Chit Chat Stocks - Portillo's (PTLO) | Not So Deep Dive

Episode Date: May 3, 2022

Portillo’s is the owner and operator of a restaurant chain that serves iconic Chicago street food. The company currently operates 69 locations across the US. Listen closely as Ian, Brett, and Ryan go through the history, financials, and future prospects of Portillo's. Enjoy the show! This episode is sponsored by Potential Multibaggers. Multis are looking for stocks that have the potential to go up 10x in 10 years. Check out the service here: https://seekingalpha.com/checkout?service_id=mp_1308 Want updates on future shows and projects? Follow us on Twitter: https://twitter.com/chitchatmoney Subscribe to 7investing with the code "Money" and get $100 off: https://7investing.com/subscribe/aff/4/ Interested in more of Ian's work? Follow him on Twitter: https://twitter.com/IanGrayLive  Contact us: [e-mail] Timestamps Company Background | (3:34) Industry | (8:58) Management & Ownership | (9:50) Valuation | (13:08) Earnings | (15:08) Balance Sheet | (17:57) Our Analysis | (20:25) Disclosure: Chit Chat Money hosts and guests are not financial advisors, and nothing they say on this show is formal advice or a recommendation. Brett Schafer and Ryan Henderson are general partners and portfolio managers at Arch Capital. Arch Capital and its partners may hold securities discussed on this show. Learn more about your ad choices. Visit megaphone.fm/adchoices Learn more about your ad choices. Visit megaphone.fm/adchoices

Welcome to Chit Chat Money. On this show, hosts Ryan Henderson and Brett Schaefer interview industry experts and riff on the world of investing. As a quick reminder, Chit Chat Money is a CCM Media Group podcast. Ryan and Brett are also general partners at Arch Capital, and Arch Capital may have positions in the securities discussed in this podcast. Anything discussed on Chit Chat Money by Ryan or Brett or any other podcast guests is not formal advice or a recommendation. Now, please enjoy this episode. Welcome in. This is the Tuesday Not So Deep Dive episode on Chitchat Money. This is the show where we go over an individual stock, mainly for the first time. I want to be clear on that because

we always get some people have expectations that are a little bit different going to these shows. This is our first look at a business. So if you know this company that we're doing, covered here already pretty well. Maybe we should say we've done some research. It's not like we're just like browsing through it. We've done some research and we're going to give sort of a first take. Exactly. So if you know a company well, this night might be the episode for you. But if you don't know it at all, it's a perfect episode for you. Today we're covering Portillo's. I think that's how we say it, right Ian? You've been there, is that how you pronounce it? Yep, that's how you pronounce it. All right. They're not using the Spanish accent correctly, but that's okay.

um i don't know whose choice is this ryan that's yours oh no it's mine wow i'm forgetting but ian you're the one that i've been there uh ian's joining us today i don't know what uh give a little teaser of your anecdotal evidence what are your thoughts good or bad food good food um definitely heavy food you know it's got hot dogs and hamburgers and um italian beef sandwiches and all sorts of you you leave there feeling pretty full i'll say that much um and it's a pretty like it's a little bit of a unique, at least the ones that I've been to are a little bit of a unique restaurant too, where they've got kind of old Chicago decorations around and it feels like you're walking into, it's not just like a cookie cutter box. They've spent some time and money to

make it a Portillo's feel. Yeah. And we'll get into more of the details, but first we have to talk about our sponsor today, and that is Potential Multibaggers. The aim of the Potential Multibaggers service is to find stocks that can go up 10X over the next 10 years or compound at 26% per year. Potential multibaggers is looking for high growth stocks to hold them for a long period of time. Now, with the stocks that have been classified into the high growth category, they've had a tough time over the last few months. So potential multibaggers can be a great asset as you're trying to research and navigate what companies are doing well, what companies are doing strongly. ryan is something this is the this is the environment where chris quite literally really

makes his money this is where you've got a lot of potential uh companies that can compound at high rates which is kind of what he looks for that's his hunting ground and they're trading at i would say generally of the stocks we've looked at lately they're trading at reasonable valuations yeah it's a it's a great it's a great time to be hunting for some of those high growth stocks so if you want to become a multi and get some of those research reports every week, you can go to Seeking Alpha and look for From Growth to Value. Google it or go to at From Value on Twitter. If you can't find it for whatever reason, DMS on Twitter or find our email in the show notes. All right, Ryan, introduce Portillo's for us. Portillo's is the owner and operator. Keep in

mind, I'm saying owner and operator there. That's not a franchisor of a restaurant chain that serves iconic chicago street food so ian kind of touched on it there the menu items include things like chicago style hot dogs uh hot dogs and sausages italian beef sandwiches chopped salads burgers fries cake and milkshakes so similar to sweet green which we discussed last week very healthy this is leaning into the real this is it's not healthy i guess i should say the uh which is probably bullish, if anything. Honestly, that's probably a good sign. Looking at the stock prices of unhealthy restaurants, yeah. Yeah. And no one item accounts for more than a quarter of their sales. So it's a pretty diverse

menu in terms of what consumers' habits are. And then they currently operate only 69 locations across the US. So this is not a huge franchise, and most of those locations are located in the Midwest. So Illinois and Indiana, that's where they started, the Chicago area. But they've also added some in Arizona and California lately. The thing that I think probably caught Brett's eye and all of our eyes is that Portillo's generates the highest per store revenue of any fast casual restaurant concept in the United States. Second is Chick-fil-A. So from everything I can tell, Portillo's has a complete cult-like following. People love the food. They love the brand. And to be clear, it's only really in Chicago area right now as a dense, dense locations.

Yeah, they're starting to expand. But yeah, as far as actually concentrating on any markets, it's pretty much Chicago. And so other things to know, almost all their store layouts consist of two-lane drive-thrus. So there's drive-thru lines on both sides. And then they also accommodate for dine-in, carry-out, curbside, delivery, and catering. So for reference in 2019, about 41% of their sales came from the drive-thru, 53% were from dine-in, and then 6% came from delivery. It's flipped a lot due to COVID. There was obviously a little less dine-in. And an interesting note here, for more than 20 years, Portillo's has actually operated

a direct shipping business to all 50 states. I had to read that twice, but you can literally, if you're like a diehard Portillo's fan and you have to have their beef sandwiches, you can order 20 Italian beef sandwiches, have them delivered to you so you can buy them online. That's how much some people love their food. and there's like basically an online site you can also buy like portillo shirts it's like online beef sandwiches it sounds i compare it to like the the fanaticism around in and out in california yeah it's probably maybe even a little further but the food's actually good there

yeah you've never been to portillo's no i'm just from the anecdotes you know in and out feels that from everyone i didn't mind in and out i think it's it's subjective to everyone but yeah basically very uh very fanatic fan base and then in as far as the history goes it's actually a pretty cool story so in 1963 dick portillo returned from serving in the marines uh and he used money from his savings plus an investment from his brother to open a hot dog stand known as the dog house. Uh, he invested $1,100 in total into this initially. And all it was, was literally a six by 12 trailer with no running water. So he had like a 250 foot long hose to supply water. Um, and they, they just sold hot dogs and it, it ended up working out. And there's

actually this cool anecdote where he was, it wasn't going so well. They were not very profitable like the first year or two. And so he would like go and sneak into his competitors' kitchens to see where they like bought their like supplies and inputs. And he was able to make it a more profitable business. And four years later, there was after some more success, Portillo changed the look of the building and renamed the company Portillo's. And by 1970, Dick Portillo, he added a partner and the company, he used that partner essentially to expand into a second location. It wasn't until 1983 that they added their first drive-thru and figured out how great of an addition that would be. But here's kind of an interesting part.

Portillo, between 1972 and 1989, started opening up a new restaurant concept called Barney's that specialized in more barbecue meals and also pastas as well. And then in 1993, Portillo decided to blend the two concepts, and this Barnelli's was introduced. And now the menu consists of, even though it's really Portillo's now, it consists of all these items. So like I said, it now has things like pasta, sandwiches, salads, and then the typical stuff you found at the original Portillo's. And the company continued to add locations throughout the country. And after 50 years of success, Portillo sold the Portillo's brand to a private equity firm called Berkshire Partners in 2014. My first thought was this is a perfect Berkshire Hathaway company. Berkshire Partners is not associated with Berkshire Hathaway at all.

Yeah. Similar to Dairy Queen, I guess. Yeah. But about six months ago, the company came public. So they were private under Berkshire Partners for eight years and now they're officially public and they've had two quarters as a public company. Yep. And now they're trying to really grow and become a national brand. All that industry competition, pretty easy. Again, looking at restaurants, it's not really difficult to see, but fast casual restaurant chains, they hit $125 billion in sales in 2019. And then they are expected to grow at a 10% rate. So Chipotle's and Panera, they're growing really, really quickly. And then if we look at competitors, it's really all restaurants. It's hard to pin it down,

but I mean, you're competing more with an In-N-Out and your local burger or hot dog joint than someone like those healthy lunchtime items, maybe like a Panera, Sweetgreen or Chipotle. it's not, I don't think it's the lunchtime run. I think I would pass out if I had the Portillo's you know, in the afternoon, but, um, and like Ryan mentioned, only place of saturation is the Chicago area and they're expanding around the Midwest and then into Arizona, Florida, California a bit, um, pretty simple industry. There's not much to talk about there. So Ian, do you want to hit management and ownership? Yep. So this one has a little bit more of a complicated ownership structure, as Ryan was talking about, it was bought by this private equity firm and their

funds, it's in a variety of funds, but they still own about 63.7% of the shares outstanding and have a lot of the seats on the board. So they're in control of what happens to this company even post IPO. And so I would say that's something to pay attention to as you dig deeper into this company is try to figure out how you feel about that, how you feel about the private equity firm i will say the ceo is this guy named uh michael osanlu um he's the former ceo of pf chang's and worked at craft hines before that previously he was a partner at bain consulting and he's also on the board and i've watched a couple little interviews with him he seems he seems to be competent he's got a lot of experience in this area um it feels like the type

of thing that there's some fairly standard, um, strategies and things like the restaurant business isn't super complicated. There's some things that are outside of your control. I think with the restaurant business that make it, um, difficult, but the actual nuts and bolts of it, there's, there's some tried and true strategies. And so having him in there, I think is probably a good thing to just have someone who's knows what he's doing relative to the restaurant business. Um, they're pretty much that's, that's the big thing with management and ownership is just to know that the berkshire funds still own about 60 almost 64 of the shares outstanding yeah and they might it could be some selling pressure if they you know their private equity firm is probably

getting ready to return capital to shareholders or however you so you would think they could be selling down here recently you would you would think that there could be some sales especially given how long they've been in the position you know i think the original transaction was in 2014 when they bought it so to think about the original capital going in eight years ago um you would expect you know i'm sure they got some of that back in the ipo but um uh you would expect that yeah that there could be some selling pressure so it's something something to watch for sure yeah and i did see that the cfo worked at the domino's pizza finance department i thought that was pretty positive sign what uh because domino's has been pretty good at that

financial engineering stuff what do you guys any thoughts on that is that positive negative yeah they also compare themselves in the delivery space to dominoes as well i think it's beef sandwiches to travel though well people buy them from 50 states away i know but it just seems like a hard like you're dunking it into this whatever that sauce and like like the juice i know seems tough hot dogs though i don't know good job yeah yeah i mean it's probably not as easy to deliver as a domino's pizza but i don't know i think they brought in good management it seems like it seems like they have the experience that it's probably necessary and i actually think it's a pretty good sign that they're still holding on to shares uh the private equity firm it seems like

they're treating this i mean they didn't just like juice it for profits they they also grew the business while they were owners so it seems like they're kind of in it for the long haul yeah who knows though we don't i guess it's speculation but yeah this episode is brought to you by lakinta by windham here you are miles from home and ready to start your vacation good thing you're staying at lakinta by windham they have free high-speed wi-fi to stream all your favorite movies and in the morning get fresh waffles with their free bright side breakfast or squeeze in a workout at their fitness center. Either way, you're ready to conquer the day.

Tonight, La Quinta. Tomorrow, you triumph. Book your stay at LQ.com. All right, I'll hit valuation. Market cap, $732 million. Ticker is PTLO. If you look at the aggregators, they're going to have some of them wrong.

I don't know why they're getting wrong data for their market cap. And apologies to the Motley Fool article I wrote. I gave the wrong market cap. So that's Koi Finn's fault. We'll blame them. But in all seriousness, that is a good point. Whenever you're actually researching a company,

make sure to just go into the shares outstanding and multiply it by the share price because sometimes Yahoo Finance, Google Finance, Koi Fin, Bloomberg, whoever can be wrong. And in this case, it's way lower than they're stated. So market cap, like I said, $732 million. Enterprise value is closer to exactly $1 billion with quite a bit of debt on the balance sheet

relative to their size. Ian will get into that on the balance sheet. EV to sales, which is enterprise value divided by trailing 12 month sales is 1.9 EV to operating income, which is enterprise value divided by trailing 12 month operating income is 33.3. And I'll give another metric here that I think is kind of important to look at. And that is enterprise value to operating income, assuming a reversion to the 2020 operating margin level of about 12.6%. In 2019, it was about 10%. But last year due to IPO stuff and inflation costs, their margins kind of went down, which is why their EV

to operating income is so high. If you use that and assume they're going to revert back to that 10% to 15% range, their EV to operating income comes down closer to 15%. And lastly, there's a lot of potential dilution incoming, 6 million stock options outstanding, plus some other RSUs stuff like that versus 36 million share count. Granting pace isn't too bad, but just expect that dilution to come down the pipe. They've given pretty generous grants to the CEO, some other executive teams. And to be honest, this will be my low lights. The board of directors gets paid way, way, way too much for business of this size. All right. Earnings, Ryan, what do you got? For the full year 2021, Portillo's had $535 million in revenue. Keep in mind, the last quarter was the fourth quarter. So this is the most recent information. So $535 million in revenue. That was up 17.5% versus 2020. And it was even up from 2019, even though they have not recouped their full dine-in levels.

So it's been kind of, that was obviously a tough for them because they were such a big dine-in business. And there's so much about eating at Portillo's is the experience of being there and seeing the themed stores and kind of getting that, it really like you're getting the full sensory experience when you're there. And so that was a big drop off for them, but they've been able to recoup that and grow. Compared to last year, their same restaurant sales increased 10 and a half percent year over year.

They had an operating income, they had operating income of $30 million, but a lot of that was bogged down by IPO-related costs, inflation in some of their raw materials or commodities, and then they opened seven new locations during the year. Well, that would be CapEx. Locations. That wouldn't be included in their expenses? I mean, I guess… In the income statement, it would be part of that. CapEx is not there, but… I guess starting up a new store, you won't have the AUV.

The extra payroll and salary. Yeah, you won't have the AUV level. So I guess, you know, startup stores will probably have lower margins. Yeah. The restaurant level adjusted EBITDA, which I typically don't use, but I think it's indicative basically of what each store is making on their own was 27%. And that's really, really high for, I think, a fast casual restaurant. And it's one of the highest in the industry.

They had $42 million in operating cash flow, but they, like Brett said, paid a lot in stock based comp related to the IPO. And then they had a lot of CapEx. So free cash flow looked pretty low, but generally they're operating cashflow margin. So the amount of each dollar in revenue that goes to their operating cashflow is around high teens percentages to even, or sorry, not high teens, high single digit percentages to low teens. And then they're targeting 10% unit growth long-term a year. Last year, they increased their store count by 8%. So, they're not trying to grow super fast. They're trying to be steady with their growth. Their stores are expensive to build out relative to say like Starbucks. So, it's not like, I don't know. It's more expensive.

It's not quite as replicable as some of the Starbucks, as like a Starbucks store, because each one's unique. They have different themes. And so, I think there's more of a thought process that goes into each new store. Yeah. And they're going for higher volume per store, right? Balance sheet liquidity in, I think this was a, I don't know, interesting balance sheet. It's a little, it's a little sticky. Yeah. These, these ones that are private equity deals are always a little more interesting. So they've got $39 million in cash. That's just a little bit less than they had at the end of last year. It's about 3 million less. They've got $394 million in goodwill, which is related to one of the, it was a little opaque, but a little, one of the operating

units um at some time or another there's some transaction that results in this goodwill on the balance sheet that's been stable for the as far back as we can see so um not a huge concern there and then they've also got about 260 million in trade names and other intangible assets which get amortized down and so that um is a is a tax benefit because it's it's an extra expense that's not a cash expense that's hitting every single year, and I assume was useful in helping to raise some of the debt. I'll also say that looking at EBITDA sometimes is probably a little bit better than looking at EBIT in this case, just because of some of the amortization that's going on. They've also got $326 million in debt. That's $326 million in debt versus $39 million in

cash. Most of the principle on that is due in 2024. And so ideally the company's in a strong position at that point or, you know, in the year leading up to it so that it's easy to refinance the debt at a, uh, at a good interest rate. And that's also going to depend on the interest rate environment. The current, uh, the current interest rate on the debt is about six and a half percent. I think it's was five and a half percent plus a LIBOR basically, or whatever the Euro currency right now or euro interest rate um and then they have a uh or they noted in their 10k that they're a one percent a one percentage point increase in interest rates correlates to about 3.3 million of additional interest expense on an annual basis and so and in rising interest rate environment

your every percentage point is about 3.3 million and so um if we got two or three percent over the next couple of years, that's a six to $9 million hit to cashflow every year, basically, because they're going to have to be paying extra interest. So that's something to note. I don't think that like destroys the business case or anything like that, but it will be a little bit of a drag on cashflow. Yeah, that's definitely, it's definitely a little wide, but we'll talk about it later in the show. This episode is brought to you by KPMG. As a business leader, how can you innovate, build trust, and move forward in a digital era. KPMG can help by bringing together the right talent and technologies, generating insights that spark opportunities. To explore

their thinking, visit reed.kpmg.us slash opportunities. All right, let's move to anecdotal evidence. First up, Ian, you've been there. Thoughts? I know that it's an important part. Like people might laugh like, oh, what had you? How was the food? But it's a very important part of, I don't know, a restaurant stock because the food's got to be good for people. Yeah, I really liked the food. I always thought it was filling. I'm a sucker for chili dogs. And so I've had the chili dog a couple of times. I think I had an Italian beef sandwich the last time I was there. And I've only been two or three times because there's not any that are really in the Central Valley in Phoenix. There's like two way out west and two way out east. And so it's

about a 30 minute drive to get out there if i'm just going from my house and so unless i'm in the area over there i don't really go um and part of that i think is because they're looking for bigger footprint stores and so they're not getting them in the middle more kind of in the middle of the city but um prices are totally reasonable the food's good and uh it's pretty fast too like i think you get you get your food you eat it and get out and go to spring training game or something like that yeah i'm i see their prices on their app i download they have to check the prices out eight bucks or six bucks for it i see those and i'm like how is sweet green i don't know i look at that i think sweet green selling at 14 and they're still in profitable

it going back to that show it i don't know it still seems crazy to me all right ryan anything i guess you've never been never been but i'm gonna pull up some uh some tweets that they had on their S1 that I thought were interesting. So like I said, it seems like it has a cult-like following. So one person said, I'm going to baptize my firstborn child in Portillo's melted cheese. Another person said, my healthiest and most stable relationship is with an Italian beef sandwich from Portillo's. So that is your anecdotal evidence. It seems good social strategy. Yeah. It seems like people definitely love it. And they also said that they get much better engagement on their social media. I don't know how relevant that can be. Cause I think some

restaurants probably just have horrendous social medias, but, um, that I do think that's fairly, fairly important in kind of building a bigger fan base. And it's, that also helps when you're expanding to new locations. Yeah, I agree. Um, the only thing I'll hit is I downloaded the app. It was okay. Uh, I felt, I don't know, like it's important for a restaurant app to be very easy to order your food because if people get frustrated, they might turn off it. And I've done that before on apps that are just totally, totally terrible. I don't think Portillo's was like that, but I actually didn't order any food, but we'll see. Prices seem good. Like I mentioned, I asked the Twitterverse on Fintwit and people gave very great, I don't know, they said so, so good,

delicious, whatever, sending gifts and stuff like that. And what's interesting is they did say they're hesitant to raise prices as fast as inflation right now because they want to take, uh i i don't know they just don't want to be a price taker given the environment and that in case to me that their auv could even be higher and it's kind of impressive that they're going at 10 even while they're not taking the like what inflation is giving them they're going a little slower and that their operating margins could be better if they want it because i'm sure they can change their prices from what like eight bucks to ten bucks people would still buy it given how expensive most other restaurants are nowadays yeah maybe i don't know ian is that am i off on

any of that because i know you've been to the store so yeah i think that's probably right um i'm not like a portillo's fanboy like some people are but it's and mostly because it's not close to me but um i think they've probably got some ability to raise prices especially considering what all the other restaurants are doing so yeah all right let's move to future growth opportunities ian what do you have this one's a little bit of a tricky one but i think that they have some opportunity with menu additions they talked on the last conference call about how they're slow to make changes and don't like to shake up the menu for just the... It's a classic restaurant. People like what they like, and they don't want to make a bunch of big changes. But they did add

a spicy chicken sandwich. And they said, that's been a huge success. And it hit 3 key boxes for them. So first, it tested off the chart with their consumers. Second, it's been incremental to the business. And third, it's operationally very simple to execute. Last year, they had about a 4.1% increase in transactions year over year. And so that doesn't take into effect any pricing increases. That's just a 4% increase in transactions year over year at the same stores. And so I think that some of these menu additions have the opportunity to do that. I think they're going to be slow to make changes like they have in the past. But I think there's some opportunity to find some like this, like a spicy chicken sandwich out into the menu, getting a few extra

sales a year from some customers, I think makes a lot of sense. That's fine. Ryan? Yeah, I mean, the growth strategy here is quite simple. So I'm trying to come up with something creative. But one development I saw that I think is kind of interesting, they said in 2021 that they began to mark up third-party delivery prices. And I think that's probably okay.

I don't think there's any harm in alienating that base, not to mention it's a very small percentage of overall sales. So I think, like I said, part of the experience is going to a Portillo's, it sounds like, not just getting some third-party delivery in a box. So pushing the prices on that, I don't see a whole lot of problem. Try to make people come into the stores. I think that's probably a higher margin for you anyways. And then just generally, it seems like they're already kind of maximizing their per-store revenue. So really, I know Brett's about to touch on this, the growth is going to come from new stores. Yeah. And one, speaking on like a new store concept, they mentioned they have one that they just started one, I think this year that has

no dining experience at all, but it's kind of like one of those drive-in places. And speaking from just personal experience, there's a, you know, there's a famous burger stand in Seattle that has a similar layout that has phenomenal AUVs, which is just average unit volume. So revenue per store. And I think Portillo's concept of kind of probably that late night craving food for people to go to drive up and have it. I don't know. It feels like that concept of work they said without giving really any data that that could help. And it also would have a lot better returns on invested capital just because you don't have the inside one. And then maybe that could help just having, you know, you have the big flagship Portillo's with the cool inside

experience. But then if you want more and more stores across the nation, it might be hard to have those big stores. I don't know. And you can have these smaller outlets that are just kind of driving ones, but I'll hit my future growth opportunity. And it's really the, I don't know, it's so simple with restaurants and it's just store count growth. That's the entire story here. They're only at 69 stores, only in Chicago, really. I mean, what they have four in Arizona, two in Florida, two in California. They just opened one in Texas. A lot of green space ahead of them. And I don't know how many stores they could have in the United States, maybe 250 to 500, depending on how well they do, but that's a long ways away at 10% plus a year. All right. Highlights

and lowlights. Ian, what'd you like and dislike about this business? Yeah, I think first off, you got to start with a great brand. There's just a lot of fans out there, Portillo's. And I think there is a path to store growth, like you were mentioning. I think that's clearly the story here is if they can grow stores 10% a year, that's, that's going to be great. And, and, you know, they're starting to test it out in a few States and it seems to be working so far. Um, and so I think those are, those are the key highlights for me. A couple of low lights is I'd say the restaurant business can just be hard, especially do, um, especially in the current macro environment we're in with rising prices, rising wages, kind of a tightening labor force. Um, it just makes

it difficult to open new stores, to hire enough people, um, to get your supply chains right and get quality food. There's been some people who have complained, um, in Arizona that some of these stores aren't the same, uh, quality, um, and food as the ones in Chicagoland. And so it's, you know, there's people, people dispute that, right? Some people say it is, some people say it isn't, and who knows what the truth is, but I think it is, I would expect that it is more difficult to maintain that quality, maintain that same level of, um, of food and the same taste even, right. Like using different water and all that type of stuff and the food, um, across the nationwide store, uh, nationwide footprint. And so I think there's, there's going to be some challenges there. And then also just the minority shareholder situation where, um, you know, your, your partners with the private equity firm, and you gotta be pretty happy with that. And I think, as you pointed out, the compensation for the board is a little steep. The CEO has obviously got has a big package right now and hopefully earns it.

But, you know, you're you're not in control and it's not the typical band of funds that are in control. It's not the typical institutional money that's in control. It's this private equity firm. So something something to be aware of. Yeah. Ryan? Highlights for me, it seems like this is a model that I think could work everywhere. I really compare it. There was a Chick-fil-A that opened up in our area, I want to say a few years back, and there was a ton of enthusiasm for it, even though it wasn't very popular up here. And so I think just having a cult-like following tends to translate throughout the country, even if Seattle maybe isn't used to it. um, that I'm, I'm using Seattle as one of the, a reference to a city that doesn't quite have

Portillo's yet. Um, I also think it's a really cool story and I know that's not super important, but it almost gives you like this nostalgic American feel. It sounds like in the restaurant and you, you feel like there's a lot of history about it. Um, so I, I just think that's kind of cool and maybe it plays well into like attracting customers as well. Low lights. I think Ian, you kind of had the nail on the head. It's a pretty tough operating environment for restaurants right now. They said that they're expecting commodity costs to rise 13 to 15% this year. And obviously commodity costs are a huge input for restaurants. So that can be pretty tough. And for growing store count, steel, wood, whatever.

Yeah, that as well. And their CapEx compared to last year looks like it's double. And I don't think they're adding that much more stores. Yeah, it's tough. It's tough to get that same return on invested capital. Here's a question for you guys. Do you think they're not focused enough on the Chicago style sandwiches and hot dogs? Because I feel like that could be something where you don't really have that in many cities. I don't know, maybe I'm wrong. Do they focus on that because i think if you had in any city a chicago style food chain with the sandwiches and the hot dogs that would do well compared to saying just portillo's because i don't know i know i i doubt many people in the i'm using seattle because that's where we live many people

in the seattle seattle area know about portillo's if unless they lived in chicago i'm sure there's some branding that's like that i'm sure somewhere if they open a store in seattle i think a lot of people would get the idea that it's chicago style yeah but their branding feels a bit weak on the chicago style though they're like it's portillo's we got chocolate cake i'm like what is this sometimes i get a little confused i don't know ian did you think it was chicago style the first time you went sort of i do i do see what you're saying brett um and i'm gonna get more into it my bear case, but I think, I think it's not a crazy concern to have. Okay. Yeah. Just a small thing. I thought, all right. Highlights. I mean, we talked about it. There's a lot of room in the

country. I think another one that stood out to me, and this might just be contrasting to the sweet green report or not report, uh, whatever, uh, sec foundings, whatever we were reading beforehand, they have a more rational idea of what a restaurant should be. That is talk about it being, you know, making money, generating cash, getting return, but good return on invested capital um volume per store obviously super impressive and you know uh green space for store down growth low lights like you guys said uncertainty on input costs inflationary store build-out costs executive and board compensation seems very very high i don't have their numbers in front of me but the board has like seven members and they all got paid i don't know

four hundred thousand dollars last year which was just way way too high um i don't like the debt situation, it's just not great. I don't know. Like all the cash they're going to generate, it's going to go back to paying interest expense and they're going to have to refinance. If interest rates rise a lot, I wonder what sort of fixed rate debt they could get or even if they could get fixed rate debt. I mean, if they have to do floating again, I don't know. It's just going to be a lot of interest expense and it will take a lot of time to get to a point where they can fully escape the debt because they're not going to generate unless they can get some. I think What are they going to get? $500 million for like 10 years? I mean, that would be an ideal

scenario or something like that. Could they ever get to a point where they generate enough cash to actually pay back the debt? I don't know, especially at the rate they're trying to grow. I think you bring up a really good point. So let's just touch on it and we can move this into the bear case. The next two years, and maybe this is why the valuation isn't too crazy compared to some of the recent IPOs that we've seen, the next two years are going to be potentially very problematic. They have potentially rising interest rate environment, high inflation, and they don't want to raise prices too much. And that debt is coming due in two years. So they're going to have to refinance potentially on lower cashflow and

higher interest rates. That's a really tough. And they want to show good profit margins because if they're profitable consistently every quarter for the next two years, then their debt will be, they'll be able to get some better debt. But if not, because of inflation, i don't know it could be a double whammy all right so i guess that that's kind of my bear case is that that they're not able to overcome that problem in a manageable way the other bear case for me is actually i'll save this for more or less interested yeah bull let's go bull case bull case in what's your bull case yeah so as we've been talking i think store growth is the important thing and that they are able to get that 10 store growth a year with stable margins kind of back to

those, at least closer to those pre 2021 levels. Um, I think they're competent operators that execute well, and they generate somewhere in the neighborhood of $130 million in EBITDA for five years from now, which is about a 10% CAGR over the next five years. Um, if they got to about 130 million in EBITDA, I think that leads to somewhere around a double in five years. And so market beating returns over the next five years, if they can, if they can hit that 10%, um, 10% your Kager and EBITDA. Yeah. Ryan? I think we all have pretty similar numbers. They're projecting long-term store count growth of 10% a year, if they can hit that. And then they can grow same store sales by low single digits. You're looking at pretty good revenue growth and

hopefully they can recoup sort of their 2019 cashflow margins and get up to 10%, maybe even maybe closer to 15% in the long run. You think they can get that free cashflow? I mean, those capex let's let's go operating cash flow but free cash flow should hopefully come closer over the long run yeah um but yeah i think if they're able to expand throughout the u.s and have success in california and potentially throughout the west coast there's probably not going to be that much of a worry i think this will be fine yeah and same for me let's just go over some numbers here if they get to 150 stores which is definitely more than five years from now probably seven to eight years from now. It's a little under a double. Yeah.

150 store growth. Yeah. 150 stores, $10 million AUV, which is per store revenue and 10% operating margin. That's what equates, if you multiply those out to $150 million in annual operating profit, similar to what Ian was doing in EBITDA, but just maybe this is eight years from now instead of five. You'd probably think that's worth a $3 billion enterprise value. And right now the enterprise value is only a billion so if you think they can get there i think the light at the end of the tunnel a decade from now could be good if the store count if all the stores are profitable yeah and i'll just add one more thing is that the debt load it doesn't appear that the debt load necessarily has to increase they've been the last couple years they've been able to grow

10 a year without um with basically cash flow neutral um in terms of capex and so if you're getting all that bump in EV, you're probably not also having to increase your debt load over that time. And so you're getting kind of, you're juicing your returns and your equity returns a little bit. But anyways. Yeah. All right. Bear case, Ian, what's yours? My bear case is kind of what you were touching on a couple of minutes ago, Brett, that I think there's a chance that the concept doesn't translate super well to the rest of the country. It's obviously been wildly popular in Chicago and kind of the surrounding area. And it's been popular in arizona so far too but one of the things that's really beneficial to them about

arizona is there's a lot of chicago transplants and a lot of chicago snowbirds in arizona and so people come to retire out to arizona or come out here for a couple months from chicago and they see portillo's and they're like sweet i'm you know i've got my favorite restaurant here i don't know how well that translates to the rest of the country or how well the rest of the country necessarily like you said the branding isn't super strong just from the like the portillo's name right it doesn't it's not super strong than the chicago restaurant right and even the menu items nearly as good as chick-fil-a like ryan was using as an example i don't think it's nearly as good right i don't i don't think it has the cachet right now i think the question is can it get that

now is it on the cusp of becoming more like chick-fil-a that you slowly start putting a couple in each of these states and people start realizing oh wow this is amazing and you're able to benefit from that because it the brand is strong in the places where it's strong and it's going to be able to become strong in the other places but if that doesn't happen i think the growth numbers aren't there which then causes the debt load to become you know more troublesome over time is you know they've spent more in capex on places that don't generate as good of um don't have the same returns as their restaurants and some of their more popular markets yeah i think important one will be california if they can get because that feels like arizona and florida you

live in arizona and so this i don't know those feel like not those feel like fake states to me it's all retirees or whatever but california is like why are you dogging on arizona hey arizona's got intel out here we got tsmc coming so you know arizona's on the up and up oh i agree i agree but i'm just like a valley of the southwest it's a silicon valley of central central arizona the uh Right. But I will say, though, I think you're right, that this story depends on California and Texas, probably. Texas. Yeah. Maybe Texas is more important than California, given that they really were hyping up the Dallas location. So I do think I think that's interesting. Something you brought up earlier and you said, like some of the Chicagoites that are down in Arizona were like, oh, this isn't as good as the Chicago Portillo's. you don't want a store that feels like oh that's a chicago thing exclusively a chicago thing because

that doesn't translate as well chick-fil-a feels more like a national thing and i think that's part of why it was so successful so that could be a potential problem the real part of the and this is i guess but why don't you hit your bear case bro because i'm going to see if you have a lesson yeah yeah nothing else down here i mean mine is just input cost that high executive pay it all drives margins down and i worry about them really you know giving a lot of cash to their executive and board members um and i also worry about the debt interest expense and the input cost i mean inflation seems to be pretty bad right now as we all know it's going to make it tough for generating cash for shareholders if you if you only highlight your restaurant level ebitda adjusted you can give

however much you want to corporate expenses yeah exactly it doesn't include it at least they're both brought unlike sweet green who touts that they are profitable and they they're actually consult on a consolidated level they are profitable looking at that 27 number i mean yeah that number is important but it's a pretty big gap between that and corporate levels given their pay um but if they execute all right that's fine the executive team deserves to get paid a lot i don't have much concern like on what the income statement is going to look like on a consolidated level i think over the long term it'll be fine i mean the food costs could be in the short run be bad but that one seems like we'll figure it out but the cash flow statement and the share

account seems like the biggest concern yeah uh from my point of view looking at this for the first time all right last question more or less interested in this one's a tough one for me i think i'll probably i'm probably a little less interested than i was when i first looked at it but i'm gonna give it a little bit more of a look um just because i think there's i do like these stories where you have have some store count um possibilities i think it does have a good brand i think you have the potential like i was mentioning a second ago that this becomes that this they are able to grow with this brand right but i don't think it's i don't think it's a certainty by any stretch of the imagination especially given the the macro environment that

this thing is able to reach all the goals that it has um and that it's set out for itself what What about if their balance sheet was cleaner, how much of a positive? Is that a big overhang? A little bit for me, but it's not as big as I would have. They're generating enough cash flow where they can deal with the debt load. And I don't think that that's a concern. I just don't know that the growth is going to be there like they're expecting it's going to be. And that even if the growth is there, if that growth is going to be as profitable as their current stores.

And they even say that their Chicagoland stores are much more profitable than their stores in some of the other States. And I worry that that trend will continue, which just, which means that, you know, I just don't know that the growth is quite going to be the profitable growth is going to be there in a way that really makes this a big winner. And I don't think like, I don't think there's a huge risk of like permanent loss of capital here because I think they, like, I think their current business is generating cashflow to cover the debt and they'll be able to, you know, survive that, but I could, who knows, you know, just all speculation on my part. Yeah. It might be maybe just an underwhelming investment. I'm a little, I almost grew less

interested as the episode went on at first when I took a look at it, I was like, wow, this is the highest grossing fast casual restaurant per store. That's obviously there's a cult like following valuation as an insane. The, the one thing I do struggle with is, and it's the same with retail as it is with restaurants it feels like a lot of successful investments in this area hinge especially on growth stories they hinge on basically your subjective assessment of the restaurant i've never been i don't really have a subjective assessment so i just have a hard time predicting like who the winners will be yeah it's a tough space i'm saying more interested in this than sweet green i think you could say that for sure i think

i'm more interested but i just don't like i think i said this last week i don't like i'll say it again i don't like physical uh concepts which means i like i don't like the real world i like the fake world the virtual world that's i mean come on big metaverse truth over here yeah well i mean uh yeah uh not the metaverse but i guess software the but serious like in all seriousness they got a lot of input costs that are gonna be high i mean beef costs are high that is unpredictable for them so no matter how well they execute if some of these inflationary things happen i mean the margins aren't going to be that great um but i mean it seems promising i don't know it doesn't seem as bold proof as say like a chipotle expanding just because chipotle or a

chick-fil-a the concept is so much simpler chicken sandwiches or burritos and those are known by people around the country already and are quite popular but it's chicago style food i think needs a little brand pumping um like we talked about before and that's that's one of the big holdups all right uh so ryan were you more or less were you more interested ryan i'm actually going to keep an eye on to see how their expansion in california goes but you're less interested for the time being oh less interesting close to climb and i'll say that oh go ahead sir i said close to climbing the fence though sure okay yeah right on the edge right i was just going to say and their earnings are coming out i think just a couple days after this episode so um their q1

earnings and so that should give a little more you know we'll get another update on this because it's a fairly you know it only went public last year and so there's just not a lot of track record here to see what management says and how it correlates to what actually happens and those types of things margins are going back to 10 we're going to be all our concerns are going to be wrong all right stop for next week ryan what do you got for us i'll let you guys vote it out uh i got three potential ones here there's robin hood which would be robin hood revisited it's down a an insane amount since we last looked at it then the other one is service now and the last one is pinterest which i think would also be another revisited uh service now seems like no one will

listen what a great company i don't know ian what are your thoughts i don't know i'm probably i would be down to revisit robin hood or pinterest i think those would be interesting to take another look at i'll do i'll vote pinterest that seems more interesting given how chaotic not chaotic how dynamic the social media market industry seems to be right now okay pinterest it is Pinterest revisited. All right. That's going to do it for this episode. Thank you all for listening. Give us a review on Spotify or Apple. Remember, we are not financial advisors. Anything we say on this show is not formal advice or recommendation. Ryan and I are general partners at Arch Capital. Arch Capital clients may hold securities discussed in this podcast.

Thank you all for listening. We'll see you next time. Don't you wish you could just hit skip on the worst parts of your life? You know, the same way you can skip an ad? I get it. I'm Siyaya and I live in Ice Cove. I've made some questionable decisions that didn't end up the way I planned. And today I'm still figuring it out. Somehow things usually get worse before they get better.

Apparently, that's how I roll. So bundle up and come along for the bumpy ride. Stream a new episode of North of North Tuesdays on CBC Gem. you