% 1.0% 1.0% 1% 1% 1% 1% 1% 1% 1% 1% 1% 1% Other, net -0.1% -0.3% -0.2% -0.2% -0.1% -0.1% Earnings Before Taxes 1.2% 2.4% 4.6% 6.6% 7.4% 8.1% 9.0% 10.0% 10.8% 11.5% 12.3% 13.0% 13.0% 13.0% 13.0% 13.0% Income Taxes Expense 0.1% 0.2% 1.0% 1.5% 2.0% 2.4% Income from continuing operations 1.2% 2.2% 3.6% 5.1% 5.4% 5.7% 6.2% 6.9% 7.4% 7.8% 8.3% 8.3% 8.3% 8.3% 8.3% 8.3% Income from discountinued operations, net of taxes 0.2% 0.2% 1.2% 0.0% 0.0% 0.0% Net Income 1.3% 2.4% 4.8% 5.1% 5.4% 5.7% 6.0% 6.3% 6.6% 6.9% 7.3% 7.3% 7.3% 7.3% 7.3% 7.3% Page 32

34 Restated Income Statement (in thousands) Period Ending 30-Jun Jun Jun Jun Jun Jun Revenues 3,860, ,276, ,858, ,761, ,820, ,846, ,914,404 3,022,237 3,196,016 3,451,697 3,831,384 4,252,836 4,720,648 5,239,919 5,816,311 6,456,105 Cost of Sales 1,101, , , , , , , , , , ,846 1,063,209 1,180,162 1,309,980 1,454,078 1,614,026 Gross Profit 2,759, ,352, ,042, ,019, ,050, ,087, ,127,515 2,206,233 2,365,052 2,554,256 2,873,538 3,189,627 3,540,486 3,929,940 4,362,233 4,842,079 Operating Costs and Expenses: Restaurant Labor 1,239, ,054, , , , , , ,116 1,022,725 1,104,543 1,226,043 1,360,908 1,510,607 1,676,774 1,861,219 2,065,954 Restaurant Expenses 922, , , , , , , , , , , ,624 1,038,543 1,152,782 1,279,588 1,420,343 Goodwill Impairment Charge Amortization of Capital Lease Rights - 65, , , , , ,716 39,289 31,960 34,517 38,314 42,528 47,206 52,399 58,163 64,561 Depreciation and Amortization 147, , , , , , , , , , , , , , , ,244 General and Administrative 163, , , , , , , , , , , , , , , ,525 Other gains and charges 196, , (75,029.00) (89,369.00) (91,467.00) 17, Total operating costs and expenses 2,669, ,209, ,846, ,771, ,771, ,879, ,865,219 1,934,232 2,013,490 2,174,569 2,375,458 2,636,758 2,926,802 3,248,750 3,606,113 4,002,785 Operating Income 90, , , , , , , , , , , , , , , ,294 Interest Expenses 45, , , , , , ,144 30,222 31,960 34,517 38,314 42,528 47,206 52,399 58,163 64,561 Other, net (4,046.00) (9,430.00) (6,001.00) (6,220.00) (3,772.00) (2,658.00) Earnings Before Taxes 48, , , , , , , , , , , , , , , ,294 Income Taxes Expense 2, , , , , , Income from continueing operations 45, , , , , , , , , , , , , , , ,857 Income from discountinued operations, net of taxes 6, , , Net Income 51, , , , , , , , , , , , , , , ,296 Common Sized Sales Growth % % -3.40% 2.15% 0.90% 2.4% 3.7% 5.8% 8.0% 11.0% 11.0% 11.0% 11.0% 11.0% 11.0% Period Ending 30-Jun Jun Jun Jun Jun Jun-13 Revenues 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% Cost of Sales 28.5% 28.2% 28.5% 26.9% 27.3% 26.6% 27% 27% 26% 26% 25% 25% 25% 25% 25% 25% Gross Profit 71.5% 71.8% 71.5% 73.1% 72.7% 73.4% 73% 73% 74% 74% 75% 75% 75% 75% 75% 75% Operating Costs and Expenses: Restaurant Labor 32.1% 32.2% 32.4% 32.1% 31.6% 31.4% 32% 32% 32% 32% 32% 32% 32% 32% 32% 32% Restaurant Expenses 23.9% 23.9% 23.1% 23.7% 23.0% 23.0% 23.5% 23.5% 23.0% 23.0% 22.0% 22.0% 22.0% 22.0% 22.0% 22.00% Goodwill Impairment Charge 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% Amortization of Capital Lease Rights 0.0% 2.0% 2.2% 2.1% 1.9% 1.7% 1.5% 1.3% 1.0% 1.0% 1.0% 1.0% 1.0% 1.0% 1.0% 1.0% Depreciation and Amortization 3.8% 4.4% 4.8% 4.7% 4.4% 4.6% 4% 4% 4% 4% 4% 4% 4% 4% 4% 4% General and Administrative 4.2% 4.5% 4.8% 4.8% 5.1% 4.7% 4.50% 4.50% 4.50% 4.50% 4.50% 4.50% 4.50% 4.50% 4.50% 4.50% Other gains and charges 5.1% 0.4% -2.6% -3.2% -3.2% 0.6% Total operating costs and expenses 69.1% 67.4% 64.6% 64.2% 62.8% 66.0% 64% 64% 63% 63% 62% 62% 62% 62% 62% 62% Operating Income 2.3% 4.4% 6.9% 9.0% 9.9% 7.3% 10.0% 10.5% 11.3% 12.0% 13.0% 13.0% 13.0% 13.0% 13.0% 13.0% Interest Expenses 1.2% 2.0% 2.1% 2.2% 2.0% 2.0% 1% 1% 1% 1% 1% 1% 1% 1% 1% 1% Other, net -0.1% -0.3% -0.2% -0.2% -0.1% -0.1% Earnings Before Taxes 1.2% 2.7% 5.0% 7.0% 8.0% 5.4% 9.0% 10.0% 10.8% 11.5% 12.3% 13.0% 13.0% 13.0% 13.0% 13.0% Income Taxes Expense 0.1% 0.2% 1.0% 1.5% 2.0% 2.4% Income from continueing operations 1.2% 2.5% 4.0% 5.5% 6.0% 3.1% 6.2% 6.9% 7.4% 7.8% 8.3% 8.3% 8.3% 8.3% 8.3% 8.3% Income from discountinued operations, net of taxes 0.2% 0.2% 1.2% 0.0% 0.0% 0.0% Net Income 1.3% 2.7% 5.2% 5.5% 6.0% 3.1% 6.0% 6.3% 6.6% 6.9% 7.3% 7.3% 7.3% 7.3% 7.3% 7.3% Page 33

35 Dividends Forecasting The valuation of a firm is heavily dependent on future expectations of dividend growth and value. Brinker International announced plans to spend $4 billion on a share repurchase plan in As a result, the dividends paid out have been steadily increasing while share outstanding have been decreasing. We have forecasted this trend to continue starting with a dividend of $0.88 per share in 2014 and reaching a max of $1.25 per share in Balance Sheet After forecasting the income statement, the next step is to forecast the balance sheet. There are many ratios and methods used to do this, but we find the asset turnover ratio is the best at tying the income statement to the balance sheet. Just like the favorable trend in sales, we have found an increasing trend in the asset turnover ratio from 1.6 in 2008 to 2.0 in Using this trend, we have forecasted the asset turnover ratio in 2014 to be 2.1. With this ratio, we then backed into the total assets figure. The total assets figure is the basis for forecasting the balance sheet. With the use of Liquidity ratios we also forecasted the current assets and current liabilities. Now that we have the total assets figure, the next step was to create a common size balance sheet to help indentify patterns and trends. Using the common size balance sheet we found a trend of decreasing current assets and an increase in long term assets. We forecasted the current assets in 2014 at 13.1% of total assets and slowly decreased it to 11% in 2018 where it remained constant. The long term assets were forecasted at 86.9% in 2014 and slowly increased to 89% in 2018 and stayed constant as well. This same trend was found in the current and long term liabilities of Brinker. Again, we continued this trend in our forecasts. We started with 27% in current liabilities in 2014 and decreased it to 20% in 2016 where it stayed constant. The long term liabilities increased from 73% in 2014 to 80% in Page 34

36 The trends we are finding in Brinker match the trends of the casual dining industry, as well as, the slowly improving economy. Page 35

37 As- Stated Balance Sheet (in thousands) Period Ending 30-Jun Jun Jun Jun Jun Jun Assets Current Assets: Cash and cash equivalents 54, , , , , , Accounts Receivale 52, , , , , , Inventories 35, , , , , , Prepaid Expense and Other 106, , , , , , Income Taxes Receivable - 41, , , Deferred Income Tax 71, , , , , Assets held for sale 134, , Total Current Assets 454, , , , , , , , , , , , , , , ,309 Non-Current Assets: Property and Equipment Land 198, , , , , , Building and leasehold improvements 1,573, ,399, ,367, ,383, ,399, ,435, Furniture and equipment 669, , , , , , Construction-in-Progress 35, , , , , , Less accumulated depreciation and amort. (945,150.00) (914,142.00) (970,272.00) (1,033,870.00) (1,076,238.00) (1,147,895.00) Net Property and Equipment 1,531, ,247, ,129, ,056, ,043, ,035, Other Assets: Goodwill 140, , , , , , Deferred income taxes 23, , , , , Other Assets: 43, , , , , , Total other assets 207, , , , , , Total Non-Current Assets 1,738, ,419, ,351, ,263, ,241, ,254, ,250,630 1,257,827 1,265,023 1,270,781 1,280,856 1,280,857 1,280,858 1,280,859 1,280,860 1,280,860 Total Assets 2,193, ,948, ,852, ,484, ,436, ,452, ,439,160 1,439,161 1,439,162 1,439,163 1,439,164 1,439,165 1,439,166 1,439,167 1,439,168 1,439,169 Liabilities and Shareholders' Equity Current Liabilities: Current installments of long-term debt 1, , , , , , Accounts Payable 168, , , , , , Accrued Liabilities 331, , , , , , Income Taxes Payable 5, , , Liabilities associated with assets held for sale 17, , Total current liabilities 526, , , , , , ,167,299 1,299, ,841 1,084, , , , ,425 (165,389) (271,560) Long-term debt, less current installments 901, , , , , ,121 Deferred Income Taxes - 4, Other liabilities 170, , , , , , Total Long-Term Liabilities 1,071, , , , , , , , , , , , , ,940 (132,311) (217,248) Total Liabilities 1,598, ,302, ,123, ,045, ,126, ,303, ,167,299 1,299, ,841 1,084, , , , ,425 (165,389) (271,560) Commitments and Contingencies Shareholders' Equity Common Stock 17, , , , , , Additional Paid-in capital 464, , , , , , Accumulated other comprehensive loss (168.00) Retained Earnings 1,800, ,834, ,923, ,013, ,112, ,217, ,282, ,315, ,406, ,494, ,597, ,712, Less Treasury Stock (1,687,334.00) (1,668,988.00) (1,678,159.00) (2,055,592.00) (2,287,391.00) (2,563,311.00) Total shareholders' equity 595, , , , , , , , , , , ,949 1,092,232 1,116,742 1,604,557 1,710,729 Total Liabilities and shareholders' equity 2,193, ,948, ,852, ,484, ,436, ,452, ,439,160 1,439,161 1,439,162 1,439,163 1,439,164 1,439,165 1,439,166 1,439,167 1,439,168 1,439,169 Page 36

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