First Watch Restaurant: Q2, Traffic Issues Are Likely Temporary (Rating Upgrade)

Core Viewpoint - First Watch Restaurant Group, Inc. reported a significant decline in consumer traffic in Q2, leading to a revised 2024 guidance that reflects continued weakness in the second half of the year, although the overall growth story remains intact unless the traffic decline becomes a long-term trend [1][5][10] Financial Performance - Q2 revenues reached $258.6 million, a 19.5% year-on-year increase, driven by a 10.1% growth in system-wide sales and prior franchised restaurant acquisitions, slightly exceeding Wall Street's expectations by $0.9 million [2] - Same-restaurant sales declined by -0.3%, primarily due to a -4.0% drop in traffic, as First Watch maintained higher pricing, impacting visitor numbers [2][3] - The adjusted EPS for Q2 was $0.18, surpassing Wall Street's consensus by $0.04, with gross margins increasing by 1.0 percentage points to 21.9% [4] Industry Context - The sales weakness experienced by First Watch is consistent with broader trends in the restaurant industry, where peers like Dine Brands and Cheesecake Factory also reported declines in same-restaurant sales [4] - The weak consumer sentiment has particularly affected weekday breakfast and daytime lunch segments, which are critical for First Watch's business model [2][5] Guidance and Future Outlook - The 2024 guidance was revised to expect comparable sales to decline between -2% to 0%, a notable shift from previous expectations of 0% to 2% growth [5] - Despite the lower comparable growth outlook, First Watch maintains a total revenue growth forecast of 17-19% and an adjusted EBITDA range of $106-112 million, supported by plans for 51-57 net restaurant openings in 2024 [5] Valuation and Investment Case - The updated discounted cash flow (DCF) model estimates a fair value for First Watch's stock at $21.38, representing a 42% upside from the current stock price [7] - The weighted average cost of capital (WACC) has been adjusted to 8.00%, down from 9.57%, reflecting changes in the company's capital structure and interest expenses [8] Conclusion - Despite recent traffic declines and a challenging industry backdrop, First Watch's pricing strategy and expansion plans are expected to drive long-term earnings growth, leading to an upgraded investment rating to Buy [10]