'cause we're on a tight ship, five minutes between.
Okay. Good afternoon, everyone. Welcome to the presentation for Portillo's. I hope everybody's already eaten, because you're gonna be very hungry if you haven't after this session. So I'm David Tarantino, the restaurants analyst at Baird, and I'm happy to have two members of the management team here today. Portillo's, just by way of background, is the operator of 86 very high-volume restaurants that feature Chicago's street food, essentially, Italian beef sandwiches, hot dogs, and a lot of other things. And it's really generated really good unit economics, and it's a brand that we think has a lot of room for growth. With us today are CEO Michael Osanloo and the CFO Michelle Hook, and we also have Barb Noverini in the crowd.
So, with that, maybe, I'll just say welcome to both of you. Thanks for being here.
Thank you, David.
Thanks, David.
I think we have some folks in the room that might not be familiar with the concept, so perhaps a good place to start is, Michael, if you could just give us an overview of the brand, what do you think makes it so special, and why do you generate such incredible unit volumes?
Yeah. Look, in a great restaurant company, it starts and ends with food, right? You have to have great, delicious, craveable food. Those, those are probably some of our best hitters. That's the Italian beef sandwich, hot dog. Our burgers are amazing. What's not on there that we probably should have on there on a, on a future slide is our salads. I think a lot of people don't realize that we sell amazing salads, hand-tossed, fresh. Our top 20 restaurants all sell $1 million or more of salad, so we, you know, we make great salads. But it starts with food, right? People love our food, and the food is craveable. We serve it in a very inviting environment. The box is beautiful. We're multi-channel before it kind of became a thing.
You know, we have the double-lane drive-throughs with outside order takers and food runners. We've got a very robust delivery business on our own, as well as with third party. We do catering. So it's just a great concept. Now, it's a 60-year-old brand, grew up in Chicago, and for the first, you know, truthfully, the first 40 years of its life, it was, like, 5 or 6 restaurants. And it's, it's grown outside its bounds. The last thing before I turn it back to you is, we very carefully monitor how consumers think of our brand, not just in Chicago, but in all the markets that we're in. And we have startlingly high Net Promoter Scores. We're very, very proud of that. That's taken decades to get there, but we have a level of fandom and followership that is, second to none.
Great. And, you know, just, you know, you've laid out some growth targets, long-term growth targets for the brand. Can you refresh us on what those are, and how fast you think you can grow here over the next, you know, several years?
Yeah. Well, there's a long-term growth algorithm, and I'll let Michelle talk about that, but our growth right now is building new restaurants in high-performing markets. And so we have loosely... We loosely have defined our growth target as the Sun Belt. And, you know, I'm playing a little loose and fast with geography 'cause we include Colorado in the Sun Belt, the Carolinas, Atlanta, but it's really go where America's population is growing. The focus of our growth thus far in the last few years has been Texas, Florida, Arizona. Why those states? Those states have 2% population growth tailwind. The greater Midwest has -1%. We're going in places in those states where there's a ton of new growth, great new housing starts.
And so we want to take a very, very attractive, hugely cash flow positive business in the Midwest and make our investments in the high-growth markets across the United States, where Americans are, you know, moving to. And so that's the growth- And the way it translates, do you wanna talk about the long term?
Yeah, we can talk about... So in the long-term growth algorithm, we'll start with new restaurant growth. So it's targeting 12%-15% growth. Now, this year, we're targeting 10%+ growth in 2024. Next year, we're targeting 12%+ growth, and then in 2026 and beyond, we're targeting 12%-15% growth on the new restaurants. On a comp basis, we're targeting low single-digit comp growth, which then translates to mid-teens revenue growth and then low teens adjusted EBITDA growth.
Do you wanna explain the low teen?
Yep, I was just gonna say that because we get this question a lot, which is: Well, why is your Adjusted EBITDA growth lower than your revenue growth? Because we're building a lot of new restaurants, right? Those are generally coming into the portfolio at a lower margin profile than what what we're mixing at today. In Chicagoland, we're doing $11 million AUVs and 30%+ margins. Outside the core, generally, and we've bifurcated regions. You know, if you look at the Midwest outside of Chicagoland, we're doing about $5.7 million AUVs, just under 20% margins. And the Sun Belt, which is what Michael described, you know, right now we're doing about $6.7 million AUVs and around 20%-ish% margins.
And so as you bring these new units into the portfolio, right, you're gonna get some a little bit of headwinds on some of the margins and, you know, therefore, some of the adjusted EBITDA. But I wanna just reiterate that our restaurants cash flow immediately, which enables us to fund all of our own growth as we move forward, and so we feel really good about our ability to fund the 12%-15% growth as we move forward. And you know that we're gonna continue to look to do that. And the growth, primarily, we've said, you know, 80% is gonna be targeted in the Sun Belt, but we will continue to build restaurants as we continue to densify the Midwest, and we still have opportunities in Chicagoland as well.
Great. One question that comes up, you know, really since the IPO is, you know, can this brand work outside of Chicago? You know, Chicago street food isn't intuitive. I guess, what's your reaction to that comment? I know you've got some proof points already, but I guess, you know, how can you make investors comfortable that the brand is working as you move further away from Chicago?
I mean, if you're a real serious investor, I'd encourage you to just go visit a restaurant in Florida, Texas, Arizona. Judge for yourself. You're gonna see people thrilled, enjoying their food, packed. We have $9-$10 million restaurants in Florida, in Texas, in Arizona. It's not like there's a huge expat Chicago community in Dallas, Texas, and that our restaurants there are all doing exceptionally well. So I think the proof is in the numbers, right? You know, we shared some of the performance of the class of 2022 and the class of 2023. We will continue proving out the story, you know, every single quarter, every single year, but it's N of 1. Consumers have voted with their wallets and their pocketbooks in Texas, Florida, Arizona. They enjoy Portillo's, they're going to Portillo's.
You're not doing $10 million on somebody who comes in infrequently or a looky-loo. You need frequency. Our average check is about, what, $12?
Per person.
Per person.
Average ticket is $22.
Yeah.
There's, you know, just under two people-
You're not doing our volumes with casual visitation.
Makes sense. I wanna come back to... I have several questions on the new, new unit growth.
Yeah.
But before I do, I wanna talk about themes in the industry, and one of which is, you know, there's been some really kind of mixed performance in traffic and, and concerns about the overall consumer spending environment. So can you just maybe talk from your perspective about your views on the consumer spending environment and, and what you're seeing out there?
Yeah, there's... Look, there's obviously a lot of chatter about the low-end consumer feeling pressure, and you definitely see the QSR players engaging in some more active promotional behavior. To me, it does not seem like it was, you know, in prior recessionary environments. You know, even you pick the biggest guy, McDonald's, yeah, they have stuff on their dollar menu, but they also have really expensive meals with the Big Mac and the Quarter Pounder, et cetera. So those meals are not coming down in prices. So they've done a really nice job of barbell pricing, and their expensive meals are every bit, you know, as expensive as most of fast casual and everyone.
So our position is that the low-end consumer, that really discount budget consumer, tends to be a very small portion of our guest, and they tend to be more drive-through focused. So for us to compete, it's not on discounting, but it's on fantastic execution, right? We wanna be as quick as possible. We still are gonna serve our third-pound burgers that, you know, you don't, like, flap in front of a lamp and see light going through. We have really delicious food, really great experience, and that's the way to compete against them. Value is not just price point. Value is what you're getting, the quality of what you're getting. Was it hot and fresh? And so we're gonna compete aggressively on the overall value proposition, especially in the drive-through. Inside, our restaurants are doing really well. You know, we are...
If you haven't visited a Portillo's, it is, and I know everybody says this, but it is, there's a lot going on. It's experiential. It's a beautiful box. People are taking selfies in our restaurants with all the tchotchke up on the walls. Each restaurant is customized to look like the local environment, and so we're a really good trade-down from casual dining.
Makes sense. You know, so just to continue on this theme, you know, the traffic performance for your business was, you know, negative in the first quarter.
Yeah.
You had a lot of terrible weather, you know-
Right
... being, you know, a heavy footprint in the Midwest. You did say it improved exiting the quarter, but I guess, what are your thought- I mean, it was... I think the comment, though, is it was still slightly negative, you know, as you...
Yeah
... entered the Q2 . So I guess, what are your thoughts on how you get that back to flat or positive, and, and what are the drivers to get you there?
Yeah. Well, you said something, David, I don't wanna lose focus on, which is: we're still a relatively small company in box count, right? So our comp base is 69 restaurants. 60 of them are in the Midwest. When the Midwest has horrible weather in January, it's gonna affect us. So it's one of the reasons why we're sort of doing this weather arbitrage by going to the Sun Belt. But we take traffic seriously, and we are doing things to drive a little bit better traffic, so a lot of little things. We expanded hours recently, right? We added half an hour on the front end in the mornings. We're open at 10:00 A.M. everywhere. I know that sounds crazy, but there are literally people in line in our drive-throughs and waiting outside our restaurants to get an Italian beef sandwich at 10:00 A.M.
So we expanded hours. On the front end, we have a bunch of restaurants that we expanded hours on the back end. We have restaurants that are open till 1:00 A.M. That helps. We have innovated on our menu to add what we think are some traffic drivers, right? We have fresh-made, hand-tossed salads. We added two salads that we think are really targeting specific consumers. We have a spicy chicken chopped salad, bold flavors, bold palate, a little bit more hearty salad. It actually appeals to a younger demographic. They love bolder flavors. And then we have an elevated salad, which is a mixed green salad with a grilled chicken, pecan, and a fantastic dressing. So it's a great salad, a little bit high-end....
My investors should love these salads because I think that they're likely to drive traffic, but in a worst-case scenario, they're higher ticket, higher margin, so even if they're cannibalistic. And then finally, we are gonna be very thoughtful about using some advertising in the right way to drive traffic. So in Chicagoland, we have tested advertising. We know it works. We know specifically that when we advertise, this is gonna sound crazy, and forgive me if you hate the Bears, but if you advertise with the Chicago Bears when the Chicago Bears are on TV, it really works in Chicagoland. So we have bought a bunch of ads, starting with their preseason games going through the season, and it's not discounting, but just to remind people that they love Portillo's, so we're doing that.
And then, outside of Chicago, we are being very purposeful about driving trial and awareness. Even though we have five restaurants now in Dallas, our awareness is still very low. People who know us love us, but I want more people to know us. So we're being very targeted, using our third-party partners, DoorDash, Uber Eats, those kind of people, to very carefully target people who have looked at our menu but haven't ordered. So there's a cookie. The next time you go on that website and you look at our menu, you're gonna get an offer from us. But I think of it very differently outside the core versus the core.
I think the other thing, too-
Yeah
... Michael, that we've talked about is focusing on speed of service in the drive-thru.
Right.
You know, we've been very open that we're slower now than we were pre-COVID. You know, we're at least 1 minute slower, and, you know, every 30 seconds is a point of comp for us. We know there's demand in the drive-thru, right? We know at peak periods that we need to see the wheels moving in the drive-thru, as we say it, and that throughput matters. Throughput in the drive-thru can continue to drive transactions as well. That's an operational focus as well, to turn that transactions from negative to positive.
Great, on that last point. You know, this is-these things sometimes take time to institutionalize across the system. I guess, have you already seen progress, or is this just, you know, something that you're now starting to focus on?
Mm
... and we'll see gradual progress as we get through the rest of the year?
We have, we've made it a very, very specific focus. I addressed all of our operators and, you know, like, you can get, you can get into this tailspin where you look at so many metrics, you lose focus on what matters, and I've made it explicitly clear to our operators that the metrics that matter to me are transactions, specifically in the drive-thru, Comp Sales, and then speed of service. So, I expect to see very, very quick progress. Now, it's not gonna happen next week, but it's not. This is not a question of it takes six months to see improvement. This, you know, this is something that you can address very quickly, and I expect to see performance improvement in the drive-thru in the next three to four months.
Got it, and first of all, I'm excited to see the advertising come back.
Yeah.
I guess, is there an opportunity to highlight your value better? I guess, and the question's in the context of an industry that is very focused on value. I guess, you know, what's your thoughts on that? Not necessarily discounting but just highlighting what you already have-
Yeah
... which is really good value-
Mm-hmm
... at least in my opinion. So I guess, is there an opportunity there that you see? And what are you doing about it?
It's tough because, you know, I, we posted a slide yesterday that shows the average price of our most popular bundle, the price of our most popular bundle versus all of our fast casual competitors with and without the arm twisted, you know, "Please tip me," little dynamic, right? 'Cause, like, we don't accept tips. But nowadays, it's very hard to go to a place and buy something and not feel guilted into- ... just hit a few buttons before you close out. So we're a smoking hot deal compared to everybody. But the reality is that that smoking hot deal is still 20%-30% higher than it was for consumers four or five years ago.
Mm-hmm.
I think that sticking price in the consumer's face right now is a non-winning formula. Even though my prices are lower and the relative rate of change is better, it's still a non-winning formula. I think that the best way to communicate value is on the other things that are not price-based. So hot, your food should be... Your fries should be piping hot when you get them. Fast, we get you your food. It's not just physically fast, but there's a sense of urgency. When the food runner in the drive-thru is bringing your food, they're hustling. Friendly, did somebody smile at you when they took your order? Do they make you feel welcome? Those are the things that I think we can very effectively compete on right now.
Absolute price points, like you guys see on social media, how a lot of the QSRs are being, like, destroyed because of their price points, and some of them are trying to push back and say, "No, we're not up 140%. We're up 40%." It's like that's not a winning argument, 'cause... And so I think that for us to connote value, it's the quality is better than ever. The quantity is unchanged. You're getting great food, hot, fresh, fast.
Got it. Let's go back to unit growth, which is the big driver of the business going forward. So, Michelle, can you start by framing up what you target in terms of a, a return when you build a new unit? And then I have a few follow-ups about-
Yeah
... what you're actually seeing, so.
Yeah, no, absolutely. Thanks, David. So we think about our new unit targets as a class of restaurants, so think about it that way, and we're targeting 25% cash-on-cash returns by year three. And so that's, that's the target that we have out there. Now, how we get there, right, is, you know, the formula that we put out there for those year three targets is, you know, generally $7.3 million-$7.5 million AUVs, and by year three, you get to 22% restaurant-level margins. Over the first two years, those margins are gonna profile in the high teens, and then they'll get to 22% in that year three, but it's not done at 22%. So the expectation is the margins continue to grow from there as we continue to build scale and awareness in markets.
We know there's cost benefits with scale, whether it's distribution, leveraging that, leveraging your multi-unit manager, and we also know as we continue to build awareness, that's gonna generate further top-line growth. What we're really excited about is what we're calling Restaurant of the Future. So the restaurants that we're building, starting in the fourth quarter, quarter onward, are gonna be 1,500 sq ft smaller than what, what we're building today. So we're building about 7,800 sq ft today. We're gonna pivot to building 6,300 sq ft, starting in Q4 and forward, and so that's gonna take at least $1 million off the build cost.
What I love is the return profile gets de-risked in a sense, and so what you would have to believe to get to the 25% cash-on-cash is we would only need to do $5.9 million-$6.3 million in AUVs to get to that. Now, if you say, "Okay," and we believe we can still target and get to the $7.3 million-$7.5 million AUVs, then the cash-on-cash can go to 30%+. And then we can talk about, you know, how the new units are performing.
We put out this data yesterday, so if you haven't had a chance to see it, I encourage you to take a look, which showcases the class of 2022 and the class of 2023, and where we are in those year one targets, and you will see that we're profiling at high-teens margins for both those classes. I caveated this yesterday, David, by saying: Look, the class of 2022 has a full year's worth of data. The class of 2023 has 4-8 full periods worth of data. These are still young restaurants.
Right.
The thing that I also want people to take away is not all classes are created equal. We are very unique in the sense of how our honeymoon curves work within our restaurants, and so depending on the profile of an individual restaurant, that could, that could vary the class and how that honeymoon looks. A first-in-market restaurant is gonna have a very severe honeymoon curve, and we can talk about an example there. A Chicagoland restaurant, right, is gonna dip a little, and then it's gonna gradually build, and then an ahead-of-growth restaurant, right, is gonna start out lower, but then that's gonna gradually build. Fill-in restaurants don't have as steep of a curve as a first-in-market. I wanna make sure people understand dynamics of the class and that it's not one size fits all.
The perfect example is the first restaurant we built in Texas at The Colony, North Dallas, right next to Frisco. In the first quarter of 2023, it was on a $17 million run rate. That was unsustainable. We had to have our food distributors coming 6-7 times a week, sometimes multiple times in a day. It was an unsustainable pace. It closed the year at $13 million, and it's stabilized now, and it's settling in at $9 million-$10 million. $9 million-$10 million is a home run. It's an unmitigated home run from all the economics, everything, but it looks like this steep curve.
What it did that was fantastic is it primed the pump for our Allen, Arlington, Denton, Fort Worth restaurants, who then start off stronger because a lot of those people have experienced Portillo's, and now they've got a Portillo's closer to home. Are we done in Dallas? No. You know, we're gonna. You need to have 15-20 restaurants in DFW to have any kind of scale, so we'll keep building. But I love that The Colony jumpstart our growth there and created a lot of awareness, but then it creates this noise because we look at the revenue from new restaurant contribution the first quarter, and The Colony's like a -$7 million contribution year- over- year. And so I think it created some misunderstandings about the performance of new restaurants.
We're gonna have another problem when we open Houston in the fourth quarter. It's gonna come out of the gates super strong, and then, you know, in a year after that, we'll be explaining to people, "Now, remember, Houston opened up, it was insane, and now it's stabilizing.
It's why we don't put restaurants in the comp base until after 24 months, specifically because of the honeymoon, but the curves do matter.
Yep, and Michelle, you know, for those that haven't had a chance to take a look at those slides, on balance with the class of 2022 and the class of 2023, are they tracking to get to what you expected them to do?
They're tracking where we expect them to track. I would call out that in the class of 2023, we did call out a couple specific restaurants that have some nuances to them. Our restaurant in Allen, Texas, there was an incident at a mall nearby there that depressed the foot traffic and traffic going to that mall. That did impact that restaurant as we were about to open. And then Queen Creek, we called out as an ahead-of-growth restaurant that generally is tracking... both are tracking lower than the average. But we're not concerned about those restaurants, right?
Mm-hmm.
I would not call those restaurants out as concerning. It's just there's factors to that-
Right
... that causes those restaurants to be below what a typical average Portillo's would perform at. And so those were the things we called out, David. We did call out that the class of 2023 does not have a first-in-market restaurant in its class. It has two Chicagoland restaurants. The class of 2024, as Michael mentioned, does have a first-in-market in Houston, and so we wanted to make sure people understand and we're being very transparent with the dynamics of the classes as they start to take shape.
... Thank you for clarifying that.
No problem.
It was, it's easy to have-
Yeah
volatility when you only have a-
Sure
- small base, right? The question I have on the investment cost side, I think some of the data you showed had, I think, a $7 million-
Yeah
- plus the last couple of classes.
Yep.
And, I know you're trying to get that down to kind of the low to mid five-
Yeah
- million-dollar range. You know, I guess, you know, what's your confidence that you'll be able to get there?
We're getting bids now for Restaurant of the Future. We're starting to put shovels in the ground on those restaurants, and those bids are in that range. They're coming in at the low end of the range. Now, those are bids, right, David? We've still gotta build the restaurants.
Okay.
But that's what gives Michael and I confidence-
Right
that we're gonna be within that range, is the data that we have today with the bids.
It's encouraging that they're on the low end. We're not done yet. We gotta squeeze, fight-
Yeah
... claw. But, you know, two years ago, the bids were not coming in range.
Great.
Oh, yeah.
Is the biggest difference just the size of the dining room? Is that essentially the change, or are there other components you would-
There's both.
I-
I would attribute it to both. So the engine that runs the restaurant is gonna be the kitchen. And we've been able to shrink our line. If you go into a restaurant in Chicago, you may see a kitchen line that's 100 feet long. I mean, it is long, and there, that's a lot of walking back and forth. Kitchen 23, which is what we're building now, shrunk that to about 65 feet. Restaurant of the Future takes it to about 47 feet, and so you get a little bit of space in the kitchen, and then the dining room, we are being very smart about how we built that out and how table utilization looks.
We worked with a third-party company, Profitality, and to do time and motion studies to look at, you know, not just the kitchen, but how people access us, looking at our drive-through stacking, looking at parking spaces, et cetera, to look at the total footprint. So it was both, David, it was both the dining room and the kitchen.
Yeah.
Got it. And then, another, I guess, key point is, the way you build your restaurants is different than how a lot of other fast casual restaurants build them, where they have leases-
Yeah
on the building, and you own the building. So I guess, could you give us some perspective on, on kind of what an apples-to-apples cash-on-cash return would look like as if you... Like, for example, if you did a sale-leaseback, what that would look like?
So, let me start, and I'll let Michelle chime in. But just so everyone is aware, in most restaurant concepts, restaurant company tends to own the kitchen equipment, they rent the building, and they rent the land. At Portillo's, we tend to own the kitchen equipment and the building, and we rent the land, and so our upfront capital cost is higher. The math is kind of undeniable to some extent because we've never closed a restaurant. We have restaurants that have been open 40, 50 years that generate $3-$3.5 million of cash flow. We get to keep it for our investors. We're not paying rent on those buildings. So if you did a, you know, a DCF analysis, you'd say, "Wow, that's amazing!" Now, there's potential negatives.
One is it's a higher capital burden, so you'd say, at some point, will this slow down your ability to build restaurants? And not for us now, and not for the foreseeable future, but it's something to have in the back of your mind. There's another issue, which is, you're sitting on all of this, this huge piggy bank of buildings you own. Would you ever do a sale leaseback? And I think the answer is, under certain circumstances, yeah, it's a very reasonable way of monetizing that if the math makes sense, right? Now, when you do that, you're gonna pay higher rent-
Mm
... and you're gonna be stuck with that rent for, you know, hopefully for Portillo's, for eternity, but you have to be mindful of that. So there is a trade-off. But what's really important is, on an apples-to-apples basis, what our cash-on-cash returns are.
80%. So if you said Portillo's, if you leased the building and just bought the equipment, what would that return look like? And we put that data out there, it would be 80%.
Right
... on an apples-to-apples basis. You know, but to Michael's point, we think that the strategy that we have in place today is the right strategy for Portillo's. But look, we're open to-
Yeah
... as we continue to grow, you know, how that growth is funded. We feel like we're very-