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MTY FOOD GROUP INC MTY.
February 11, 2019 - 2:03pm EST by
Supersny
2019 2020
Price: 69.00 EPS 3.73 4.4
Shares Out. (in M): 25 P/E 18.5 15.7
Market Cap (in $M): 1,307 P/FCF 13.2 11.2
Net Debt (in $M): 172 EBIT 137 164
TEV (in $M): 1,480 TEV/EBIT 14.6 12.7

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Description

  
EXECUTIVE SUMMARY
MTY Food Group represents a high quality, capital light, ~100% franchise restaurant business that fits the Outsider & Compounder Roll Up Frameworks. Its franchise business model leads to recession resistant annuity revenue streams which represents a good late cycle business/stock at good entry point. The stock is currently trading >15% off its peak in November 2018 and only +5-10% since its 10/10/18 Q3 print when they beat consensus EPS by >25%.
 
It’s an opportunity to Partner with Outsider Stanley Ma (Founder, ~20% owner) in early Phase 2 “Replication”. Ma has a tremendous track record as MYT has put a +25% CAGR over last 3 years vs. +9.2% and +6.9% for the S&P 500 and the TSX, respectively. Ma has already nearly doubled EBITDA over the last two years and he is moving to Chairman so that he can focus on larger M&A. The company flies under the radar with limited Analyst coverage as management team eschews Bankers, public interviews and the media. However MYT just did its first quarterly call which shows that they are becoming more shareholder friendly and more institutionalized which could be a good sign for stock liquidity as the stock graduates to larger and more widely distributed research coverage.
 
Also, the stock is extremely cheap based on conservative M&A estimates: trading at ~17x 2019 P/E, ~10.6x 2009 EV/EBITDA, ~8.2% 2019 FCF yield. Franchise restaurant comps trade at >20x P/E and ~15x EV/EBITDA (see Appendix) for larger, slower growth companies. In addition, EPS is understated by ~$25mn of amortization per year and therefore 2019 “Cash” EPS is actually $4.40 (~$0.80 higher).
 
It’s especially interesting right now because comps are improving. Q3 2018 comp was + and its two year stacked comp inflected positive (+0.8%) in Q3 2018 vs down -1.5% in Q1-Q2 2018. This was driven by “Bread & Butter” higher margin franchise revenue streams. In addition, management is shifting incentives so that regional managers will now have their bonuses tied to comparable sales.
 
On top of this, margins inflecting upwards as EBITDA margins were +800 bps y/y in Q3 2018 and they are expected to be +630bps FY 2018. Mgmt says margin expansion is “sustainable” in US, but consensus still has limited margin expansion going forward
 
Lastly and critical to the thesis, M&A will continue to be the main driver of growth, yet consensus excludes M&A from its estimates. MTY has already added ~4,000 units via M&A since 2016 and since 2017 has added another ~773 units (~15% unit growth) via M&A and this is not all in #’s yet. Furthermore, MTY is under levered at ~1.7x PF 2018 ND/EBITDA and they are willing to lever up to >3x for the right deal. While this isn’t my base case this implies that they can spend ~$900mn on M&A in 2019-2020 and still remain under its target. This could add ~$150mn in EBITDA or ~115% growth vs. PF 2018 EBITDA without issuing another share
 
COMPANY OVERVIW
Stanley Ma, founder of the MTY Group, opened his first restaurant in Montreal in 1983: “Le Paradis du Pacifique”. Over the subsequent ~10-15 years Ma began to develop new brands in house that fit unfulfilled niches in the marketplace. By 1995, MTY became a subsidiary of Golden Sky Ventures Inc., a company listed on the Vancouver Stock Exchange. However, it wasn’t until 1999 that MTY Group made its first acquisition, Fontaine Santé. In May 2010, MTY Group listed its shares on the Toronto Stock Exchange under the “MTY” ticker.
 
MTY started with one unit in 1983 and by 2008 the company surpassed ~1,000 units. By 2012, MYT surpassed 2,000 units before this jumped to >5,000 units by 2017. Using conservative assumption they will reach >6,000 units over NTM. In November 2018, MTY completed it’s a mgmt succession plan. Stanley Ma moved to Exec Chairman and former CFO Eric Lefebvre moved on to become CEO so that Stanley Ma could be more focused on larger M&A, while Eric focused on operations.
 
MTY Food Group Inc. is now one of the largest franchisors in North America’s restaurant industry with 5,690 locations (5,615 franchise, 75 company) and ~100% of its EBITDA comes from Franchise locations. MTY deploys a portfolio approach with >75 brands, that cover all styles of food and preferences as this is key to responding to the different tastes of consumers today and in the future, but the company still remains relatively undiscovered.
 
Currently ~47% of units are based in Canada while ~44% are in the US and ~9% of units are based outside of North America. However, given its more well established, Canada contributed ~61% of YTD EBITDA in 2018. In addition, Quebec is largest region post Imvescor with ~27% of salesandCold Stone Creamery is its biggest brand with >20% system wide sales.
 
TARGET PRICE & VALUATION
Based on estimates I believe this investment has an asymmetric upside/downside with Base case ~$103 (+69%), Bear case ~$53 (-12%), Bull Case ~$119 (+95%). This implies that its >5x Base/bear case upside/downside over next two years
 
While management doesn’t provide long term guidance, my base case assumes continued stable / slightly + comps, continued EBITDA margin expansion as well capital allocation that in-line with its historical cadence. For comps, I assumes +0.9%, +0.7%, +0.7% for FY 2019, 2020 and 2021 as higher growth concepts are added to its comps base. In addition, Mgmt incentives are now tied to comps, continue to replace lower AUV concepts with higher AUV concepts
 
I assume EBITDA margins in of ~43.0%, ~43.9% and ~45.0% for FY 2019, 2020 and 2021 as MTY continues to efficiently leverage its scale – as the bigger MTY gets, the higher its margins can get.
 
Lastly, I assume incremental M&A of ~$150mn (on top of already announced), ~$200mn and ~$250mn for FY 2019, 2020 and 2021. I CONSERVATIELY assume it is able to acquire brands at 8x EBITDA, which is a blended avg of large deals (8-10x EBITDA) as well as small deals / broken brands (~5-6x EBITDA). For my base case I use ~19x P/E as MTY’s average five year forward P/E multiple is 19.3x.
 
VARIANT PERCEPTION
Based on my base case my for FY 2019 my EPS is ~15% higher, while my EPS is >30% higher than consensus based on FY 2020 estimates.
  
I believe this large variant perception in earnings power stems from a few things. First, sell-side doesn’t include future M&A despite >20 years of consistent M&A and >95% of MTY’s EBITDA growth comes from M&A. Also, sell-side doesn’t model in much EBITDA margin expansion. 2019 consensus only has ~39.6% EBITDA margins and I believe MTY might surpass this in 2018.
 
Next, investors are overly focused on comps, which remain positive, instead of M&A and synergies. This playbook is similar to CSU.CN, SSNC and ATD/B.CN which were all previous successful Compounder Roll Ups where management took slightly positive comps where focused on M&A and synergies as this both produced a better ROIC and return on time.
 
Lastly, sell-side is overly focused on unit growth and MTY has closed more stores than they have opened organically for past few years. This is strategic as management is constantly culling underperforming franchise operators that they have inherited through acquisitions while looking to replace them with higher AUV brands. This is possible as MTY controls all of the franchisee leases and so they can easily replace one stale brand in a location with a stronger growth brands. As seen below, average revenues/unit continues to show strong growth.
 
OVERVIEW OF INVESTMENT THESIS
 
THESIS #1: HIGH QUALITY PLATFORM
 
STRONG REVENUE GROWTH POTENTIAL
• Consistent organic growth in core business
• Organic growth typically +0-1%
• Secularly growing industry – people continue to eat out more
• New brands coming with better organic growth
• Misunderstood business model - makes recurring $ of multiple revenue streams - royalties, distribution, other services
• Driven by long term secular trends around continued growth in dining out
• Portfolio approach leads to consistent +0-1% organic growth – similar to CSU.CN
• Complimented by M&A – which has driven five year revenue and EBITDA CAGR’s of +23.5% and +21.8%, respectively
• Recession resistant - focused on low price ~$7 avg price
o Limited GFC impact (comps -1.5%)
• Shifting focus towards rolling out BonApp – new mobile ordering / food delivery app – testing and moving slowly to not cannibalize/hurt franchise operations
 
HIGH QUALITY MARGINS & RETURNS ON CAPITAL
• “Bread & Butter” – core focus is on recurring franchise revenue streams
• Franchise business margins >50% EBITDA margins
 
HIGH ROIC/CAPITAL LIGHT
• ROE ~20% and very scalable - ~100% franchise model, does require much CapEx (CapEx <1.5% of sales)
• Can create, test and roll out new brands with minimal upfront investment
• MTY enters into longer term leases with real estate owners and then subleases to its tenants
 
STRONG CASH FLOW
• Strong Cash Flow - CFO > net income (>130% over last five year)
• Due to amortization of intangibles and + net working capital
• Limited CapEx ($3-5mn/yr) – nearly completely offset by disposals each year
 
RECESSION RESISTANT BUSINESS
• Stable franchise royalty streams from >5,000 units and >74 brands across North America
• Comps were down 1-2% during the GFC
 
THESIS #2: BEST IN CLASS OUTSIDER MGMT TEAM
 
BEST IN CLASS MGMT
• CEO Stanley Ma, built the business from scratch. Has been at the helm for >30 years
 
• Created the business >35 years ago and remains the largest shareholder
• Owns ~19.4% of shares outstanding
• Shares have appreciated at a compounded annual return of 38.6% over the last 15 years
• S&P 500 +6.5%, TSX +7.4% over same period
• Ma has driven consistent M&A as a core strategic strategy and has acquired ~5,000 units and countless brands
• Prudent balance sheet without using excess leverage (usually quickly de-levers <2.0x post deals)
• Use extensive and repeatable playbooks to identify acquisition targets and integrate them
• Under Ma, MTY revenues have grown from ~$52mn in 2009 to >$330mn (6x over last 10 years)
 
M&A PLAYBOOK
• Established track record of value creation from past M&A
• As of Dec 2018 has acquired >60 brands in >20 years
• Stock +25% CAGR over last 3 years vs. S&P 500 +9.2% CAGR and TSX +6.9% CAGR
• Like most other Compounder Roll Ups, MTY has a specific and repeatable acquisition strategy
• Retain the management where growth can be accelerated by incremental capital and MTY DNA
• Target subscale brands where MTY can extend the brand or look to take the brands internationally
• Reduce fixed costs to boost operating leverage
 
INTEGRATION PLAYBOOK
• Acquisitions usually come in at lower margins and successfully moves them up over time
• Companies/brands remain autonomous and managed in a decentralized manner
• Upon acquiring MTY usually reduces head count and fixed corporate costs
 
ROBUST FUTURE M&A OPTIONALITY & TARGETS
• Levered at ~1.7x ND/2018 EBITDA vs. ~3x comfort range
• Willing to go to ~4.0x ND/EBITDA for larger strategic deals before deleveraging
• At 8x EBITDA they can spend $1.2bn. Would add ~$150mn in EBITDA (+113% vs. 2018 EBITDA)
 
THESIS #3: ENTERING EARLY PHASE 2 = ALPHA BURST
• Speed & size of deals accelerating leading to non-linear value creation
• Did huge Kahala deal in 2016. Added >2,500 units and created US platform
o Similar to CSU’s TTS deal in 2014 – finally added leverage to do larger platform deals
• Since 2017 added another ~773 units (~15% unit growth) via M&A
o Additional ~331 unit brand closed in Q4 2018 (SweetFrog)
• Leading to outsized EBITDA growth / margin expansion – highest margins in several years
o OpEx/sales dropped from ~64.7% of sales to 56.6% y/y in Q3 2018
o Ex-Imvescor + M&A costs, Canada franchise expenses would’ve been -2% y/y
• “There's certainly not a lack of targets; there are plenty of targets”
 
NOW DOING LARGER NEEDLE MOVING DEALS EVERY 1-2 YEARS
• Kahala Brands – Announced in Dec 2015. Closed in July 2016
• Largest acquisition. Purchase of Kahala Brands for ~$300mn
• Added >2,500 units and created US platform – like Couche Tard’s Circle K deal.
• Signpost in MTY willingness to add leverage
• Kahala, and similarly Imvescor, were their own Compounder Roll Ups
• Run by self-made entrepreneur CEO that took stock to help build MTY
• Created platform for US growth in Scottsdale, AZ. Kahala’s HQ became HQ for US platform
• Included many strong, but stale brands like Pinkberry, Blimpie’s and Cold Stone Creamery
 
Imvescor – Announced Dec 2017. Closed March 2018
•  In Dec 2017 announced acquisition of Imvescor for ~$250mn. Closed in March 2018
• $50mn cash, ~$200mn equity, added 1 Board member
• 5 brands, 262 restaurants
• ~$416mn in system sales (+15-20% PF revenues)
o Added faster growing brands. Will help drive organic growth starting Q2 2019
• 13.2x EV/EBITDA pre-synergies & 10.6x EV/EBITDA post synergies – including no revenue synergies
• Leverage only moved to 2.1-2.2x ND/EBITDA - preserves optionality
• Both asset light franchisers with solid brands and focused on acquiring fast growth chains
o Focus on suburbs/rural vs. urban
• Shared benefit from synergy realization
• Reduced MTY’s exposure to malls
• Increased MTY market share / scale in Quebec market
• Now have higher caliber portfolio of scalable brands
• Doubled MTY exposure to sit down / full service restaurant segment (22% of sales vs 10% previously)
 
OTHER SMALLER DEALS NOT YET IN THE #S
SweetFrog – Announced in Sept 2018. Closed in late Sept 2018 (FQ4 2018)
• Acquired for $35mn USD
• Adds 331 locations
o 254 franchise, 78 company owned
o Company owned will convert to franchise ownership
• 323 in the US, 8 location Int’l
• $92mn in LTM sales
Casa Greque – Announced Oct 31, 2018. Closed in early Dec 2018 (FQ4 2018)
• Acquired for $20.9mn
• Adds 31 franchise locations in Canada
• $45mn in LTM sales
South St. Burger – Announced Dec 11, 2018. Closing in next 90 days, or by March 2019. (FQ1 2019)
• Price not disclosed
• 26 franchise & 14 corporate owned located in Canada
• $28mn in LTM sales
 
THINKING BACKWARDS
• Illiquidity: Float is only ~$900mn USD and over the last six months daily liquidity on average has been $5.8mn USD/day
o Mitigants: Higher upside required to compensate for illiquidity risk
o Post earnings the stock traded $14-$32mn/day
• Organic Growth: Organic growth is only slightly positive but had been negative a few years ago. As they get bigger need to
find more and more franchisees
o Mitigants: Cold Stone (>20% sales) continuing to perform well with slightly positive comp.
▪ Has many openings in newer international markets
o Newer brands come with higher organic growth and strong turnaround opportunity
• Inability to “Move the Needle”
o Mitigants: Company upsized facility to $500mn. Remains under levered at <2x.
o Willing to lever up to 4x for the right deal.
▪ At 8x EBITDA they can spend $1.2bn and add $150mn in EBITDA (EBITDA +113% vs. 2018 EBITDA)
▪ At 10x EBITDA they can spend $900mn add $90mn in EBITDA (EBITDA +68% vs. 2018 EBITDA)
• Ice Cream/Yogurt Weakness: Portfolio includes many ice cream and yogurt brands. Cold Stone >20% of system sales
o Mitigants: Cold Stone remains positive and MTY continues to add newer, fresher brands (Pinkberry, SweetFrog)
• Management Succession: CEO Stanley Ma, 71, is moving from CEO to Exec Chairman
o Mitigants: New CEO Eric Lefebvre is well groomed, continuation of same playbook
o Brands are managed in a decentralized manner and our VAR suggests that the management teams are very strong.
o Ma is now Chairman/Coach and focused on M&A vs. operations.
o Seen this before at other successful Incline Compounder Roll Ups. CSU.CN, Liberty companies and ATD/B.CN
 
MTY.CN TOP HOLDERS
• Chairman Stanley Ma own 19.4% (>$300mn)
• Insiders in total own ~22.4% of shares
• Mostly Canadian shareholder base
• Canadian shareholders = ~49% of shares, US shareholders ~8.3% of shares
  
SENTMENT
• Sell-side is very thin, with no bulge bracket coverage
• Sell-side is mixed with 50/50 buy/sell but average target price is only ~$66
 
COMPARABLE MULTIPLES
• Franchise comps trade at ~22.7x 2019 P/E and ~14.8x EV/EBITDA
  
 
I hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise do not hold a material investment in the issuer's securities.

Catalyst

Continued positive comps + margin expansion. Increased liquidity and sell-side coverage. Another needle moving acquisition. 

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