Employees prepare food orders at a Portillo's restaurant in Chicago, Illinois, on Tuesday, September 27, 2022.
Christopher Dilts | Bloomberg |
Company: Portillo's (PTLO)
Business: Restaurant Portillo owns and operates fast-casual restaurants in the United States. The company offers Chicago-style hot dogs and sausages, Italian beef sandwiches, grilled burgers, tossed salads, crinkle-cut fries, and chocolate cake shakes. Portillo's also offers its products through its website, app, and certain third-party platforms.
Market value: USD 901 million (USD 12.27 per share)
Stock chart symbolStock chart symbol
Portillo's in 2024
Activist: Engaged Capital
Percentage ownership: 9.90%
Average costs: $11.50
Comment from an activist: Engaged Capital was founded by Glenn Welling, a former director and managing director of Relational Investors. Engaged is an experienced and successful small-cap investor and makes investments with a two- to five-year investment horizon. Its approach is to hold management and the board to account behind closed doors.
What happens
Engaged said the company has been communicating with Portillo's about potential steps to improve the company's business, including optimizing restaurant performance, improving cash-on-cash returns at the restaurant level, improving corporate governance through potential changes in the composition of the board of directors, and exploring a sale of the company.
Behind the scenes
Portillo's is an iconic Midwestern fast-casual chain founded over 60 years ago, offering a differentiated menu centered around Italian beef sandwiches, hot dogs, and milkshakes. The company was acquired from its founder by private equity firm Berkshire Partners in 2014 for about $1 billion. Berkshire took it public in October 2021 at $20 per share, and about a month later, the stock price rose to $54.22 per share. Since then, Berkshire has sold off its position from 66% to 19%, while the stock has fallen back below its IPO price. Portillo's Chicago locations are still among the most productive fast-casual restaurants in the industry, with an average unit volume (AUV) of $11 million and a restaurant margin of 30%. Locations outside Chicago have achieved AUVs of $6 million to $7 million, more than double the industry average for quick service and fast-casual restaurants.
While Portillo's has a much larger AUV than its competitors, the company has an even larger average floor area than its competitors. Although management has reduced store size, its stores are still 1.5 to 3 times larger than its competitors. But store size is only one of the problems. This problem is exacerbated by the fact that the company owns its buildings, although it leases the land on which they are located. In an industry where cash-on-cash returns are paramount, this structure does not make much sense. In addition to making the stores more expensive to build ($6 to $7 million, which is two to three times more than the competition), these large floor areas have created inefficiencies in labor, maintenance, and various other expenses within the restaurant. In addition, management has been slow to implement customer retention mechanisms, such as loyalty programs and ordering kiosks, which have proven successful among the competition. And although customers rate the food and the brand very highly, brand awareness is not as strong as it could be. This is likely due in part to the low marketing budget: 1% of sales compared to 2 to 3% for growth companies.
The good news is that all of these issues bring with them many opportunities — and many value creation opportunities are already underway. Management has announced that a new “restaurant of the future” will open in the fourth quarter, reducing the footprint from 10,000 to 6,300 square feet and reducing construction costs to about $5.2 million (from $6 million to $7 million). This is a good sign that the company recognizes the problem and is taking a step in the right direction, but this is only a fraction of what can be done to optimize capital allocation. In addition, management has begun investing in technology and testing small kiosks to increase sales growth in stores, renew the operational focus on drive-thru, and reduce wait times. The company is also launching a major promotional initiative in Chicago to coincide with the start of the NFL season. These are great moves, but the pace of these initiatives has been too slow.
Engaged believes that by actively engaging and hiring a new Chief Operating Officer at Portillo's, it can accelerate and optimize improvements in the company, which would lead to the expansion of this popular regional chain into a national brand. Currently, Portillo's trades at 10x forward earnings before interest, taxes, depreciation and amortization. That is a significant discount to other, much more established, well-known and national QSRs such as Shake Shack (24x) and Chipotle (27x). Closing this gap will require significant improvements in capital allocation, technology initiatives, marketing plans, real estate restructuring and operational advancements. Engaged supports management and expects to recruit a strong operator for the currently vacant COO position. Engaged has a lot of experience in this industry and could be right, but we believe this is a tall order for an activist campaign – more so than usual. We believe it needs more than just a new COO, but directors with experience in finance, marketing, technology and real estate. Engaged itself has a strong track record in this sector, having held board seats at Del Frisco's and Jamba, and has also settled for an independent board seat at Shake Shack. We expect the company to seek a board seat at Portillo's, and the company could certainly benefit from the experience and institutional perspective that Engaged brings.
Finally, if management cannot create value for shareholders through these operational improvements, there may be a strategic decision. Berkshire Partners took the company from the Stone Age into the 20th century. Now someone needs to take the baton and lead it into the 21st century and into the future. That could be another private equity firm or a strategic investor that has the infrastructure and team to quickly grow Portillo's into a national brand.
Ken Squire is founder and president of 13D Monitor, an institutional research service on shareholder activism, and founder and portfolio manager of the 13D Activist Fund, a mutual fund that invests in a portfolio of 13D activist investments.