GTIM Valuation and Industry Comparison

I decided to do a more in-depth valuation analysis on GTIM to demonstrate why I think it is so attractive currently.

Before getting into it however, I wanted to mention that there were more insider purchases last week. The CFO bought 30,000 shares and the CEO bought 5,000 shares. The June quarter earnings should be good. June is a seasonally strong quarter, it will have more than double the Bad Daddy’s restaurant operating weeks year over year, there will be no acquisition costs unlike last year, and with only one Bad Daddy’s opened during the quarter and the delay in the next opening, pre-opening costs should be down. So adjusted EBITDA should be strong. Hopefully that gives the stock some support, but regardless of whether it does or not I still believe the long term picture is very bright for GTIM, which I think my valuation analysis will show.

To perform the analysis I looked at all the US listed restaurant stocks I could find which had share prices above $1, positive EBITDA, and were regularly reporting. I ended up with a comparison group composed of slightly over 50 stocks.

I compiled statistics on several measures of valuation including price to sales, trailing and forward PE ratios, and EV/EBITDA ratios. I decided the best measure to use was EV to adjusted EBITDA. For most of the stocks in the group EBITDA and adjusted EBITDA were very close. However for the smaller, faster growing companies there were more significant differences between EBITDA and adjusted EBITDA due mainly to pre-opening costs being a higher percentage of operating income. If these smaller companies weren’t expanding so quickly they would be showing greater earnings, thus I felt that using EV/adjusted EBITDA made for a fairer comparison.

I thought the best way to visualize the data was to plot EV/adjusted EBITDA versus the long term expected growth rate, resulting in a sort of PEG ratio, except using EV/adjusted EBITDA. To calculate adjusted EBITDA, I started with the ttm EBITDA from Yahoo Finance, which it gets from Capital IQ. To arrive at adjusted EBITDA I added ttm pre-opening costs, obtained from company filings. I did not make any other adjustments to arrive at adjusted EBITDA. The long term expected growth rate is the 5 year expected growth rate, also from Yahoo Finance, which it says is from Thomson Reuters.

I also compiled statistics on store counts, restaurant level operating margins, and sales per square foot from company filings. These statistics help gauge how realistic the long term expected growth rate is. Smaller store counts mean longer runways for growth, strong restaurant level operating margins can be indicative of a concept with strong consumer appeal, and high sales per square foot can indicate strong cash-on-cash returns (which were not readily available for all compaines otherwise I would have listed it instead of sales per square foot).

Now I can describe the chart below. On the Y-axis is the 5 year expected growth rate. On the X-axis is the EV/adjusted EBITDA ratio. Next to each data point is ticker symbol, number of worldwide store units, restaurant level margin, and sales per square foot. Lastly the colored backgrounds indicate long term expected compounded annual stock returns (more on this in a bit).

At a given EV/adjusted EBITDA ratio, a higher growth rate is favorable. Likewise, at a given growth rate, a lower EV/adjusted EBITDA ratio is favorable. Therefore, generally, the more towards the upper-left area of the chart the better it is, and the more towards the lower-right area of the chart the worse it is.

The blue diagonal lines are drawn at constant EV/adj EBITDA to growth ratios of .5, 1 and 2. This is referred to as the PEG ratio when using PE ratios, but here I am using EV/adj EBITDA instead. The idea is the same, though. A ratio of 1 (meaning the valuation ratio is equal to the growth rate) is generally considered fair. A ratio of .5 (meaning the valuation ratio is half the growth rate) is considered inexpensive, while a ratio of 2 (meaning the valuation ratio is double the growth rate) is considered expensive. So again, being above and to the left of the 1 line, and especially the .5 line, is good, whereas being below and to the right of the 1 line, and especially the 2 line, is worse.

Lastly the colored backgrounds indicate expected long term annual compounded stock returns if the company grows earnings at the expected rate for 10 years and trades at a valuation ratio equal to its growth rate at the end of those 10 years. For example, consider a stock which currently has an EV/adj EBITDA ratio of 10 and an expected long term growth rate of 20%. It is in a green region (an expected compounded annual return of between 20% and 30%). So if the stock grew earnings 20% a year for 10 years, and at the end of those 10 years traded at an EV/adj EBITDA multiple of 20, the stock price would appreciate from both the increase in earnings and an expansion of its multiple, resulting in a 20-30% compounded annual return. Conversely, stocks which currently have a relatively high EV/adj EBITDA multiple compared to their growth rates would sit in orange or red regions, actually resulting in negative annual compounded returns if the stock grew earnings at the expected rate for 10 years and traded at a multiple equal to that growth rate at the end of those 10 years.

Restaurant-Group-2

The average EV/adj EBITDA ratio for the group is 12.43 with a standard deviation of 7.19. The average expected growth rate for the group is 15% with a standard deviation of 6.2%.

GTIM compares very favorably to the group. It is nearest to the upper-left corner of the chart, and is one of only two stocks in the darker blue region (40-50% compounded annual return). This is due to GTIM’s high expected growth rate (30%) compared to its EV/adj EBITDA ratio (12).

Just to show what a difference pre-opening costs can make for smaller, faster growing companies, the average difference between EBITDA and adjusted EBITDA for the entire group is 6% (adjusted EBITDA is 6% higher than EBITDA) whereas for GTIM the difference is 100% (adjusted EBITDA is double EBITDA).

The number of units, restaurant level margin, and sales per square foot listed for GTIM are for Bad Daddy’s only since Bad Daddy’s will come to represent the vast majority of GTIM’s growth and sales. With only 17 Bad Daddy’s units, GTIM has the longest runway by far, and the restaurant level margin is solid at 15.9% compared to the group average of 18.0%, and the sales per square foot is above average at $693 compared to the group average of $587.

If GTIM can grow as expected I have no doubt the stock will provide spectacular returns. So I wanted to review once more the reasons why I think GTIM will grow as expected.

  • I think Bad Daddy’s is taking share from all the large, established casual dining chains such as Applebee’s, Chili’s, Outback Steakhouse, Olive Garden, etc.
  • I think Bad Daddy’s is appealing to millenials who like trying new places instead of going to the aforementioned chain restaurants.
  • Reports suggests that contrary to the popular narrative, millenials are increasingly moving to the suburbs. However they still want the things urban living provides ready access to – farm to table restaurants, craft beers, walk-able areas. There is even a name for it – “hipsturbias.” This is fueling demand for the types of lifestyle centers that Bad Daddy’s is locating in.
  • I like that Bad Daddy’s is positioned in the casual dining space instead of the overcrowded fast casual space.
  • User reviews for Bad Daddy’s continue to be very good.
  • Bad Daddy’s is proving itself. The locations opened so far are meeting the target economic model.
  • With only 17 locations so far, the runway for growth is very, very long.
  • I think there are some trends favoring the restaurant sector such as increased eating out versus cooking at home, consumers increasingly spending on experiences as opposed to goods, and more recently lower commodity prices.
  • I feel I can understand restaurants fairly well and I do not think they can be “Amazoned.”
  • I think management really gets it. On the most recent earnings call they mentioned where they believe their sales are coming from. They mentioned that they don’t want to appear anything like a chain restaurant. They mentioned that they don’t want to do any big media advertising for Bad Daddy’s for fear of ruining the local, independent feel. They mentioned Texas Roadhouse as a model for using local and social advertising. Texas Roadhouse (TXRH) is one of the few restaurant stocks near an all time high, so I would be very happy if GTIM could emulate TXRH’s success.
  • I think management has really zeroed in on where to place new locations. Management has mentioned how the best leading indicator for store openings is the level of outperformance of competing local chains. Coincidentally I happened to catch a feature on Nightly Business Report the other day on the CEO of Texas Roadhouse where he mentioned that that was one of his best indicators for new location success as well.
  • I think management is honest and forthright in its communication. Having held the stock for around 21 months now, and having listened to numerous conference calls and presentations, and having increased my knowledge of the restaurant sector, I feel that management has been transparent, has largely delivered on what they said they would, and has not clammed up when addressing their problems. I also feel that management is long term oriented, and are good capital allocators.