MTY Food Group,
revisited...
10/04/2020
Ticker: MTY
Exchange: Toronto Stock Exchange (TSX)
Stock Price: CAD$23,77
Market-Cap: CAD$587M
I think it’s fair to say that the restaurant industry is going through its worst period ever. People are not allowed to leave their homes, social distancing is the new normal and restaurants are suffering, badly!
At the store level, a restaurant owner must pay salaries to the employees, rent to the franchisor, interest on the loan, insurance, etc. And these are just the fixed costs.
The franchisor, in turn, will receive royalty payments every month, rental payments, marketing fund payments, IT fund payments, etc. Then he’ll turn around and pay his landlords for the leases on those restaurants, the interest and maturities on the debt (to the bank or investors), etc. Again, these are just the fixed costs.
And then the landlords – which most of the times are funds or Real-Estate-Investment-Trusts (REIT) with lots of debt – will have to tell their lenders that they cannot pay because they haven’t been paid by the tenants. It’s like a house of cards. I had already mentioned it before on my latest take on The Gym Group.
I don’t think banks will want to foreclose on these funds and REIT’s and these funds and REIT’s won’t want to foreclose on their tenants and the tenants won’t want to foreclose on their franchisees. We will definitely see cases where this will happen, but in general, I don’t think it will be the norm.
So let’s take a look at MTY. MTY is a 398 bagger. A bagger (or multibagger) is a company whose stock price has at least doubled in price. So a 398 bagger means that you could’ve multiplied your money by 398 if you invested in this stock some 20 years ago. You can thank Stanley Ma, the founder and Chairman.
The all-time high for MTY’s stock price was back in 2018 when it reached CAD$73,18. Today it trades for CAD$27,77. What I’ll be trying to figure out today is whether there is a reason for such a sell-off or if, on the other hand, this could be a great investment opportunity.
If you’re not familiar with MTY’s business, you can go back and read my previous write-ups. This is a franchisor in the Quick-Service-Restaurant sector. It owns more than 80 brands like Papa Murphy’s, Casa Grecque, Cold Stone, Tiki Ming, etc. Most of the company’s revenue comes from royalties paid by the franchisees on their gross revenue. This is a high margin, low capital-intensive business. A great business, many would say.
The problem starts when there’s a global pandemic which forces all of the restaurants to close doors. Without people eating at its restaurants, the franchisees don’t sell food, the company doesn’t collect royalties, it isn’t be able to pay its lenders or pay the rent…
It’s not only MTY that is going through this. Every single restaurant owner in the US, Canada and some parts of Europe is going through the same. The scale is just unheard of.
For instance, The Cheesecake Factory said that it won’t be able to pay the rent to its landlords in April. You see, in “normal” times, if a tenant tells its landlord that it won’t be paying the rent, the landlord will just take the property and lease it to somebody else. But now, in the middle of one of the biggest crisis ever, to whom will these landlords lease their real estate? The franchisor’s bargaining power is huge. Any landlord will prefer to accept a late payment or even a lower payment than no payment at all.
As in my latest “The Gym Group” analysis, what we want to be doing right now is the Zero Revenue Liquidity Test. I’ve recently come across this study by Raymond James research that looks into the liquidity of a group of American restaurant chains. Given that I’ve been doing this Zero Revenue Liquidity Test for some companies recently – and to make sure that my general assumptions are correct – I’ve decided to look at a couple of these companies and check if I could reach similar conclusions. I chose “The Cheesecake Factory” and “Shake Shack”.
Note: Thanks to @eighttrack for sharing this on twitter.
After a brief look at the companies’ financials, I’ve concluded that – keeping the costs unchanged from 2019 – The Cheesecake Factory would be able to survive for 11 weeks (versus the 24 in the picture) and Shake Shack would be able to survive for 32 weeks (versus the 158 in the picture).
Now, how does Raymond James get to such higher numbers? I don’t have access to the whole report so I can only speculate, but I would say it’s because they are modelling a radically lower cash burn than in 2019.
It’s not easy to estimate these cost-cutting measures without some kind of guidance from the companies.
Fortunately MTY has issued a press-release from which we can draw some conclusions. I will spare you the small print and just share the important stuff:
First of all, from the 7.373 restaurants in MTY’s network, 2.100 are now closed and the rest is working in a reduced capacity (delivery or take-away). This means that there are approximately 5.300 restaurants which are still open. I expect these to materially decrease in the coming days.
Then the company tells us that it has temporarily laid off over half of its workforce and that the management team and directors have reduced their base salaries. I wasn’t expecting anything else. This is the least you can do to show you’re in the same boat as your employees.
So let’s see what we can figure out from these clues.
First of all, we’ll need to find the “sources” of cash which are available to the company and the “uses” of cash for the next 12 months.
Sources:
The company has cash and cash equivalents in the amount of $51 million. Then it has an “undrawn revolver facility” of $181 million. This just means that it can ask the bank for $181 million more. A revolver facility is something like your credit card. The company has a certain amount that it can use and if it pays part of it today, it will be able to use it again tomorrow.
Ok, so the $50 million plus the $181 million add up to $231 million.
Uses:
Now is where it gets tricky. It’s very hard to identify all the costs and check which are fixed and which are variable. I’ve read every single Earnings Call transcript since Q3 2018 to see if there were any clues, but I had no luck.
Fortunately, we had that piece of information we’ve seen previously.
On November 30 2019, the company had 2.825 employees. If half of it was laid off, it means that the company now employs some 1.400 people. In 2019 the wages and benefits paid were $107 million (CAD), which would be about $2M per week. With the recent cuts, we could say that the weekly cash burn just for salaries would be about $1M.
The rest of my assumptions lead me to Operating Expenses for 2020 of $254 million. These operating expenses assume several variable expenses like for instance Cost of Goods Sold which are only generated if something is sold. So what I’m doing is to be extra-punitive. I assume that the company will have to pay for several costs that would be generated only if there was some revenue, but I’m not assuming any source of cash coming from that revenue.
So, those $254 million plus $14,3 million in interest payments plus $5 million in debt maturities add up to total “uses” of $273 million, which divided by 52 weeks would mean a cash burn of $5,2 million per week give or take. I’ll be sharing my excel model on the Facebook Group so you guys can check all of these assumptions.
Adding it up:
If we divide the Sources by the weekly cash burn, we’ll get to the number of weeks the company can survive with zero revenue: $231M ÷ $5,2M = 44 weeks!
According to my calculations, MTY can survive for 44 weeks with zero revenue.
Bare in mind that I’m letting several important things out of this math. I’m assuming that the franchisees will be able to pay the rent or that the landlords will let MTY defer those payments. Thus, I’m not accounting for charges related to litigations, disputes or closed stores nor am I accounting for accounts receivable or accounts payable, etc, etc. The reality is much more complex than any calculation one might make, but even so, one should at least try to understand where the company stands right now.
Wrapping up:
I believe the restaurant industry, especially the quick-service-restaurant industry, to be the best positioned for a “quick” turnaround among the hardest-hit industries out there (hotels, cruises, restaurants, airlines, gyms…).
It was Gavin Baker on the Invest like the best podcast (which I highly recommend) that said something along the lines of “Who doesn’t want to go out and eat some greasy fast-food when this is all over?”. All of my friends are clamoring for a lunch or a dinner out.
When all of this is over, I’ll bet you that I’ll go out for lunch and dinner even more than before. It’s called revenge spending. I know fast-food is no luxury and it’s exactly for that reason that I think it will be even more popular in the coming years.
This is the part where I should reach a conclusion. This stock has been hardly hit and if we pictured a “normal” scenario, this would be trading at a normalized EV/FCF of 9,2 or an EV/EBITDA of 7,3, which is ridiculously cheap.
But the thing is. I’m still not completely convinced. Not because of anything in particular, don’t get me wrong. It’s just that this is such a fluid situation that I still don’t feel I’ve grasped it well. I’m not sure what the new MTY will look like after this virus thing. Having said that, MTY is a serious contender to enter the All in Stocks Portfolio, but not just yet. I will be studying this industry in the coming days and weeks and if or when I make a decision, I’ll write about it.
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