In some ways, the first major chapter of Fiesta Restaurant Group’s comeback is complete. The company’s strategic renewal plan fixated on Pollo Tropical and Taco Cabana’s top-line. And the turnaround that followed was dramatic. That continued into the third quarter, where total revenues upped 10.1 percent, year-over-year, to $174.6 million, due primarily to same-store sales growth. Comps boosted 6.5 percent at Pollo Tropical, marking the third consecutive quarter and 10th consecutive month of positive gains.
Taco Cabana’s comps lifted 12.2 percent versus the prior-year period, giving the chain two consecutive quarters and six consecutive months of gains.
While these figures are rosy, Fiesta’s stock dropped more than 20 percent Tuesday. There were a few anchors at work.
To start, while impressive, both results lapped an extremely difficult Q3 2017 period pummeled by hurricanes Harvey and Irma. In that quarter, Pollo Tropical’s comps fell 10.9 percent and Taco Cabana’s dropped 12.6 percent. Fiesta estimated the hurricanes negatively impacted adjusted EBITDA and income loss from operations by about $3–$4 million at Pollo Tropical and $1-$1.15 million at Taco Cabana, and that same-store sales and transactions were hurt 5.5–6 percent at Pollo Tropical and 2–3 percent at Taco Cabana, respectively.
But beyond the hurricane tailwind, estimated at 2–3 percent for Taco Cabana alone, Fiesta still showed solid profitability growth with consolidated adjusted EBITDA up 14.2 percent in Q3. Here’s where investors expressed concern, however.
Earnings per share of 11 cents missed the Zacks Consensus Estimate of 19 cents per share by a significant amount. And, perhaps more notable, the company said it expects total capital expenditures in 2018 to be at the high-end of the $60 million to $70 million range it set earlier “due in part to additional restaurant investments being made to improve food quality and support new menu, catering, and technology platforms.”
The turnaround hasn’t been a cheap one.
But Richard Stockinger, Fiesta’s president and CEO, said the efforts to develop a strong long-term business required substantial near-term investments, and it was always geared toward sustainable return. “… they have also led to enhanced guest experiences through improved food quality and hospitality, and have enabled us to build a track record of comparable restaurant sales momentum and increased profit per transaction,” he said. Each brand relaunched this past year, with massive menu overhauls core to the changes. The product upgrade alone affected almost 90 percent of Taco Cabana’s menu. At Pollo Tropical, the change touched 90 percent of the offerings with food and ingredient enhancements, including removing artificial ingredients.
The next step in Fiesta’s fix is going to involve improving margins and cost controls.
“Now that we have stabilized the top line, we are focusing on consistently generating comparable restaurant sales growth at our existing restaurants, adding incremental off-premises sales, expanding margins, and optimizing our restaurant portfolio,” he said.
The pricing equation
Taco Cabana and Pollo Tropical have experienced significant pricing boosts during this comeback effort, which are the leading culprit behind the comps lift, not traffic. But this isn’t just a straight check average lift, either. Much of the changes, from menu improvements to the experiential improvements at Taco Cabana, like the TC Patio Program, were meant to court a different kind of customer. More families. Younger guests. A focus on dine-in seekers rather than value ones. In Taco Cabana’s case, a positioning that fits somewhere between discount-strong competitors like Taco Bell and the high-ticket polished fast casuals.
The third-quarter gain at Taco Cabana consisted of a 12.1 percent increase in average check, inclusive of 7.7 percent in pricing and positive sales mix associated with higher-price promotions and new menu items with higher food costs. Restaurant transactions increased 0.1 percent, negatively impacted by the reduction in overnight operating hours, which hit comp sales by about 0.9 percent. Again, a shift in direction that’s adjusting the Taco Cabana traffic base from those looking for a quick bite at a low price.
At Pollo Tropical, the comps growth comprised of a 5.2 percent increase in average check, inclusive of a 4.9 percent gain in pricing, and a 1.3 percent increase in comparable restaurant transactions.
Lynn Schweinfurth, Fiesta’s CFO, said the pricing would thin as the company laps some of its own efforts. At Taco Cabana, the near term will be over 6 percent. Pollo Tropical should see pricing drop into the low 4 percent range in Q4. But next year, the company doesn’t expect to see a lot of incremental pricing now that, again, its top line has stabilized.
Fiesta recently completed a systemwide rollout of its MY TC loyalty program. It also updated its online ordering platform and mobile app.
Earlier in the month, the company launched gift card sales in Sam’s Club, and expects digital gift cards to be ready before year’s end.
Kiosks are also coming, with tests planned for 2019. About half of Fiesta’s business currently takes place within the restaurant, either from dine-in or take-out. Schweinfurth said the company hopes to see higher average checks and better accuracy from the kiosks.
Fiesta is in the process of adding upgraded point-of-sale tablets at certain locations to accept payment to increase in-store dining sales as well.
On the off-premises side, Fiesta plans to conduct a pilot test with a third-party delivery vendor in early 2019, and is implementing the infrastructure of its catering program, Stockinger said. A third-party delivery test is coming to Pollo Tropicals in South Florida in the coming weeks, with a larger rollout expected in 2019. Taco Cabana expects to test the service next year as well.
Back to the bottom line
“While it’s important to build and solidify our sales base in recognizing the investments we made in the four-wall operations, we also need to improve upon our margins through food and labor cost management. Labor initiatives are well under way, including labor scheduling forecasting and tracking processes and updated batch-cooking guides to reduce over time,” Stockinger said.
These labor controls include Fiesta increasing the use of shift leaders to promote leadership development with the added benefit of reducing costs. Also, detailed labor scheduling and the controlling of overtime.
Last year, Pollo Tropical returned to broadcast media right before Q3 after a two-month hiatus and spent more to rebuild its momentum. That higher advertising spending and speed of service opportunities in 2018 dragged transactions, Schweinfurth said.
“We have proactively addressed speed of service challenges with the implementation of portable POS tablets in our drive-through and promotional calendars for the balance of this year and in 2019,” Schweinfurth added.
Schweinfurth said Pollo Tropical was impacted by higher cost of sales as a percentage of restaurant sales due to lapping the hurricanes when the company had a limited menu set of item that carried lower cost, as well as the menu enhancement investment that drove the turnaround (both brands refreshed 90-percent plus of their offerings).
“In the third quarter, we recognized $6.4 million of impairment and other lease charges,” Schweinfurth said. “This consisted of a $5.7 million of impairment charges related to three Pollo and five Taco restaurants that are underperforming, but that we continue to operate and $0.7 million related to an office relocation and previously closed restaurants due to adjustments to estimates of future lease costs.”
The project will complete by year’s end, and Fiesta also sees higher utility costs in Q3 typically. So some cost burden should lift.
“While we are still finalizing our plans for 2019, we anticipate spending less capital in 2019 compared to 2018, as we expect to open fewer restaurants next year as we refine our four-wall model and evaluate our portfolio, and with the completion at the end of 2018 of the deferred maintenance capital project related to the plan, partially offset by more restaurant remodel,” Schweinfurth added later on.