This Dividend Growth Stock is Potentially 16% Undervalued

Brinker International (EAT) owns, operates, develops, and franchises the Chili’s Grill & Bar and Maggiano’s Little Italy restaurant brands.

Brinker is a Dividend Contender with a current string of 12 straight years of dividend increases.

Brinker’s price has been falling all year, which has caused its dividend yield to rise a point to an attractive 3.3%. (Price and yield are inversely related.)

CaptureThe purpose of this article is to examine Brinker’s valuation. Not every price drop makes a stock well-valued.

Dividend Safety

I always kick off these valuation articles by confirming the company’s dividend safety. I only want to invest in companies whose dividends are safe.

For a more complete discussion of dividend safety and reliability, see Dividend Growth Investing Lesson 17: Dividend Safety.

I use two services to assess dividend safety. The first is Simply Safe Dividends. They use the following scale to score dividend safety:

Here is how Simply Safe Dividends scores Brinker International:

CaptureSimply Safe Dividends’ score of 88 out of a possible 100 points for dividend safety suggests that the dividend is very safe and extremely unlikely to be cut.

Safety Net Pro agrees. They use the following scale to score dividend safety:

Safety Net Pro gives Brinker its highest safety grade:

CaptureWith that reassurance on Brinker’s dividend safety, let’s proceed to our valuation steps and see how the company’s stock stacks up in terms of fair price.

Valuation Steps

To value a stock, I employ 4 methods and then average them out. For a complete discussion of my process, please read Dividend Growth Investing Lesson 11: Valuation.

Step 1: FASTGraphs Default Valuation

In the the first step, we check the stock’s current price against FASTGraphs’ basic estimate of its fair value.

For its basic estimate, FASTGraphs compares the stock’s actual price-to-earnings (P/E) ratio to the historical average P/E ratio of the whole stock market, which is 15.

That fair-value reference is shown by the orange line on the following graph, while the black line is Brinker’s actual price.

CaptureAs you can see, the black price line is below the orange fair-price line. Brinker currently has a P/E ratio under 15. That suggests that Brinker is undervalued.

How much? That is easy to calculate.

We divide the stock’s actual P/E ratio of 13 (shown at the upper right) by the ratio of 15 that was used to draw the orange line.

We get 13 / 15 = 0.87. Translating that to 87%, this step suggests that Brinker is 13% undervalued.

We can calculate Brinker’s fair price by dividing its current price by 0.87.

That’s $41.30 / 0.87 or about $47.

I round fair-value estimates off to the nearest dollar to avoid creating a false sense of precision. Valuations are estimates, not scientific calculations.

Step 2: FASTGraphs Normalized Valuation

In the second step, we compare Brinker’s current P/E ratio to its own long-term average P/E ratio. By doing this, we judge fair value by recognizing how the market has historically valued Brinker itself rather than by how the market has valued all stocks over many years.

CaptureThis step suggests an even more pronounced undervaluation. That’s because Brinker’s average valuation looking back 10 years has been P/E = 15.3 (see the dark blue box in the right panel). That’s more than the 15 used in the first step.

How much is the undervaluation? We use the same equation as before: 13.0 / 15.3 = 0.85, or 85%. So this suggests that Brinker is 15% undervalued.

The fair price using this valuation method is $49.

Step 3: Morningstar Star Rating

The next step is to see what Morningstar has to say.

Morningstar ignores P/E ratios. Instead, they use a discounted cash flow (DCF) model. They discount all of the stock’s projected future cash flows back to the present to arrive at a fair value estimate. (If you would like to learn more about how this works, check out this excellent explanation at moneychimp.)

Unfortunately, Brinker is not one of the stocks that Morningstar rates. So we do not have the benefit of their valuation or fair price estimate for this stock.

Step 4: Current Yield vs. Historical Yield

Finally, as a 4th valuation method, we compare the stock’s current yield to its historical yield. If a stock is yielding more than its historical average, that suggests that it is a better value than usual.

Brinker’s current yield is 3.3%. According to Morningstar, its 5-year average yield is 2.2%. Thus Brinker’s yield is 50% higher than its 5-year average, suggesting that its stock price is 50% beneath its fair value.

However, in this step, I cut off differences at 20%, because I think that this is an indirect way of estimating fair price.

Doing the math, we get a fair price estimate of $41.30 / 0.8 = $52.

Valuation Summary

Using the approaches just described, our valuation for Brinker International comes out like this.

CaptureThe average of the 3 fair-value prices is $49 compared to Brinker’s actual price of about $41. That’s a 16% discount to fair value, which I call Undervalued.

So far this year, Brinker has announced two dividend payments, each being flat with the one before. The company typically declares its increase with the 3rd payment of the year. Last year’s increase was 6.3%, announced in August and paid in September.

Disclosure and Caution

I do not own Brinker. The fact that the stock’s valuation is favorable does not mean that I would select it for my own portfolio. A fuller analysis would be required. Three areas for exploration would be data points that you can see on the FASTGraphs.

• High debt level
• Mediocre credit rating (BB+)
• Falling earnings estimate for 2017

So as always, this is not a recommendation to buy Brinker International. Always perform your own due diligence. Check out the company’s dividend record, quality, financial position, business model, and prospects for the future. Also consider whether it fits (or does not fit) your long-term investing goals.

— Dave Van Knapp

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