It’s been a tough year for American steakhouse chain Del Frisco’s Restaurant (NASDAQ:DFRG). Del Frisco’s Restaurant stock  has lost half of its value since making its way toward $20 per share in March which has led many to consider picking the beaten down stock up in hopes of a rebound.

The firm’s second quarter results told an optimistic story about future growth, but Del Frisco’s Restaurant’s heavy dependence on debt makes it a worrisome investment.

Second-Quarter Roller Coaster

Last week the firm released its second quarter results, after which Del Frisco’s Restaurant stock investors were taken on a wild ride. Part of the reason for that was surely profit taking, but another aspect is the fact that the results were decidedly mixed.

On one hand, sales were up more than 9% from the year-ago quarter and restaurant level EBITDA margins were up 20 basis points. Management maintained its long-term financial targets of more than $700 million in revenue by the end of 20201. Based on those targets, Del Frisco’s Restaurant would be growing its revenue by about 10% per year. 

However, a deeper dive showed that things weren’t quite as rosy as management seems to believe. For one, although improving restaurant level margins are commendable, investors should keep in mind that they don’t take into account important metrics like administrative costs- a big-time expense for restaurants. Adjusted EBITDA margins, on the other hand, were down 220 basis points. 

Perhaps the biggest problem for Del Frisco’s Restaurant stock was declining traffic. Not only did the chain suffer fro declining comparable restaurant sales, but traffic was down 7.5% during the second quarter. While the company’s 1.4% comps decline was disappointing, it was the traffic loss that hurt the firm’s growth story the most.

Losing customers in any business is bad news, but for restaurants it’s even worse. First of all, fewer people means less money. There’s only so much you can raise prices before declining traffic will offset that balance. But more important is the fact that customers breed more customers. The atmosphere in an empty steak house isn’t worth paying for and that kind of trend can be extremely damaging to the firm’s reputation.

Debt and Del Frisco’s Restaurant Stock

While you may be able to overlook Del Frisco’s Restaurant’s shortcomings, there is one looming grey cloud that investors should be wary of- debt. A big part of the Del Frisco’s Restaurant stock growth story is expanding its store footprint significantly.

That’s worrying because not only is the firm already struggling with its existing locations, but opening new restaurants is an expensive gamble. Plus, Del Frisco’s Restaurant isn’t currently earning enough to finance those new locations, which means the company has to rely heavily on debt and leverage in order to make it’s plans come to life. 

Compared to its peers, Del Frisco already carries a much higher debt load and although the firm has vowed to pay that down in the coming years, it’s difficult to believe that’s going to happen when you consider the firm’s lackluster revenue growth and aggressive expansion plans. 

The company is planning a secondary public offering in which it will sell $75 million worth of shares, the proceeds of which will go toward repaying the loans Del Frisco’s took out in order to acquire Barter Restaurant Group.

While that’s encouraging, there’s no guarantee that people will want to buy any of those shares, let alone $75 million worth. Del Frisco’s is also exploring the sale of its Sullivan’s business, which would also bring in an influx of cash, but again there’s not guarantee that a buyer will be found.

The Bottom Line on Del Frisco’s Restaurant Stock

If you trust management and you’re on board with their lofty targets, then now might be an ideal time to buy Del Frisco’s Restaurant stock. However, when looking at the firm’s peers in the restaurant industry and their own second quarter results, Del Frisco’s looks like a sub-par pick.

While declining restaurant traffic is a concern across the board, peers like Texas Roadhouse (NASDAQ:TXRH) and Dardin Restaurants (NYSE:DRI) had a much better showing.

The restaurant industry itself is shaky at the moment, and choosing a financially unsound firm like Del Frisco’s is simply too risky in my opinion. 

As of this writing, Laura Hoy did not hold a position in any of the aforementioned securities.