New Long – RAVE Restaurant Group

I went long Rave Restaurant Group (RAVE) today. RAVE is a micro-cap stock with a market cap of roughly $150 million. They recently changed their name and ticker symbol. Prior to that they were Pizza Inn (PZZI).

RAVE is similar to GTIM in that it is a micro-cap restaurant stock which is undergoing a transformation. I actually discovered RAVE at the same time I discovered GTIM last year, but I felt that GTIM had the better potential. Recently RAVE’s transformation has been accelerating and the stock doubled in short order. With the cash I freed up from the sale of SFM, I decided to initiate a half position here in RAVE.

RAVE’s legacy chain is Pizza Inn, which consists almost entirely of franchised units. Pizza Inn is a buffet type pizza place, which I consider to be in general decline. What interested me about RAVE is their Pie Five concept. Pie Five is a fast casual, build your own pizza concept. It is sort of like a Subway for pizza. You choose your toppings and it is prepared in front of you. It then goes into a quick bake oven which takes only a few minutes. There are no Pie Fives in my area so I haven’t been to one, but I have been to similar places. Reviews for Pie Five on places like Yelp are good (average seems to be around 4 stars) although the number of reviews is not especially large.

I think this type of concept is here to stay. However it is also insanely crowded, which is largely why I didn’t invest in RAVE (then PZZI) when I discovered it last year. I am aware of at least 10 similar concepts, many with substantially more buzz or backed by bigger parent companies (Blaze, Pieology, Project Pie, Mod Pizza, Pizza Rev by Buffalo Wild Wings, Pizzeria Locale by Chipotle, etc).

Another factor which caused me not to invest in RAVE when I first discovered it was that the unit economics of Pie Five didn’t look particularly attractive. AUV (average unit volumes) when I looked at it last year were around $700,000-$800,000.  This didn’t seem very good to me when I compared it to places like Chipotle and Habit Burger, which have AUVs in the $1.5M-$2.5M range. GTIM’s Bad Daddy Burger Bar concept had AUVs in the $2.5M range, which was a large part of what attracted me to GTIM.

One more factor which turned me away from RAVE last year was that although they seemed to be making a lot of noise about their Pie Five concept, they didn’t seem to actually be opening many locations. Pizza Inn created the Pie Five concept in 2011, but as recently as late last year they had only around a dozen or so units.

A final factor which dissuaded me from investing in RAVE last year was that even if I thought the Pie Five concept held promise, I considered the Pizza Inn concept to be in long term decline. Often with a company which has one business which is declining and another which is increasing, the stock goes nowhere for a long time until the increasing business overwhelms the declining one. I contrasted this with GTIM, which although I invested in it primarily for Bad Daddy’s potential, the legacy Good Times chain was also growing.

So again I ask, what changed?

1) In RAVE’s most recent quarter Pie Five same store sales increased 16.9%, and AUVs were approaching $1M. Additionally I looked into AUVs for traditional pizza chains and discovered that $1M actually compared favorably to places like Domino’s, Pizza Hut, and Papa John’s which were in the $700k-$900k range. I was originally skeptical of the AUV potential for these fast-casual pizza places but then I came around to the idea that they may have more potential than I thought because they may appeal to a different type of consumer. Whereas I view the traditional pizza places as a family/group type order, primarily for dinner or parties, the fast casual pizza places are meant to be individual orders, and with the customization and quick preparation may have more appeal for lunch as well as dinner.

2) RAVE has significantly accelerated their opening of Pie Five units, both company owned and franchised. At the end of their December quarter they had around 30 locations system wide, and they stated by the end of their fiscal year (which ends June 30) they expect to have around 60 units open (about half of which will be company owned). That is a doubling of system wide units from 30 to 60 just from December to June.

3) While I am still concerned by how much competition there is in this space, I came to the conclusion that many of RAVE’s competitors’ expansion plans seem to be based on opening high traffic/high buzz locations (the types of places which might generate 1000 reviews on Yelp), whereas RAVE seems to be happy opening everyday, ordinary locations. And for the competitors owned by Buffalo Wild Wings and Chipotle, it appears they are being very deliberate in the pace of their rollouts, perhaps waiting until AUVs approach closer to what they are used to in their existing businesses, lest their new concepts drag down the growth their investors are used to/expecting. Thinking about this some more, I began to think this might work in RAVE’s favor as competitors follow a more methodical approach limiting themselves to larger markets while RAVE blankets everywhere else.  RAVE’s established infrastructure appears to have helped them sign up franchisees rapidly.

4) RAVE’s Pizza Inn concept stabilized in the December quarter, actually achieving 6.4% same store sales growth. If the Pizza Inn business just stabilizes, then at least that won’t be a drag against Pie Five’s growth.

5) The stock doubled. This may seem like a negative, but I actually ultimately considered a positive. I did ask myself, why should I buy this after it has doubled? But then I recalled that part of the reason I spurned RAVE last year was I was afraid it would go nowhere until Pie Five growth overwhelmed Pizza Inn decline. The fact that the stock doubled told me that the market had taken notice. It was ‘on the radar’ now. RAVE picked up their very first analyst coverage, from Roth, who has a $20 price target. With only 30 Pie Five locations and a $150 million market cap, I felt it was still very early in the story, even if the stock had already doubled.

RAVE has a clean balance sheet, with not a lot of spare cash, but not a lot of debt either.  Future dilution appears fairly limited. RAVE shares a lot of characteristics with GTIM which I consider favorable – low market cap, low number of shares outstanding, low institutional ownership,  low analyst coverage, catalyst for transformation.

Like GTIM, RAVE is not yet profitable. However I felt that right here, just as RAVE is ramping up store openings, the risk of not investing was greater than the risk of investing. If/when RAVE reaches 300 Pie Five locations open, that is when I would feel the risk is greater because they might be bumping up against the competition more.

I only used about half of the proceeds from my SFM sale on RAVE, so my cash increased a bit to around 15%.