Description

There is no shortage of restaurant write-ups on VIC (both long and short), but nonetheless, I think BOJA is the most compelling in the space at its current price (admittedly I might be biased as I’m from the Southeast).  I think it makes a lot of sense that value investors like restaurant concepts – they are easy to understand, easy to model, easy to assess as a businesses (unit economics), not subject to much technological disruption (people will still need food 50 and 100 years from now), and generally have very long runways for growth.  At the right price and with the right concept, they make for phenomenal long term investments. 

LimitedDownside did a BOJA write-up in September 2017 which I would highly encourage anyone interested in this to read (to make it easier on myself, I won’t be repeating much of what he said on unit economics or some of the general stats on the businesses).  My thesis is generally the same (excellent, proven concept at an attractive price) but I want to fill everyone in on what has happened with the business since then and provide a few personal opinions on what I think the market is underappreciating.

I began spending a lot of time on the QSR and fast casual restaurant industry in mid-2016, predominantly due to the dramatic decline in Chipotle’s stock and the daily coverage in the news.  While I had been a Bojangles customer for most of my life, this was when I noticed it was publicly traded (still majority owned and controlled by the PE firm Advent International).  And like LimitedDownside, I think busted IPOs can occasionally provide some compelling opportunities.

For those unfamiliar, Bojangles is a Southeastern fried chicken LSR concept with a specialty or focus on breakfast (~40% of sales).  It’s most distinguished item which provides the primary moat or brand value is its made-from-scratch biscuits.  I personally love their chicken but the biscuits are their true “differentiator” relative to other fried chicken or breakfast concepts. It attempts (unsuccessfully in my opinion) to spin itself as more of a fast casual restaurant than a QSR as everything is made in plain sight and there are servers that bring you your food.  It doesn’t allow any of its restaurants to have a microwave.

Why is the stock down so much?

Starting from the beginning, the company IPO’ed in May 2015 at $19, rallied to nearly $30, and subsequently declined to the $14-16 range 12-18 months later.  Essentially, newer and trendier QSR/fast casual concepts such as Potbelly, Noodles, Zoe’s, and Shake Shack IPO’ed in the 2013-2015 time frame with tremendous success pushing the market multiples on the entire space (including Bojangles) to highly overvalued levels.  The air was slowly let out of this balloon starting in the second half of 2015 with multiples compressing across the industry.  Bojangles initially garnered a substantial premium, initially trading as high as 20x forward EBITDA and 40x forward P/E.  Same store sales growth slowed in 2016 and that premium multiple turned into a discount around when LimitedDownside posted his piece. 

This was around when I began buying the stock.  While my entry price has obviously been poor and I’ve been wrong for now, I don’t beat myself up about it too much.  At the time, Bojangles had been in existence for nearly 40 years and had just demonstrated its 26^th consecutive quarter of SSS growth.  SSS growth was slowing and margins were historically high, but even with conservative assumptions of 1-2% future SSS growth, average margins, and company-guided 7-8% unit growth, the purchase price implied a high teens IRR with decades of runway.  I looked very smart shortly thereafter as the stock rallied to a high of $22 before reporting its 1Q17 earnings.  This was even after the company had reported large SSS declines for January and February in its 4Q16 earnings.

I sadly did not sell a share during this run-up which was unrelated to fundamentals as I simply believed the stock was getting closer to fair value.  The company has since posted 1-2% SSS declines for the first three quarters of 2017 and will likely do similar or worse numbers for the 4^th quarter.  The market has punished the stock for this with it declining 45% from its highs in April as I write this.  Margins have shrunk predominantly due to the sales deleverage substantially hitting EBITDA and net income while the market multiples have also declined which is obviously a vicious combination.  I guess I learned my lesson on paying any sort of growth multiple (I generally stick closer to the deep value parts of the market).

What now?

The stock has muddled around the $12 context since mid-October and got a temporary pop after disappointing 3Q earnings due to the announcement of a $50mm share buyback authorization (~11% of the company at current prices).  I think it’s worth pointing out that the stock received no boost at all from the new tax plan coming together despite the fact I expect it to increase FCF by ~15%.

At the current price of $12.15, the stock is trading at 7.5x trailing EBITDA and 13.6x trailing EPS.  LTM EBITDA is $79mm (compared to 2016 EBITDA of $89mm) and Street consensus for 2018 and 2019 EBITDA is $68mm and $72mm, respectively.  To start, I think consensus is far too low.  I assume 1.5% SSS growth, flat contribution margins in 2018 and 70bps of improvement in 2019 and am coming out to $77mm and $86mm, respectively.  I think these are conservative assumptions as my contribution margins are still significantly lower than any other year going back to 2012.  Below are summary financials any me forecasts through 2019:

At the current price and assuming most of FCF is used to buyback stock, you are paying 5.6x 2019 EBITDA and will be earning a FCF yield of 17%, on my assumptions.

What is being overlooked or underappreciated

To start, I think the market must be lower than my expectations (and possibly below the Street as well) otherwise the multiples above are far too cheap.  Thus my first opinion is that the market is underappreciating the resiliency of this brand.  Even the venerable McDonald’s had -1% SSS declines in 2014 (LSD traffic declines for 2013 and 2014 but partially offset by price increases) so I don’t think SSS declines of 1-2% in a single indicates the death of Bojangles as the market price seems to imply.

I think most would agree that New York based concepts generally receive a substantial premium in the market (see SHAK multiples) and as a corollary, concepts unfamiliar to New Yorkers can occasionally be discriminated against.  Bojangles began in Charlotte and truly has a cult-like following in the Carolinas (similar to Chick-fil-A in Georgia but Chick-fil-A has a much strong presence and brand recognition nationally).  Many of these units do more than $3mm in AUVs which is pretty spectacular outside of densely populated urban areas.  If the market truly thinks this brand has “run its course” I think it’s wildly mistaken, especially with respect to its units in the Carolinas.

Secondly, while its not totally unique to Bojangles, I think the market doesn’t appreciate the combination of franchised and company-owned concepts.  Franchise-only concepts trade at 15-20x EBITDA, while BOJA with nearly 60% of its units franchised, garners a mid-high single-digit multiple.  The capital efficiency and stability of a franchise model are obvious, but there is only so much white space for a good restaurant concept and the absolute dollars made per restaurant are much higher for company-owned so I think it’s the right business decision to own the majority of your core markets.

Somewhat combining the prior two points, I don’t think the downside protection of Bojangles is appreciated at this price.  Even if the expansion to “adjacent markets” and outside the Southeast is untenable (we’ll never see the 20x EBITDA multiple again), the core units are tried and true and aren’t going anywhere.  Unit growth may grind to a halt but the base of units doing over $2mm in AUV (system-wide average is currently $1.8mm) are very safe and stable.   The 433 (and growing) franchised units also provide stability against general cycles in the QSR category (food/labor inflation, etc.).

Lastly, I don’t think the risk asymmetry at the current price is appreciated.  While my points above illustrate why I think the downside is muted, I think the potential upside is tremendous.  The same vicious combination of shrinking margins and declining multiples reverses if there is any sort of meaningful SSS growth.  Applying the same unit economics the company demonstrated in 2015 (which was worse than 2016) on the 2019 expected units, the company generates of $100mm in EBITDA and $70mm in FCF.  At a 15x FCF multiple, this would be greater than a $30 stock.

Catalyst

• Share buybacks
• SSS growth
• Margin improvement