I was overall pleased with GTIM’s Q1 earnings, and liked what I heard on the earnings call about the company’s strategic direction going forward. Some notes:
- The North Carolina Bad Daddy’s have an average unit volume of around $2.7 million with around a 20% restaurant level operating margin.
- New store openings are targeting $2.5 million average unit volume and around 17% restaurant level operating margin, generating 40% cash on cash returns.
- The Colorado Bad Daddy’s, excluding the Cherry Creek location, generated $3.3 million in restaurant level cash flow last fiscal year, generating 28% cash on cash returns.
- Construction around the Cherry Creek location should be done around March. Company has an out on the lease at year end if store does not rebound to pre-construction sales level.
- Management believes they can maintain Colorado restaurant level operating margins with 3.5% price increases the next few years.
- Fiscal 2017 and 2018 store openings are generating sales 12.3% above the system average.
- Management believes that they can grow Bad Daddy’s store count by 20-25% annually from internally generated cash flow once they reach around 45 Bad Daddy’s locations.
- Gross debt should peak towards the end of fiscal 2020 Q2.
- As the company grows to $10 million + in EBITDA, with 8-10 new store openings per year, very little additional debt will be needed.
- Management believes they can grow adjusted EBITDA by 40%+ the next few years while keeping debt/EBITDA below 2.
- As Bad Daddy’s sales continues to grow, the overhead efficiencies from Good Times restaurants becomes less impactful, and company can evaluate alternatives from continuing to harvest cash flow, monetizing assets, or franchising locations.
I believe management laid out a clear, credible path to increased profitability and shareholder value.
In contrast, I do not believe the recently departed directors have articulated a clear strategy at all. Their first SEC filing merely mentioned an increased focus on productivity, without providing any details or specific proposals. Their second filing mentioned re-franchising Colorado restaurants, as well as franchising other areas.
I am not against franchising. I could point to successful examples of both franchised and company owned (as well as mixed) models. However I do not believe franchising is the right approach for Bad Daddy’s at this time.
As the company mentioned, the Colorado Bad Daddy’s excluding the Cherry Creek location generated $3.3 million in restaurant level cash flow last year, which is accretive to earnings. If the company were to re-franchise those units they would be exchanging that cash flow for a franchise fee of maybe around 5% of sales, which would be significantly less.
I think franchising works best for concepts suited to large numbers of locations, such as Subway, McDonalds, etc. Bad Daddy’s is not such a concept. The higher price point, and more finesse required to execute the concept limit the potential number of locations compared to more quick serve or fast casual concepts. For a concept such as Bad Daddy’s I believe that the benefits of the company owned model of capturing all the operating profit and greater quality control outweigh the benefits of the franchise model, which is primarily the use of other’s capital to expand rapidly and collect franchising fees.
Additionally, if you believe the Bad Daddy’s concept is solid long term (which I certainly do), then re-franchising now seems the equivalent of selling them at the low, when their profitability is likely at a low point due to absorbing the increases in the Colorado minimum wage. After the last of the minimum wage increases in January 2020, profitability should be on the upswing again.
I think management is doing a good job, and keeping an even keel with an eye on long term shareholder value. I think complaints by the departed directors of the stock under-performing during a period of strong overall market returns is not a valid complaint. GTIM should be compared to peers, specifically smaller emerging restaurant concepts. If you look at that cohort, they have almost all gotten crushed – from Habit Burger, to Zoe’s Kitchen, Noodles & Company, Shake Shack, Rave Restaurant Group, etc.
The departed directors reliance on straw man arguments such as that and lack of a clearly defined strategy lead me to believe that they are simply upset that they got stuck in an out of favor, under-performing sector while the rest of the market was ripping higher, and they wanted a quick pop, instead of sticking it out for the longer term, larger opportunity. I believe the franchising approach they are advocating is risky at this time because there simply won’t be a large enough installed store base to generate a meaningful enough franchise royalty stream capable of supporting a significantly higher stock price, not to mention increased execution risk.
Bottom line, I want to see management continue on the path they outlined, growing adjusted EBITDA to $5 million, then $10 million, and on. As adjusted EBITDA reaches those levels, all sorts of possibilities for accelerating increases in shareholder value open up – from accelerating store unit openings, to stock buybacks, to issuing dividends. I still believe that GTIM has the potential to be a 10-bagger, and that management has the best plan to get there.