AFC Enterprises (AFCE), which is the franchisor of the Popeye's brand, is an attractive long term investment at current levels. The company is currently valued as though it is a very average owner of restaurants with modest growth prospects. In contrast, the company represents a highly advantaged, virtually completely franchised model which allows for predictable free cash flow. In addition, the company has significant growth prospects ahead of it for the next few years. One can appreciate this potential growth by reviewing the company's five-year guidance which it initially established during 2010. Importantly, since Cheryl Bachelder took over in 2007, the company's performance has been truly superb inspiring confidence in the company's long term targets.

Company Description: Popeye's has just under 2,000 units today virtually all of which are owned and financed by franchisees. Approximately 80% of the units are in the United States with the rest dispersed internationally in a number of fast growing markets. In terms of unit economics to franchisees, the concept boasts the following averages which highlight the profitability of the model at the franchisee level according to the a recent company presentation:

-          Average Sales Volume: $1.3M

-          Average Building and Equipment Investment Cost: $750K

-          Average EBITDA: $200K

-          Cash on Cash Returns: 26.7%

Current Valuation: The Company recently guided to adjusted EPS of $0.91-$0.95/Share for 2011. In addition, give the highly franchised model, true maintenance capex is only a few million dollars adding another 5-10 cents per share to get to FCF of around $1 per share. Included in this guidance is an incremental few million dollars which will be used to help accelerate growth internationally. This last bit was something of a surprise to the market which reacted negatively when the new guidance was announced. At a current stock price of around $14.65 one can thus pay essentially an average market multiple of FCF for AFCE today. The company also boasts an extremely solid balance sheet with current net debt of around $50mm vs 2010 EBITDA of $45M or just over 1.1x trailing.

Potential Upside: The company, however, deserves a premium multiple owing to the following factors:

-          Pure franchised model: As mentioned above, this is not an ordinary operating business but rather one with highly favorable cash flow characteristics where the company is able to earn a return with very limited investment of their own capital. This is particularly powerful to the extent the company is able to ramp up unit growth as incremental return on capital for new units is effectively infinite. In addition, in more turbulent times, as long as franchisees don't go out of business en masse (which they are clearly incented to avoid at all costs), cash flow to the franchisor stays relatively consistent. This can be seen in the last five years of franchise revenue which has gone $82.6M, 82.8M, 84.6M, 86M, 89.4M annually from 2006 to 2010.

-          Growth: The company recently confirmed its 5-year guidance which consists of annual diluted EPS growth of 13-15%, Global SSS of 1-3% and net restaurant openings of 4-6%. The company commented that the growth should accelerate to some degree in the latter years as the new unit pipeline ramps up. Based on the company's existing footprint, recent sales performance and general conservatism, these targets should be achievable. As for the unit growth specifically, the company's less than 1,600 domestic units ought to allow it to double its US footprint over the long term and opportunities abound in many international markets for growth including its segments in North Asia, Asia-Pacific, Middle East, Latin America, Europe and Canada. If the company hits its guidance targets, it will be generating FCF per share well north of $1.50 in a few years. In addition, the more restaurants the company opens, the more marketing dollars are available to the system which should continue to aid sales efforts.

-          Performance: Since Cheryl Bachelder took over in 2007, the company has delivered impressive same-store-sales and net openings including 2010 SSS of 2.6% and net openings of 39 units which far outpaced the general QSR (+1.2% avg) and chicken QSR (-4.8%) SSS benchmarks. In addition, the company has paid down over half of its net debt outstanding during that time and recently announced a new share repurchase strategy which includes a targeted $20-25M buyback during 2011.

Disclosure: We and our affiliates are long AFCE.  We may buy / sell shares in the future.  This is not a recommendation to buy or sell shares