Description
Star Buffet is a very cheap stock with a compelling catalyst in a market devoid of cheap stocks with catalysts.
Background & Industry
First, a little background. The Company was spun off from CKE in 1997 after CKE decided to exit the buffet business. Bob Wheaton, the current CEO, became part-time CEO of Star Buffet and remained an Executive Vice President with CKE at the time of the spin-off; he left CKE to become the full-time CEO of Star Buffet in 1999. Star Buffet is a restaurant operating company with 44 restaurants under seven different themes. The Company’s themes include the Hometown Buffet (franchised, 16 sites), Casa Bonita (2 sites), North’s Star (6 sites), Florida Buffet (11) and JB’s (9). The stores are primarily located on the West Coast (10 in Arizona) and other warm weather states (7 in Florida) and are therefore less exposed to weather related dips in sales than other restaurant operators. Star Buffet has been a net closer of stores in recent years as Wheaton has been focusing on unit profitability above all else. Each of these concepts (with the exception of Casa Bonita, a Mexican-themed restaurant) is a regional buffet brand focusing on a broad product selection at a reasonable price (average check of $6-$8).
The Company seeks to differentiate itself from competitors by providing higher quality and better tasting product than its competitors. While this sounds quaint and obvious, the Company actually has a reasonable strategy to accomplish this, by providing “made from scratch” food. Star Buffet’s restaurants feature large kitchens and small freezers. Food is prepared similar to the way Luby’s used to prepare food before it was destroyed by mgmt. Quality is stressed, food is prepared fresh daily and each brand maintains unique recipes that cater to regional taste profiles of customers. Other points of differentiation stressed by Company management include superior service and a clean and friendly environment.
In comparing the Company’s product offerings to its competitors, STRZ primarily compares itself to other buffet style restaurants, including Golden Corral, Ryan’s and Old Country. However, the Company also competes with other segments of the restaurant industry. Management separates the restaurant industry into five segments:
- Casual Theme: Chili’s, TGIF, etc. These concepts tend to have reasonably high quality food with checks ranging from $10-$30. This segment is the fastest grower in the industry at 3-5% per year.
- Family Dining: Denny’s, Bob Evans. Very similar to buffet in terms of product quality but slightly higher price points of $8-15 per check. This segment is growing at 0-2% per year.
- Buffet: Golden Corral, Star Buffet: Value segment, offering reasonable quality food at a low price of $6-$8 per check. This segment is growing at 0-1% per year.
- QSR: Wendy’s, McDonald’s: Unique segment with broad customer base. Price of $4-$8 per check. This segment is growing at 2-4% per year.
- Specialty: Krispy Kreme, Starbucks: “Catch all” segment with unique operators that do not compete directly with other segments.
While the buffet market is obviously not the most compelling in the restaurant industry, a number of factors suggest that it is not in secular decline. A few well documented trends support the restaurant industry as a whole. As the population ages, people will continue to trend toward eating out. Also, many restaurant analysts have noted that the cost spread between a home prepared meal relative to dining out has compressed in recent years. Finally, new unit openings in the buffet style segment have slowed to less than 1% in recent years as capital flows to the more exciting segments of the industry. Additionally, Star Buffet believes its core market is large and relatively stable. Wheaton stated that they are targeting the “Wal-Mart” customer. People with limited disposable incomes seeking value will seek out buffet and family dining concepts – this is unlikely to change in the foreseeable future, in my view.
Investment Thesis
So why invest in a slow growth restaurant operating company with multiple brands in an unexciting segment of the industry? The answer is simple: management and valuation.
Management
Wheaton is a big key to the success of this company. He is a 20+ year industry veteran and has a great handle on industry trends and operating and financial management. I have had a number of conversations with him recently and have been very impressed with his emphasis on shareholder value and prudent management of the capital structure. He has proven this in recent years. After Star Buffet was spun off from CKE, CKE provided a number of key services to STRZ, including back-office and corporate functions (they also owned over 10% of the stock). This ended in 1999 as CKE cancelled the service agreement and sold off its stock. This left STRZ with an overleveraged balance sheet and the need to create infrastructure to support the operation. Wheaton has effectively maneuvered through these issues over the past few years, dramatically reducing the Company’s debt level while maintaining profitability, and creating an infrastructure to support the Company.
Wheaton owns 49% of the common stock and is extremely focused on shareholder value. One example of this is management’s lack of interest in an MBO, despite valuation metrics that suggest this type of transaction would certainly be in the cards (and probably a windfall to management in the long-term). Management has intimated to me that an MBO is not attractive as an option as it leaves public shareholders high and dry. Wheaton seems to believe that an MBO is a management enrichment program that is only done by those who are somehow morally corrupt. Instead, he believes in doing his job and creating value and eventually the stock will reflect its intrinsic value. He has a decidedly practical, long-term outlook for the company. This is the type of attitude I want from the CEO of a company I own.
Valuation
Here is the bottom line:
Net Debt: $6.8 mm
Sh.’s Out.: 2.9 mm (all options out of the money at around $10 per share)
Sh. Price: $6.50
Mkt. Cap. $19.1 mm
TEV: $26.0 mm
LTM Rev.: $69.2 mm (0.37x)
LTM EBITDA: $5.2 mm (4.9x)
LTM EBITDA-CapEx: $3.4 mm (7.6x)
EPS: $0.55 (11.8x)
Operating Cash Flow: $4.1 mm (4.0x)
FCF Yield: 13%
FCF Yield (Forward): 20% (Approximate – capex coming down next year)
Price/Book: 0.9x
Price/Net Tangible Book: 1.1x
This is easily the most compelling aspect to the stock. I have not found many stable businesses trading below a hard book value with a 10% FCF yield, much less the approximately 20% FCF yield this company sports. First, tangible book value. The following is an overview of the historical and current balance sheets:
$’s in Millions, Jan. FYE
2000 2001 2002 2003 10/31/03
Assets
Cash 1.0 1.1 .7 .4 .3
A/R 2.1 1.2 1.3 .6 .6
Inv 1.1 .9 .8 .6 .5
Other .3 .4 .4 1.7 1.7
Current 4.5 3.6 3.2 3.3 3.2
Fixed 36.2 34.8 33.8 28.4 26.5
Other 3.7 3.3 2.9 3.6 2.9
Goodwill4.6 4.3 4.1 4.0 3.8
Total 49.0 46.0 44.0 39.3 36.4
Liabilities
A/P 5.2 5.4 4.5 4.0 3.5
S-T Debt2.7 3.0 3.7 5.0 2.8
Other 4.3 4.1 3.5 5.1 3.6
Current 12.2 12.5 11.7 14.1 15.1
L-T Debt16.2 11.7 9.3 4.2 4.3
Other .5 .4 1.2 1.1 .9
Total 28.9 24.6 22.2 19.4 15.1
S-Equity20.0 21.4 21.8 19.9 21.3
Tangible Book Value stood at $17.5 million or $5.94 Per Share. This in and of itself is attractive relative to a $6.50 per share stock price; however, I believe book value to be understated. The Company has 11 owned properties which have been on the books at cost for, in most cases, over 5 years. Additionally, I believe Wheaton to be a very savvy real estate buyer. One of his main roles at CKE was in real estate and he stresses buying properties only at “reasonable” levels. He views the purchase of real estate as a key component to the acquisition of any new restaurant property. I was unable to get a sense for the extent of the understatement of the owned real estate on the books in my conversations with the team, but they have consistently stressed their “conservative” approach to real estate buying.
Another attractive point to this story is that pretty much all of the debt remaining on the balance sheet is in the form of long-term mortgage notes, freeing up any cash flow to be returned to shareholders. As you can see, the Company has been focused on repaying debt in recent years. With this overhang gone, the Company can focus on ways to maximize shareholder value through distributions, in one form or the other, to shareholders.
The historic income statement follows:
$’s in Millions, Jan. FYE
2000 2001 2002 2003 LTM
Revenue 99.1 94.0 83.2 74.8 69.2
COGS 66.1 63.1 55.2 51.4 46.6
GP 25.5 23.0 20.9 19.7 22.6
Margin 33.3% 32.9% 33.7% 31.2% 32.7%
SG&A 25.5 23.0 20.9 19.7 17.4
D&A 3.9 3.8 3.8 3.5 3.3
Op. Inc 3.6 4.1 3.3 0.2 1.9
Margin 3.6% 4.4% 4.0% 0.3% 2.7%
Interest1.4 1.6 1.1 0.7 0.8
Other -0.1 .6 .5 1.6 0.0
P-T Inc.2.3 1.9 1.7 -2.1 1.1
Inc Tax 0.8 0.7 0.3 -0.8 0.3
Net Inc 1.4 1.4 1.5 -1.3 0.8
EPS .48 .48 .73 .07 .55
Note – 2002 and 2003 EPS excludes one-time items
Wheaton has been focused on turning around the operation and optimizing cash flow by paying down debt and closing down stores. Much of the top-line erosion has come due to the closure of unprofitable stores. Although he inherited a number of border-line locations with the spin off of the Company, it appears that the store base is finally stable. Same store sales of currently opened stores have been insignificantly negative (note the company does not publish SSS numbers). Note that going forward the Company should benefit from lower beef costs which are a significant component of the Company’s cost structure.
So how does this undervalued story find a catalyst? Simple. The majority of cash flow this year will flow to shareholders. It appears the Company will spend around $1 million in capital expenditures to maintain the current store base (Wheaton expects this number to be down year over year versus the current year as a number of sizable maintenance upgrades were made to the store base that were one-time in nature; note that this is significantly below depreciation of $3 million+). With stable operating cash flow of around $5-$5.5 million (I am assuming no lift from lower beef prices and no working capital impact), $4-$4.5 million is available to common stockholders. The cash will most likely be returned to shareholders through a dividend and stock repurchase. Most of the distribution will come in the form of a dividend as it will be difficult for the company to practically buy back a significant amount of stock given the illiquidity of the shares. For example sake, if management were to distribute 80% of FCF in the form of a dividend, they would be announcing a dividend that would provide a yield of 15-20%! The move toward distribution of excess cash flow to shareholders is reflected in this statement from the Company’s most recent 10-Q:
“The Company believes that available cash and cash flow from operations will be sufficient to satisfy its working capital and capital expenditure requirements during the next 12 months. Further, the Company believes that it will spend less than $3 million a year on capital expenditures for the next few years. The Company believes that the combination of capital spending and an acquisition strategy that is not projected to require significant amounts of capital suggests that the Company may generate operating cash flow in excess of expected needs. In such event, the Company plans to consider the return of some capital to its stockholders through a stock repurchase program or a cash dividend or both.”
The Company will also pursue acquisitions but only at reasonable prices. I believe Wheaton to be a very solid acquirer of restaurant properties. He is focused on purchasing restaurants at less than 4x cash flow and only if the underlying real estate is valued on favorable terms. My guess is the announcement of a significant dividend or stock repurchase will come sooner rather than later as the Company is now generating significant excess cash in excess of debt service.
Catalyst
Announcement of a significant (5%+ yield ) dividend and stock repurchase