Thoughts entering the New Year

As I mentioned in my year end review, I feel very comfortable entering 2016 with GTIM as my only position. The big picture reason I like GTIM is simple.  With its Bad Daddy’s Burger Bar concept,  it is a classic regional retail/restaurant stock with national expansion potential. However there are many such stocks, most of which will go nowhere. So why do I feel confident betting that GTIM can fulfill its potential? There are several reasons.

1) I believe that the Bad Daddy’s concept is appealing to consumers. It was named by Zagat as one of the best burgers in the country and it is getting good scores on the review sites (Yelp, Google, Urbanspoon, Tripadvisor, etc). The food covers the biggest segments (burgers, sandwiches, and salads) and has options for different diets, and customizable build your own burger and salad options. While Bad Daddy’s is not for the healthier eating conscious, they do have options for vegetarian, gluten free, and low carb diets.

2) I like that Bad Daddy’s is positioned in the full service segment, rather than the fast casual segment. I believe that fast-casual has become very crowded – Bad Daddy’s would have to compete with Chipotle, Panera, Zoes, all the fast casual better burger places like Shake Shack, Habit, Five Guys, all the other fast casual upstarts in other categories too numerous to count, and even all the fast food chains which are trying to upgrade their offerings.

By positioning itself in the full service segment instead, I think Bad Daddy’s competition is rather places like Buffalo Wild Wings, BJ’s, higher end burger places like Zinburger and Hopdoddy’s, steakhouses, gastropubs and sports bars. Still crowded, but far less so than fast casual in my opinion.

3) I think the positioning as full service, slightly higher priced, fits well with where new retail developments and remodels are going – more upper scale, experiential, lifestyle type developments instead of the declining legacy malls and strip mall sites. I think this opens up different, and better long term site opportunities for Bad Daddy’s than if it were competing for the same spots that all the fast casual places are vying for.

I think some of the details of the Bad Daddy’s concept, such as the addition of rooftop bars to some locations,the selections of local craft beers, and the build your own burger and salad options fit in well with the trend towards experiences in both restaurant and retail.

4) Whereas in most industries being the dominant, established player brings tremendous advantages (economies of scale, brand recognition, etc), I think that in a few cases it actually starts to work against the industry leaders, such as when a brand becomes associated with fast or cheap (McDonald’s or Walmart) rather than better-for-you or upscale. In food in particular, I think the trend among the younger demographic (call them millenials if you want) is to discover and try new places rather than the old familiar chains. I think Bad Daddy’s is designed to appeal to this demographic in particular, with its small-box concept.

I think Bad Daddy’s is doing well to avoid the chain perception, even as it adds locations, by making each location feel like a one-off by doing things such as not having all the exteriors look exactly the same, and having the local craft beer selections in different regions.

5) Bad Daddy’s unit economics are attractive, with a high average unit volume (around $2.5 million), high sales per square foot (above $700/sq ft), good restaurant level operating margin (target of 20%), and attractive cash-on-cash returns (40% return after second year open). If Bad Daddy’s maintains those targets as they open more locations I think GTIM will become quite profitable.

6) I think the restaurant sector has some tailwinds which make it attractive for the foreseeable future. Data has shown a long term trend towards eating out versus cooking at home, with recent data showing  spending on dining out surpassing spending on groceries for the first time.

I think restaurants and other small-luxury type indulgences are benefiting from lower gas prices. Even if gas prices were to move up, I am not too concerned because I think these types of small luxuries are among the few indulgences still affordable to the increasingly squeezed middle class consumer.

Dining out is not in danger of being ‘Amazoned’, as many other retail sectors have been. In fact shopping site developers are courting more of the types of businesses which are resistant to online shopping, such as restaurants, exercise/workout places, and other experiential destinations.

7) I think food commodity prices, in particular beef prices, have peaked for the foreseeable future. As they come down that should help restaurants margins. While wages are increasing, to the extent that they are the product an improving economy, I do not think it is something to be overly concerned about.

8) GTIM’s senior management is experienced in the restaurant business. Board members include  former CFO experience at Burger King and Pizza Hut as well as experience in restaurant property REITs.  Directors and executive officers collectively own a lot of GTIM’s shares.

I believe that management is honest and forthright in their communication with shareholders, and have the long term interests of the business at heart. I think management is being prudent in their expansion plans, waiting for the right sites to come along instead of pursuing growth at all costs.

Management has largely delivered on what they said they would do in the roughly year and a half I have been following the company. They acquired complete ownership of the Bad Daddy’s concept and they have mostly met their store opening schedule. If I had one complaint about management it would be that they have been slightly optimistic in their store opening guidance, with the shortfall due mostly to factors outside of their control. I would prefer if they accounted better for such uncertainty.

9) GTIM’s insiders have bought shares recently. Although it could be called just a token amount, the CEO bought 2,000 shares around $6.10 in August. Perhaps more encouraging, the CFO bought 30,100 shares around $4.24 last month (December).

10) It is still early enough in GTIM’s story that I feel saturation is not a near term concern, and GTIM’s valuation is still reasonable enough that I think just a couple years of expansion could have a significant impact on GTIM’s share price. This is in contrast to the plethora of fast casual IPOs of the past few years, which debuted with high valuations and were much further along with their store counts. In almost all of those cases I could envision a scenario in which they grow store counts as expected for several years but the stock price hardly appreciates as it grows into its valuation.

In the case of GTIM, I would be more concerned if they were already at 200 Bad Daddy’s locations, or even 100. But at only 15 or so units, I think Bad Daddy’s should be able to grow to at least 50 units easily. There are numerous public restaurant stocks with 100+ units which are profitable and have much higher market caps than GTIM, but whose concepts don’t have the potential I think Bad Daddy’s does.

11) Although Bad Daddy’s base is very small at only around 15 units, it has been proven in 4 states (Colorado, North Carolina, South Carolina, and Tennessee) in 6 metropolitan areas. One of the Colorado locations has the highest average unit volume in the system. This, plus the appeal of the concept, give me confidence it will work as GTIM expands the concept to other geographic locations.

12) GTIM has a healthy balance sheet, with around $14 million in cash and $3 million in debt. With cash on hand, cash from operations, and a modest amount of debt, GTIM has the resources needed to fund their expansion plans well into 2017 with minimal dilution.

13) As it stands currently, GTIM is trading at around 10-11x fiscal 2016 (which ends in September, not December) EV/adjusted EBITDA. I think adjusted EBITDA is appropriate to look at in GTIM’s case since they are growing off such a small base and pre-opening costs are a meaningful percentage.

I think GTIM can open roughly 10 Bad Daddy’s units a year for the next several years. At $2.5M AUV, that will add $25 million in sales each year. Add in a little same store sales growth, and perhaps a few new Good Times units each year and I think GTIM could increase sales by $30 million a year for the next several years. GTIM has guided to around $70 million in revenue for fiscal 2016. So I think they could do $100 million in fiscal 2017, and $130 million in fiscal 2018. GTIM has guided to adjusted EBITDA at around 6.5% of sales for fiscal 2016. That should expand by a couple of percentage points over the next few years.

If GTIM’s growth pans out as I think it could, then I think GTIM would deserve to trade at least at industry average EV/EBITDA ratio (around 15x) or EV/sales ratio (around 2x) for healthy, growing concepts. Either way I arrive at a price target of at least $15-$20 by the end of 2018. That represents compounded annual growth of over 50% over the next three years.

14) GTIM is a company I think I can easily understand. I feel I understand the restaurant industry fairly well. And GTIM is a purely domestic story so there are no foreign macro conditions to consider. I can follow the user reviews to see if ratings are slipping. As new locations are opened I can monitor if they are producing unit volumes and economics equal to the system average. If things play out as I expect, then sales, earnings, cash flow, cash and margins should all grow and be fairly easy to track.

15) I think the risk/reward at current prices is very attractive. I think the downside at current levels is only around 10-20% and the upside is 200% or more.

So all the above are why I am comfortable with my GTIM position going into 2016, and also partially explain why I was reluctant to sell any GTIM last year, even as I grew more nervous about the overall markets.

This turned into a rather long post, so I will go over the rest of my New Year’s thoughts in a follow-up.