Saturday, December 1, 2012

Cheaper than a burrito, Mexican Restaurants

I enjoy meaningless metrics for some reason.  I remember in 2008 hearing a commentator on TV say that Citi's shares cost less than an overdraft fee.  In the case of Mexican Restaurants (CASA) you could either buy a combo platter at one of their restaurants, or 8-10 shares of their stock.  Mexican food is known for being inexpensive, and like the food Mexican Restaurants is inexpensive as well.

Mexican Restaurants falls into one of my favorite investing categories, a company that is mis-priced on so many different levels it's almost unbelievable that the opportunity exists.  Let me lay out exactly how cheap Mexican Restaurants is; the cost to franchise one of Mexican Restaurant brands is between $814,000 and $2,504,000 per store.  As an individual you could either invest $2.5m to start a franchised location, or buy all of 52 of Mexican Restaurant's stores for $3.7m.

The company is a restaurant operator in the American Southwest, they own 52 locations, have 13 franchisees and one licensed location.  The company has had a rocky few years with a trail of losses extending from 2008 until very recently.  As the company accumulated losses over the past few years they cut underperforming stores and rationalized their workforce.  They continued to lose money until this year when operations turned around and their cost cutting paid off.  As part of the cost cutting measures the company delisted.  If anyone is still wondering why they're cheap, they have a history of losses, they're tiny, and they're unlisted.

There's not much about Mexican Restaurant's stock to not like.  They are trading at 35% of book value, and at 5x their net income from the first 9 months of this year.  After a $2m debt payment this quarter book value will increase to around $4 per share.  The company will also be debt free at the end of the year.

Here are the company's results for the past three years:


Valuing the two pillars, asset and earnings

Assets - Valuing the company on an asset basis is the easiest and most stable.  Earnings can change from quarter to quarter and year to year, asset values are much stabler.

The company's most recent book value was $11.285m, this is against a market cap of $3.6m.  Most of the company's assets consist of restaurant locations and associated equipment.  The company leases their locations, it's unclear if they own the buildings or just the equipment inside the buildings.  Without this information it's really hard to know the exact value of their property plant and equipment.

It's hard to know the exact value, but we're not out of luck, on the Casa Ole (one of their brands) website there is a little tab with information about franchising a location.  The website states that it takes an investment of between $814,000 and $2,504,000 open a single location.  Based on that information I built the following table:


We don't know the breakdown of costs per location so I created three scenarios: pessimistic, moderate and optimistic.  I just did some basic extrapolation to get a total number.  The number you're looking at is what it would cost in theory for the company to re-create themselves at the current investment level they demand of a franchisee.  The first thing you'll notice is that these values greatly exceed the market cap, by a factor of 10x to 36x.  

It would be foolish to stop here and state that Mexican Restaurants is worth anywhere between $42m and $130m on a replacement cost basis.  No one is replacing the company, or trying to build them from scratch.  Their equipment is used, and has probably lost a lot of value.  Even with a lot of the value lost there is still value left.  If we take my grid above and estimate that a current location is worth 10% of the buildout cost the value of the assets drop to a range of $4m to $13m.  The book value of the locations is $12.3m, which after working through the gymnastics above seems to be reasonable.

I wanted to work through all of this to show that even though book value is an accounting construct it does roughly reflect a real world value.  Some readers might question my 90% discount as overly cautious, but I'll ask a rhetorical question to answer why I used that value.  A set of new chairs and a table for a restaurant cost $300 based on prices online.  If a local Mexican restaurant was going out of business and was selling their tables and chairs how much would you willingly pay for the used set?  For $30 I could probably convince my wife to put them in a man cave, anything more and they wouldn't be coming home with me.

Earnings - Initially it would seem tough to value the company based on earnings coming out of a recent turnaround.  The company has been losing money for the past four years, so maybe the recent earnings are a fluke.  If one looks further back into their history it's clear they know how to make a profit, here's a clip from their 2009 annual report:

Note that they earned $.63 a share in 2005, $.32 in 2006, and $.10 in 2007.  The number of shares in the above graphic are similar to the current number, so the EPS figures are relevant.  If the company can get anywhere near past earnings this is an incredibly cheap stock.

Over the past nine months the company has earned $722k against a market cap of $3.6m.  If the company just breaks even the next quarter they're trading at an effective P/E of 5x.  My suspicion is that now that costs have been contained they're going to do better than break-even next quarter.  It's not hard to see where if earnings do recover how this company could be a double or triple at a minimum.

Of course no company is perfect, and it's always possible to find something to not like about an investment.  In Mexican Restaurants' case there are a few things I could nit-pick on, the first is they have a convoluted capital structure.  The company has convertible preferred stock, common stock, and warrants.  A company with multiple securities in the capital structure isn't necessarily bad, but it's a sign that they had to resort to expensive equity raising measures in the past.  The company has some cash in the bank, but not nearly enough to weather another extended downturn.  If results were to head south of the border again they might have to raise money through equity or preferred offerings again.

A second nit-picky item is the company reports in their latest annual report that $167k of their cash was restricted.  It was ear-marked for community relation purposes at employee discretion.  In theory this could be anything from someone wearing a burrito suit standing on a corner with a sign advertising to a charitable donation, or a local restaurant sponsoring a baseball team.  Without further detail it's hard to know exactly, but the result is clear, $167k of the cash should be removed from the balance sheet.

Lastly even though the company is escaping the burdens of debt they do still lease a number of their properties.  They don't break out ownership vs lease, but my impression is a large number of the locations are leased.

The risk with Mexican Restaurants is that they'll hit with another prolonged downturn and their lease expenses become a burden.  If they don't hit another bump in the road it's hard to see how this stock doesn't appreciate significantly.

If you're looking for even more reading on the company my friend at OTC Adventures wrote them up here.

Talk to Nate about Mexican Restaurants

Disclosure: No position

10 comments:

  1. I'd be careful with this one. Book value for a restaurant is almost meaningless. A large portion of it is leasehold improvements which are worthless in a liquidation.

    I also look at the # of locations as a negative, not a positive. If you annualize its earnings, you get around $1 million....which means the average restaurant is earning less than $20k/yr on sales of $1.3 million. That tells me that CASA has a lot of money-losing stores.

    If I had the option of buying 10 stores that earn a combined $1 million or 50 stores that earn a combined $1 million, I'd choose the 10.

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    1. Good points on leasehold improvements, I agree the trinkets on the walls are worthless, but I'd think there is at least some value in the kitchen and dining room equipment, the cash registers etc.

      The company is barely profitable, and I agree there are a lot of underperforming stores, management has been dropping them as leases expire, which to me is a good sign.

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    2. Looking at the latest annual report, the net pp&e was 13 million. They sold 48,794 of assets for proceeds of 5,610. That would imply that the assets are worth about 11% of the carrying cost. If you knock 90% off the pp&e balance, then BV goes negative.

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  2. I don't know if they look cheap if you look at a liquidation, but they are on pace to earn $1 M this year even with the under performing restaurants. I prefer to buy things that are cheap based on average earnings over several years so I am steering clear of this one, but if I had to bet on it I'd say it will work out well at this price.

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    1. We're thinking alike on this one, nice run rate even with the dumpy stores. The company has been closing stores over the past few years, so as those run off earnings could improve more.

      Due to the squishy nature of book value, and the uncertainty of earnings this falls into what Graham would call an intelligent speculation. There is a solid basis for a reasonable speculation, but it doesn't necessarily classify as an 'investment'.

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  3. How many stores are franchised? Is the franchisee model their go-forward business plan?

    Franchising can be a great business if they are effective at marketing to and training new franchisees as it's a capital-light business model.

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    1. They have 52 company owned locations and 13 franchised locations. I don't know where they want to head in the future, but if they can get the franchising right they can do well.

      I believe the franchise locations are burrito outlets in strip malls similar to Moes or Chipotle.

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    2. Nate:

      I am a shareholder in this one, and have been for years.

      I am based in the Houston area, and have been to several of their locations. I have been to the annual shareholder meeting.

      The franchised locations are primarily "Casa Ole", none of the "Mission Burritos" are franchised. They have stated that they will do this if they can the concept down. Some of these locations have been successful and and a couple have been bad.

      They are definitely NOT returning cash to shareholders at this point. Management is AGGRESSIVELY paying down bank debt. If you look at the capital structure of this company, you will see that it has TREMENDOUSLY de-leveraged over the past few years.

      This is one of the CHEAPEST stocks that I ever had the privilege to invest in. At less than $.50/share, I wish I could buy the whole company.

      Look at the Price to sales metric, price to book, EV/EBIDTA and you will see it is a very cheap stock.

      Imagine if they can improve results somewhat...If they can get their NET margin on sales to 3%, you could be looking at a stock with a P/E of just over 1.

      As to book value, I STRONGLY suspect it is UNDERSTATED.

      We'll see...

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  4. Thanks Nate. Reminds me of Sardar Biglari. Took a controlling position in Western Sizzler about 10 years ago.
    About 40 company locations could eventually be franchised.
    The 64,000 dollar question (since none of us are in a position to do what Biglari did) is what will management do with the excess cash flows?

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    1. That is the $64,000 question, I would hope they don't re-invest it because at this point they've shown they aren't very good at creating profitable restaurants. If they returned it to shareholders this could become very interesting.

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