We believe that Del Taco Restaurants (TACO) is a compelling long idea with a one year price target of ~$14.  The company differentiates itself from other QSR’s on the basis of its product quality (freshly cooked food with refrigerators in many stores displaying fresh produce) at a good value relative to Taco Bell and other QSR’s (average TACO 2014 check of $6.49).  TACO shares have been pressured by general market volatility, investor aversion to SPAC’s, leverage (2.6x debt to EBITDA), concerns related to weakness at El Pollo Loco and fears over increased competitiveness in the QSR category.  We believe that these concerns are excessive and expect continued strong fundamental performance to drive strong share performance over the long-term.  TACO recently preannounced strong 5.8% Q4 comparable restaurant sales and provided solid 2016 guidance for comparable restaurant sales up 2.5% to 4.5%.  Improved premium offerings and store remodels should continue to drive check growth and margin improvement.  Despite high unit level margins and cash on cash returns, TACO trades at the lowest valuation in the QSR group at just ~8.2x EV/2016E EBITDA, well below peers with deteriorating fundamentals.  We expect shares to trade to ~$14 over the next 12 months based on 10x EV/EBITDA.  TACO is a U.S. focused business with no exposure to volatile emerging markets and no foreign currency related headwinds.  An improving low end U.S. consumer (with lower gasoline prices) should also provide tailwinds for TACO.  The company may also see some modest traffic benefit from Chipotle’s issues although the thesis is not predicated on any traffic benefit from Chipotle.  We believe that TACO is well positioned to deliver long-term HSD to LDD revenue growth (LSD to MSD comp growth) with margin expansion driving annual EPS growth into the double digits over the long-term.         

COMPANY OVERVIEW

Del Taco Restaurants, Inc. (TACO) is the second largest Mexican-American QSR chain in the U.S. with nearly 550 restaurants in 16 states (primarily in the Western U.S.).  Del Taco’s menu has fresh items consisting of classic Mexican dishes and traditional American favorites including hamburgers and crinkle-cut fries.  TACO restaurants offer handmade pico de gallo salsa, fresh sliced avocado, marinated grilled chicken, lard-free beans slow-cooked from scratch and cheddar cheese grated from 40-pound blocks with a working kitchen at each restaurant.  Del Taco also has a value menu (Buck and Under), which contributed ~22% of 2014 revenue.  Restaurants are open 24 hours per day and serve breakfast from 11 pm to 11 am daily.  TACO became a public company when it completed a business combination with Levy Acquisition Corp. (a special purpose acquisition company) on June 30, 2015.    

KEY INVESTMENT POINTS

The company is driving a mix shift to more premium products, leading to high relative same store sales growth and improving margins.

TACO continues to strengthen its position as a QSR+ restaurant through product innovation across its tiered menu strategy including items such as fresh sliced avocados, handcrafted ensaladas, and freshly grilled carne asada steak.  The new premium products are driving menu mix improvement, contributing over 2% to TACO’s check growth over the past few quarters and driving operating margin improvement.  The mix benefit is further enhanced by the restaurant re-imaging program (combined solutions) to enhance the focus on fresh and increase the premium positioning (more fast casual offerings) with 479 restaurants completed as of September 8, 2015.  Recent innovation has enabled TACO to consistently deliver same store sales growth above the peer group average while growing operating margins.  With an average check of just $6.49, below Taco Bell at $7.20, TACO has significant room for additional growth in check through more premium products. 

TACO has a long-term expansion opportunity into new territories as well as infill of existing markets.

Management expects to open 14 to 18 restaurants system-wide in 2016 (LSD growth), followed by MSD system-wide unit growth in 2017 and HSD system-wide unit growth thereafter.  This growth is expected to come in the form of both company stores and franchise stores.  78% of TACO’s revenue is from Southern California and we expect the company to expand into new markets over time (current store base is primarily in the Western U.S.) while continuing to infill existing markets.  We believe the concept (fresh quality at a value price) and product offering will resonate in new regions.  Of note, TACO has only ~550 restaurants, well below Taco Bell at nearly 6,000 in the U.S.  Management is targeting 2,000 units over the long-term and we believe that TACO has a strong long-term growth opportunity.    

Unit level margins are at the high end of the peer group and cash on cash returns that are the highest in the QSR group and not far below high performing quick casual concepts. 

TACO’s model generated unit level margins of 18.7% in 2014 (with margins improving in 2015) at the high end of the peer QSR group.  With continued same store sales growth, operating leverage and menu mix benefits, we expect additional unit level margin expansion.  In addition, TACO generates best-in-class, cash-on-cash returns that improved from 22% in 2012 to 26% in 2014.  We expect cash-on-cash returns to continue expanding over time.

VALUATION

The company’s valuation does not properly reflect its long-term growth prospects and strong business model.

TACO is trading at just 8.2x EV/2016E EBITDA, well below the peer average of ~13x and below underperforming LOCO at 8.7x.  We expect that continued solid performance from TACO will lead to multiple expansion to closer to at least the low end of the peer group and that over time additional multiple expansion towards the peer average levels is likely.  A conservative 10x forward EV/EBITDA multiple on our 2017E EBITDA suggests a one year price target of ~$14.  To calculate our price target, we use a share count of 41 mil. shares to account for an estimate of 1.4 mil. shares issued related to the 12.25 mil. warrants outstanding (exercise price of $11.50) at a projected share price of ~$14. 

TACO has an experienced and capable management team.

Paul Murphy has served as President and Chief Executive Officer since joining the company in February 2009. Mr. Murphy previously held various positions with Einstein Noah Restaurant Group, Inc. between 1996 and 2008, including President and Chief Executive Officer beginning in 2003. 

Lawrence Levy has is the Chairman of the Board and previously served as Chairman and Chief Executive Officer of Levy Acquisition Corporation before the merger.  Mr. Levy was previously Executive Chairman and Chief Executive Officer of Levy Restaurants until 2004, before the company was sold to Compass Group USA.  He brings significant restaurant industry experience to the company.      

RISKS

Key risks include, 1) highly competitive industry,  2) weakness in the U.S. consumer, 3) expansion into new markets may encounter headwinds, 4) volatile supply costs, 5) dependence on franchisee performance (~241 franchise owned locations), 6) higher labor costs, and 7) exposure to Southern California, which accounts for ~78% of total company’s revenues.