Description

Freshii is a franchisor of healthy QSR restaurants with almost 400 locations in over 20 countries. After a very hot IPO in Q1 17 (priced at CAD $11.50,  high end of upwardly revised range), FRII's stock collapsed after the company was forced to lower its 2019 unit growth expectation as a result of a failure its Target partnership, slower development from multi-unit franchisees, and an under-resourced corporate development team.  However, this shortcoming appears to be more of a timing issue than a fundamental business flaw.  System health remains strong with consistently strong SSS and the low capital cost and solid returns of the company's stores have created strong demand among potential franchisees.  While it may be volatile, FRII shares should have solid downside protection at CAD 4.90 and solid upside to CAD 13 which appears like a solid risk-reward at $6.60.

Capitalization and Valuation

***** NOTE USD FUNCTIONAL CURRENCY VS CAD SHARE PRICE*********

FRII has 32.3mln shares for a mkt cap of CAD 213mln and USD 161mln at CAD 6.60 and CAD/USD 0.75.  The company has USD 28.3mln of cash  for an EV of USD 132mln.  2018 revenue is expected to be 23.1mln (5.7x) and EBITDA is expected to be 8.8mln (15.1x).

Business

Freshii franchises health-food conscious QSR restaurants with a focus on the millenial customer base. The company considers itself "the Zara of fast food" because of its focusing on menu innovationto stay abreast of new food trends and diverse menu (no category > 18% of sales). After research by the company's in-house chefs and nutritionists, they aim to bring a new healthy menu item to the masses at an affordable price point. The company was the fastest chain to hit 200 stores, reaching that goal in 11 years which was fater than McDonalds, Subway and Domino's.

The company has an attractive proposition for potential franchisees.  Freshii has a very flexible store model that does not include cooking equipment.  This allows significantly lower capex costs (~$260k) compared to QSR peers ($1mln+).  These lower capital costs have allowed Freshii to claim >40% cash-on-cash returns at lower than peer AUV levels.  In conversations with current franchisees I have found that most are very satisfied with their restaurant and the support for Freshii corporate.  Most are expecting to open further stores as evidenced by the fact that despite its rapid expansion, >30% of Freshii store openings are coming from the existing franchisee base.

Management

CEO Matthew Corrin founded Freshii in 2005 with one store in his hometown of Toronto and started franchising in 2007. He owns almost 20% of the company and controls the vote through his 100% ownership of the super-voting Class B Shares.

Despite having limited business and restaurant experience, Corrin has quickly developed Freshii in a multi-national franchisor with an attractive brand that appeals to young, urban customers despite only raising $4mln pre IPO and without spending on franchisee advertising until 2018.  The company's highly regarded culture (2016 winner of Best Workplace Culture at 2016 Canadian HR Awards) is focused on its mission of bringing healthy food to the masses.

Corrin has quickly moved up the learning curve to be a public company CEO noting that he "became maniacal about listening to and reviewing quarterly and annual earnings calls of the best publicly traded restaurant stocks."  He was won multiple awards including  Ernst & Young Entrepreneur of the Year award, Canada’s Top 40 under 40, Inc. Magazine’s Top 30 under 30, Restaurateur of the Year by the Canadian Association of Foodservice Professionals and Top Franchise of the Year in Canada.

His commentary suggests he has a long-term orientation and is numbers focused.  He lives and breathes the business and interviews every single store manager before they are hired. Some quotes:

Matthew: I don’t look at the share price. I literally have no idea what the share price is today. So, just the short answer is no and the reason is you just can’t control…when you’re building something for the long-term, like week to week, quarter to quarter doesn’t actually matter. You know, for every year, I expect that we will continue to execute on our mission and the share price will then move accordingly to that mission and that execution, but you can’t control what happens day to day and week to week, and so, then there’s no point in focusing on it. In fact, I think it’s dangerous to focus on it.

"Our attitude is bad stuff first, good stuff last and every morning in our huddles, it's the worst things first and then we roll into other updates. ... But I think that's really important and also finding ways to talk to [franchisees] directly is very important. ... It really makes me feel like we have our finger on the pulse."

"There have been some public statements around how other brands are handling and how other brands are suggesting franchise owners handle the minimum wage increase. My view is man of those suggestions feel short-term in nature. So while the immediate savings will be intact, I think the long-term impact on the culture potentially gets compromised."

"Creating a culture is the most important profitable aspect"

Corrin also has an eye for free publicity, launching two widely reported campaigns targeting Subway and McDonald's franchisees and trying to get them to switch to Freshii.  These campaigns provided significant free publicity and inbound franchise interest.   Below is an excerpt from the Subway letter:

We have a sincere  proposal to help  Subway appeal to  the next generation  of

fresh food lovers and your franchise partners globally.

Rather than risking the  closure of another 900  Subway stores in 2018,  let’s

explore a partnership. Let’s work together to convert select Subway stores  to

Freshii restaurants. This will allow Freshii and Subway to achieve a  mutually

beneficial  outcome:   supporting  entrepreneurial   franchise  partners   and

continuing to deliver on our missions.

Over time, we too plan to open thousands of restaurants around the world as we

continue to  deliver on  our mission  of making  healthy food  convenient  and

affordable for  all citizens  of the  world.  But we  could get  there  faster

together

By allowing some of your franchise partners to convert now, we believe  you’ll

be creating a better business future  for them.  You’ll also be improving  the

future of your remaining franchise partners who will continue to operate their

Subway restaurants in a  less crowded marketplace. The  health of the  overall

Subway system will be improved.

Upside

The company's 2017 setback was a result of a lack of corporate development capabilities, not the any weakness in underlying store operations or demand for the Freshii brand from franchisees.  Through Q1 2018, Freshii has delivered 20 consecutive quarters of positive SSS growth, showing that the underlying operations appear attractive and the Freshii brand and product is resonating with consumers.

The company's likelihood of achieving their unit growth goals look much more solid now.  The company needs to add another 350 stores to achieve its goal.  At Q1 18, Freshii had contractual commitments to open 385 new stores with 150 already engaged in the active opening process.  Furthermore, the company got a large boost from its UK master franchisee who spoke publicly about adding 200 Freshii's in the UK in the next 5 years, the majority of which are not included in Freshii's guidance at this point.

The company has opportunities to increase its same store sales by expanding into the breakfast daypart (currently testing), rolling out an improved mobile app and expanding

The company also has upside optionality from non-restaurant sales.  Freshii started a successful partnership with Air Canada for onboard meals and has just announced a pilot program with Shell Canada for grab and go at Shell stations.  These meals differ from the restaurant offerings and so the company believes they have the potential for significant incremental revenue and is looking to expand to other geographies and with other partners.

Even with the growth setback, FRII is still expecting to double its store count from FY 17-->FY 19.  With that growth and continued 3-4% SSS growth FRII EBITDA could reach over 18mln in FY 2020.  Keeping the multiple at 16x EBITDA, then FRII would be worth CAD $13, almost 100% upside from current levels.  CAD $13 would be just under a  5% FCF yield which seems reasonable for a capital-light, fast growing franchisor.

It should be noted that if FRII is successful, EBITDA will have grown at a ~50%% CAGR from 2018 to 2020 and there would still be significant unit growth opportunity as FRII would only have ~750 stores globally with a significant runway for future global growth.

Downside

FRII has a solid balance sheet with ~USD 0.90 per share of net cash and is expected to generate ~8.8mln of EBITDA in FY 18.  At 10x 2018 EBITDA which is a far below normalized result, the stock is worth ~$CAD 4.90.  CAD 4.90would also be a ~7% FCF yield on ~ CAD 0.34 of FCF per share.

Another way to look at it is that FRII should generate ~17mln of "recurring" (royalty & other) revenue in FY 18.  CAD 4.90 would be ~5x this recurring revenue stream which seems conservative given the strength of the brand and the growth potential.

Catalyst

Continued system sales growth

Progress toward 2019 unit growth goals

Additional non-traditional partnerships and expansion of existing programs