Valuing Fogo de Chao Suddenly Becomes Foggy Proposition

 | May 15, 2017 | 12:00 PM EDT
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Fogo de Chao (FOGO) , one of the few restaurant names I find somewhat intriguing these days, had been on a very nice roll since October. Indeed, FOGO shares were up 50% from October to late April before getting a 20% haircut last week.

It wasn't because of operating performance that the shares tumbled, as Fogo de Chao reported first-quarter results last Monday that were responsible for just a very small portion (-1.5%) of last week's damage. FOGO 's earnings were in line with consensus estimates (18 cents a share) and it beat expectations on revenue ($76.4 million versus $75.3 million), while same-store sales were just modestly positive (up 0.3%). The market all but shrugged.

The thing that really sunk the stock was the Tuesday announcement by stockholder Thomas Lee Partners, which owns nearly 79% of the company, that it would sell a block of 4.5 million FOGO shares, or about one-sixth of the shares outstanding. That news sent FOGO shares down about 7% on the day. While this is technically a secondary offering, FOGO will not get any proceeds from the sale.

However, the damage was not yet complete, as the offering had not yet been priced. That pricing occurred after the market closed on Thursday, and the $14 offering price, which is 6% below Thursday's closing price, brought with it more damage, sending shares down another 8%.

The decline here is not surprising under the circumstances. Take a stock trading at $17, with normal average volume below 50,000 shares a day, dump 4.5 million shares on the market out of a large institutional stake, and watch what happens next.

It will be interesting to see how the situation unfolds from here. The potentially good news is that this offering may provide more liquidity in the stock. In addition, there is no dilution; the shares being sold are existing shares

The stock needs to adjust from here. The market believed Fogo de Chao to be worth $17 a share prior to the secondary, which valued it at $14. That disparity has cast a shadow on the stock, real or imagined, which the markets will work out in the daily tug of war between price and value.

This stock is still relatively cheap versus other restaurant names, at about 14x next year's consensus estimates. The thing that may be holding its valuation down, apart from the stock offering, is its exposure to economically struggling Brazil, which is where 10 of the company's 47 stores are located.

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