Is Portillo’s Stock a Good Buy Right Now?

Portillo’s (NASDAQ:PTLO) is a small hot dog and Italian beef restaurant chain of 88 stores that enjoys an extremely strong following in its hometown of Chicago.

Taken public in 2021, the chain now hopes to expand from Illinois to become a national force in the fast-casual dining market.

Shareholders, however, have yet to see the benefits of this expansion plan. The stock has lost over 23% in the last year and much more since its IPO.

Is Portillo’s an undervalued buy, and can the chain turn its losses around to produce positive returns for its shareholders?

Portillo’s Advantages and Growth Opportunities

The bull’s argument in favor of Portillo’s stems from its top notch restaurant-level performance.

The company’s average unit volume as of the end of Q2 was $9.0 million, a number that is unmatched by the vast majority of other chain restaurants. For comparison, Chick-fil-A, a restaurant chain also known for its high AUVs, was estimated to average about $6.7 million as of last year. McDonald’s, easily the dominant fast-food chain in America, comes in substantially lower at just $3.6 million.

As such, the value of a single Portillo’s location in terms of its ability to contribute revenue is substantially higher than that of most other chains.

Furthermore, Portillo’s boasts a restaurant-level EBITDA margin of about 24.5%. Though the real restaurant margin is of course much lower once taxes and other expenses are accounted for, this non-GAAP margin level is quite impressive in its own right.

In addition to having unusually strong restaurant performance, Portillo’s hopes to scale up its number of restaurants steadily over the coming years. Over the next two decades, the chain hopes to add 920 restaurants.

Outside of its home base in Illinois, most of the chain’s new locations are currently being opened in Sun Belt states, particularly Texas. If Portillo’s can maintain its AUVs at new locations, this growth strategy has the very real potential see the chain’s revenues and earnings move steadily higher over many years.

To some degree, the effect of ongoing expansion on revenue is already being seen. In Q2, for instance, the company reported $181.9 million in revenue, up 7.5% from the previous year. This increase came despite a 0.6% decline in same-restaurant sales.

Finally, Portillo’s has the advantage of already being profitable. In the last fiscal year, the company earned $0.40 per share, resulting in a net margin of 3.3%. Although this is still quite low, it’s worth noting that the company is spending quite a bit to continue building new locations.

As time goes on and more restaurants are built, it’s likely that margins could improve and result in higher long-term earnings.

Slow Progress and Diluted Shares

For all of Portillo’s seeming advantages, the company has been somewhat slow in delivering both revenue and earnings growth.

For the full year of 2021, for instance, the company reported revenues of $535 million. In the last 12 months, that number was $703 million. Though certainly respectable, this revenue growth rate is far from what high-growth investors may have expected.

Though the fact that the company is already profitable is a plus for investors, it’s worth noting that earnings growth has also been slightly slow. The company’s first profitable year was 2022, in which it earned about $11 million.

At the end of Q2, Portillo’s trailing 12-month net income stood at $23 million. As with revenue, this growth is far from negligible. Starting from such a low baseline, however, investors may have expected more rapid earnings growth.

Another serious speed bump for longtime shareholders has been the company’s tendency to increase its number of outstanding shares via secondary offerings. At the end of 2021, there were 36 million outstanding shares of PTLO. Today, that number has nearly doubled to 65 million.

Cumulatively, these factors have driven the price of PTLO far below its IPO level. When the chain was first taken public, shares were priced at $20 and quickly rose to over $30 on its first day of trading. The share price currently trades more than 50% lower than that figure.

The Case for Value at Portillo’s

Where value is concerned, Portillo’s is a bit of a mixed bag. At 1.3 times sales, the company is priced quite reasonably for a growth stock.

The forward price-to-earnings ratio of 44.9 is rather high, but once again well in line with high-growth stock pricing.

Given that Portillo’s is still early in its expected growth trajectory, the company could justify such a valuation if it can continue expanding while maintaining its restaurant-level margins and superior AUVs.

There is, however, a case for actual undervaluation when Portillo’s is compared to other fast-casual chains. Chipotle (NYSE:CMG), the undisputed giant in the space, trades at 7.2 times sales and 51.8 times forward earnings.

Chipotle may be worth a premium due to its history of incredible growth, but other fast-casual restaurants closer to Portillo’s size trade at similarly high multiples.

Cava (NYSE:CAVA), for instance, is priced at 19.2 times sales and nearly 300 times forward earnings, despite generating only slightly higher sales and net margins than Portillo’s. As such, it may be fair to say that Portillo’s is likely undervalued when compared to fast-casual stocks generally.

The Effects of Activist Interest

A final point that’s worth noting about Portillo’s is the fact that it has recently attracted the attention of an activist investing firm. Engaged Capital announced in mid-August that it had acquired a roughly 10% stake in the company.

Though it isn’t pressing for management changes, Engaged hopes to encourage Portillo’s to make operational changes that will result in faster growth and higher earnings.

The primary changes Engaged hopes to implement have to do with the size and expense of the company’s restaurants.

Portillo’s locations are unusually large by fast-casual standards, averaging about 7,700 square feet. The company had already announced plans for a small footprint restaurant concept that would reduce this to between 5,500 and 6,000.

Engaged hopes to promote the idea of smaller restaurants, as well as changes to real estate ownership that would help Portillo’s expand faster and capitalize on its restaurant-level economics.

Shareholders have responded positively, sending the price of PTLO up by over 25% over the last quarter or so. Though today’s shareholders must pay higher prices than before Engaged announced its interest, the company’s guidance may help Portillo’s reach its potential in the long run.

Is Portillo’s Stock a Good Buy?

Now that an activist investor, Engaged Capital, has taken a large stake, Portillo’s stock is a good buy as operational enhancements drive higher margins.

Despite generating steady revenue and earnings growth, it’s fair to say Portfillo’s has lagged the market in terms of share price performance. In part, this can be attributed to its slow-but-steady approach to growth, as well as its gradual but substantial increase to its number of outstanding shares.

With that said, Portillo’s is also a business that boasts outstanding restaurant-level performance and a potentially long growth runway.

By focusing on major cities in the Sun Belt for its expansion efforts, Portillo’s may be able to expand without allowing its superior AUVs to suffer in the process.

Furthermore, the chain is a favorite of Illinoisans who are increasingly flocking to southern states. giving it a ready-made clientele in its new chosen markets.

Overall, Portillo’s could be a good buy for investors seeking steady, long-term returns. The chain’s discounted price tag compared to other fast-casual restaurants makes it fairly attractive, especially if the new activist interest results in operational improvements and more rapid growth.

While PTLO may take time to produce returns for investors, the company’s fundamentals and growth opportunities both seem strong enough to make it worth considering.

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The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.