Sunday, August 30, 2009

Spotlight On: Restaurants

Spotlight On: Restaurants

The restaurant industry is experiencing significant damage from the contraction of the economy as consumers continue to cut back on discretionary spending. At the beginning of 2009, the food service industry consulting firm Technomic forecast industry nominal growth of -2.2 percent. That estimate is probably too conservative. In June, the National Restaurant Association confirmed that challenges persisted for this industry and that same store sales and traffic continued to soften. We can expect to see an increase in bankruptcy filings as over-leveraged chains begin to violate loan covenants.

The restaurant industry is composed of several segments: quick service restaurants (QSR) and the casual ding segment. Some would say the QSR segment is better positioned to weather the storm because of consumer perceptions of vale, lower priced menu items and the poaching of customers from full-service restaurants. In this segment, Burger King (BKC), McDonald's (MCD), and YUM Brands (YUM) appear to be the healthiest with significant liquidity and do not have near term maturities.

Our outlook for the casual dining segment is negative as costs continue to escalate and consumers are either trading down to the QSR segment or just staying home. Several companies have engaged in large debt-financed acquisitions or share repurchases and are now feeling the pinch. Examples include Darden Restaurants (DRI) and Brinker International (EAT). These companies may experience credit downgrades as they struggle with their debt. 

Market capitalizations of most major restaurant operators have declined drastically on the past 12-18 months. However, because of lack of access to low cost debt and free cash flow pressure, we do not expect much in the way of share repurchases or restaurant acquisitions. An increase in the number of bankruptcy-related closures will reduce industry capacity. Buffet's, Vicorp, and Metromedia Restaurant Group all filed for bankruptcy this year and are closing hundreds of restaurants.

In this challenging environment, we find one company, Rick's Cabaret International (RICK) as an interesting prospect. Rick's is an operator of "adult" nightclubs and bars. From Reuter's:

"Rick's Cabaret International, Inc. incorporated in 1994, owns and/or operates a total of 19 adult nightclubs that offers live adult entertainment, restaurant and bar operations. Nine of its clubs operate under the name Rick's Cabaret; four operate under the name Club Onyx, upscale venues that welcome all customers but cater especially to urban professionals, businessmen and professional athletes; four operate under the name XTC Cabaret; one club that operates as Encounters; and one club that operates as Tootsie’s. The Company’s nightclubs are in Houston, Austin, San Antonio, Dallas and Fort Worth, Texas; Charlotte, North Carolina; Minneapolis, Minnesota; New York, New York; Miami Gardens, Florida; Philadelphia, Pennsylvania and Las Vegas, Nevada. The Company owns and operates adult entertainment Internet Websites. The Company’s online entertainment sites include CouplesTouch.com, NaughtyBids.com and xxxpassword.com. In April 2008, the Company acquired a media division, including the trade magazine serving the multi-billion dollar adult nightclubs industry. As part of the transaction the Company also acquired two industry trade shows, two other industry trade publications and more than 25 industry Websites."
What makes Rick's a standout in this industry? For one thing, it is profitable. Sex sells. Rick's has a current P/E of 12.4 vs a three year average of 23.5x. Other valuation ratios are similarly depressed. Price to Book is now 0.96 vs 2.54 and Price to Sales is 0.98 vs a three year average of 2.15. The company's gross margin is a strong 65.9 percent for the training twelve months (TTM) vs 65.3 for FY2008. TTM operating margins are down to -2.0 as compared to 22.9 percent in 2008 but net margins are about 7.6 percent.

Debt is not an overwhelming problem for Rick's. Total liabilities to total assets are 45 percent; long term debt to capital is 30.2 percent and long term debt to equity is 43.4 percent. sales growth is strong at 45 percent y-o-y and continuing strength in gross profit which grew 19.8 percent y-o-y. There is weakness in net income which declined .8.5 percent y-o-y.

At current prices, RICK is trading at 12.22X FY09 consensus of $0.64, 8.19X FY10 consensus of $0.955 and 5.47X FY11 consensus of $1.43. The June 2009 quarter actual of $0.20 beat the Street consensus of $0.19 and the March 09 actuals of $0.16 beat the consensus of $0.11.

Disclaimer: Author holds no position in any company mentioned in this article.








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