Description

Bab, Inc. (BABB) is the perfect company to own in the current low rate environment. The Company has minimal capital requirements and has a consistent record of paying out its earnings in dividends, giving it a yield of 8.3%, based on last year's pay out. Yes, it's a small Company with limited liquidity but it's a significant bargain that cannot be found in the macro world. The business is extremely straight forward and is easily understood and analyzed. There is no complicated technology or cloud-based growth analysis here.

The Company was established in 1992 primarily to franchise out Big Apple Bagels stores. In 1997 it acquired  the rights to My Favorite Muffin stores.  The Company primarily licenses Big Apple and My Favorite Muffin stores. As of November 2015, the Company had 84 franchised units and 3 licensed units in 23 states and one international location. In addition, it had seven units under development. The Company also derives income from the sale of its trademark bagels, muffins and coffee (Brewster's) through non traditional channels of distribution, including a licensing agreement with Kohr Brothers.

The BABB franchised brand consists of "Big Apple Bagels", featuring daily freshly baked bagels, flavored cream cheeses, premium coffees, gourmet bagel sandwiches and other associated products. Licensed Big Apple units serve frozen bagels and other licensed products. The Big Apple Bagel units are primarily concentrated in the Midwest and Western United States. In the past few years the Company has made a concerted effort to eliminate poorly performing franchises, hence the total number of franchises has tended to decrease. Over the last few quarters the number of franchises looks like it's stabilizing.

My Favorite Muffin franchises feature a variety of freshly baked muffins, coffees and related products and units operating My Favorite Muffin and Bagel Cafe feature these products as well as  a variety of freshly baked bagels sandwiches.SD frozen yogurt can be added to either the Bagel or Muffin franchises as an additional brand. Brewster's Coffee products  are also sold in most franchises.

The Company assesses a $25,000 initial franchise fee for the first store and $20,000 for each additional store. In addition there is an ongoing 5% royalty on net sales and a 3% ongoing fee to fund the system-wide marketing fund. 

In  2014, a Master Franchise Agreement (MFA) was entered with a Dubai Company which includes ten Middle Eastern countries. BABB received a $200,000 franchise fee as payment for the first 15 locations opened. Franchisees will pay a 3% franchise fee, of which 50% will go to BABB and the rest to the Master Franchisee. The first Big Apple international location was opened in November 2015. It doesn't sound like a great deal for BABB, but it gives the Company its first international exposure.

Of course, this is a very competitive business but BABB is fairly well established in its region given its 24 year operating history. As investors, at the current valuation we are not so much looking for growth but stability so that we can collect a consistent payout. But, we believe the growth will also come and will obviously be a significant additional benefit. My point is that we don't need it to justify an investment in the shares.

The Company has only 17 employees, operates no franchises on its own and simply collects the fees and runs the marketing program. It's not a bad deal. The franchisees do all the work and you collect a nice fee for simply their use of your brand name. The capital requirements are minimal and earnings basically flow to the owners. 

Results

The Company just released first quarter results (February 2016) and performance was excellent. Total revenue was up 18% versus last year, driven by a volatile 70% increase in licensing fees. EPS was over $.01 per share versus a loss  last year, driven by a lawsuit settlement last year. The Company seems well on track to deliver the $.05 per share we anticipate this year, which in all likelihood will paid out as dividends. 

Value

With a trading price of $.60 and $.05 in earnings the shares trade at 12X earnings, which is extremely cheap relative to any large successful franchise you compare it to. With the earnings expected to paid in dividends, as in past years, the dividend yield is 8.3%. The balance sheet (as of November 2015) is solid with $1.26 million in cash and minimal debt ($33,400). BABB is simply a cash generation machine operating in a stable business.

Management owns 35.7% of the shares, pay themselves reasonable salaries and is committed to rewarding shareholders with continued dividends. 

Risks

1) This ia a micro cap with limited liquidity.

2) A larger competitor could inflict significant damage on the Company.

3) Management has essential control of the Company with their large position.

Catalyst

1) The Company's undervaluation.

2) Significant future growth could attract investors.

3) Management may simply decide to take it private near the current cheap valuation.

4) Do we really need a catalyst given the nice dividend we are collecting?