Description

MTY Food currently seems like quite an attractive opportunity to us. The company is already relatively cheap on last year's numbers (~11.5 x FCF FY22) but will see a basically assured dramatic improvement in all financial metrics this year. We think true FCF will cross the CAD160mn (translating into a CAD200mn reported FCF) run rate in about a year vs. MTYs current market cap of CAD1.4bn - which translates into a decent 12% yield relatively soon. FCF has historically compounded at very attractive rates (e.q. 10y CAGR of >15%), and their M&A playbook, the main driving force behind that CAGR, plus MTY future organic opportunity are underestimated at the moment.

MTY is no stranger to VIC (multiple pitches already) with the most recent write-up by rickey824 less than a year ago (August 2022). Hence, I won't discuss the general business story again, since there is already lots of content on the company available on the forum. That said, I'd be happy to go into more detail on topics via Q&A. For starters here (link) is their latest presentation for a general overview and a quick starting point. 

Our thesis and the reason for this pitch are simple: We think MTY was already a good long at ~11.5xFCF at the time of the last write-up but has become a lot more attractive since then. 

The share price is unchanged vs. a year ago but MTY has added substantial earnings power due to the completion of two large good-to-great M&A transactions. MTY had a break of almost three years with no deals but eventually deployed multiple years of FCF at the end of last year. In both cases, PE owners wanted to sell the companies. The competing bidders eventually pulled out of the process, very likely due to the sharp rise in financing costs and MTY ended up as the remaining bidder winning the transactions with lower bids. In addition to the acquisitions, the company also continues to enjoy organic improvements with a tailwind from inflation/pricing and some fading of the final negative pandemic impacts (e.q. better net restaurant developments). 

Now getting to the crux of the thesis: The two acquisitions and some decent organic growth are about to dramatically improve this year's operating results. The first quarter already showed an EBITDA improvement of +80% YoY to CAD64mn for the quarter and increased LTM numbers to CAD216mn in EBITDA. So far, the market doesn't seem to care or maybe worries about the debt load, or didn’t like the lower-than-usual cash flow conversion. Who really knows these things… 

That said, with each additional quarter, it should become increasingly harder to ignore the strong earnings power improvement. We think MTY's EBITDA for FY23 will be ~CAD270mn vs. an EBITDA of CAD185mn for FY22.  

Capital allocation in the next few quarters will be focused on debt paydown. The two debt-financed acquisitions cost a little over CAD280mn each (BBQ Holdings CAD285mn and Wetzel's Pretzels CAD282mn). Net debt now stands at roughly CAD780mn and current Net-debt to EBITDA (not accounting for leases and lease receivables) per Q123 stood at 3.6x. That said delevering will happen quickly from here.  

We believe that MTY is well on track to generate CAD270mn in EBITDA on an annual basis compared to CAD216mn on an LTM basis (or the CAD256mn Q1 run rate). MTY repaid ~CAD30mn of debt last quarter vs. ~CAD30mn of reported FCF in the quarter. Without an additional acquisition, debt paydown should continue at least at ~CAD30mn per quarter going forward. Cashflow in the quarter was negatively impacted by a non-recurring ~CAD10mn, due to two acquisition-related payouts. Capex was ~CAD8m in Q1 but will also moderate to a lot more normal levels for MTY at likely less than half that on a quarterly basis. Reported FCF adjusted for those two things gets the number already to ~CAD45mn. In addition, the first quarter is usually a seasonally weak quarter for MTY (historically ~20% of annual EBITDA, but the Q1 contribution will likely be higher this year due to other seasonality of the recent acquisitions, but will remain below 25%. 

Considering the increase in EBITDA and the debt paydown, we believe that MTY will end FY23 at or below 2.5x and will be below 2.0x net debt / EBITDA on FY24 numbers (well below their 4.0x covenant) if there are no further acquisitions taking place between now and then. Overall there shouldn’t be any concerns about the debt load and cashflows should ramp nicely from here. 

As (predominantly) a franchisor, MTY also has very little capex needs/a very high EBITDA cash conversion. In fact, over the last 10 years, net capex (capex - PPE sales, mostly due to refranchising of acquired corporate restaurants) was actually a negative number and gross capex averaged only ~5% of CFO over that time frame. The newer higher corporate mix from BQQ Holdings will change that but overall not materially so. Interest costs per end of Q1 are running at ~CAD50mn p.a. or ~6% of CAD830mn in debt. Fast forward a year and interest payments should be at ~CAD40mn not considering any benefits from a potentially lower rate environment by then. So we think it is reasonable to expect a reported FCF run rate of >CAD200mn p.a. by then. Adjusting for lease payments and necessarily getting closer to the true FCF numbers, takes ~CAD40mn of the cashflow numbers. A step up from around ~CAD20mn in 2022, which is again due to the higher corporate location mix with leases from BBQ (Wetzel added only a small amount).   

A little bit more on the deals. Both deals seem like good ones to us. 

First, on BBQ Holdings: MTY paid a relatively low price for BBQ at ~7x EV/EBITDA or ~11xFCF prior to likely decent improvement opportunities on the purchasing front (given the differences in scale) and some other SG&A synergies (BBQ was a small public company). This VIC write-up shortly before the acquisition is a good source for what was going on at BBQ prior to the acquisition and the opportunity that MTY is likely to continue to execute on. I posted a quick snapshot below (# are in USD, MTY paid USD17,25 a share) and finally the related PR. BBQ conservatively adds ~CAD35mn in EBITDA and looks like a good deal. 

Second Wetzel’s Pretzels: At a purchase price of 0.85x total system sales, the WP deal looks rich at first glance. However, based on WPs reporting and some guestimates, MTY likely paid around ~12x EV/EBIT or around ~10x FCFF which we think is potentially a great price for this restaurant brand. Especially if they can also extract some synergies (e.q. MTY purchasing leverage at a significantly larger scale very likely means higher rebates to keep). 

WP looks like a great business to us. It has very attractive unit economics, is simple to operate and is a growing concept, where growth can potentially be accelerated. For example here is a glance at their mall-based store profitability from their pre-pandemic filings. 

WP is doing very well at the moment with strong SSS growth in 2022 and a nice pipeline of new stores that should take the total store count to over 400 this year. Here is a good recent press release link for the brand and another interview. Below is the store count development over the last several years. In addition to store growth, same-store sales have also grown by about 5% p.a. over that timeframe.   

With WP in its portfolio, MTY owns another well-known healthy US restaurant concept that is among the top brands in its category. Together with Cold Stoney Creamery and Papa Murphy’s ~50% of earnings are coming from these three concepts alone. We think of Papa Murphy’s as a decent concept and Cold Stone and Wetzel Pretzel as great ones. To make just one point on Cold Stone, since MTY acquired Cold Stone in 2016, the concept has compounded its total system sales at +7% p.a. (at a stable store count)   

Summing this point up, even though MTY’s concept of buying mature brands cheap has worked very well, the company is successfully turning towards a higher quality portfolio with now more than half of its profits stemming from such concepts. As noted by Rickey824, this development is further supported by new incentive structures that reward organic growth and a lot more focus on it since Stanley handed the CEO over to Eric.

We think getting a ~12% FCF yield a year out is too cheap for this business, a yield in the 6-7% range would seem a lot more appropriate for the company.

Catalyst

Earnings Increases

Delevering