- Good Times Restaurants (GTIM) should continue to rise due to consistently high same-store sales growth in the core Good Times chain and a ramp up of the new Bad Daddy's Burger Bar chain. The latter is arguably the single greatest growth driver yet the most overlooked due to the lack of analyst coverage and the fact that the concept is still relatively new.
- Moreover, GTIM has a strong balance sheet to support growth with a minimal amount of debt and ~$5.2 million in cash.
- Furthermore, management actually "walks the walk" when it comes to maximizing shareholder value, unlike a more visible peer who continues to resist activist pressure.
GTIM operates Good Times Burgers & Frozen Custard, a regional chain of quick service restaurants (QSR). The menu includes all natural beef and chicken, fresh cut fries, fresh frozen custard and other unique offerings. Each item is made to order and not pre-prepared. There are 35 locations in Colorado.
GTIM also operates Bad Daddy's Burger Bar, an upscale and full service restaurant with a menu that includes gourmet burgers, chopped salads, appetizers and sandwiches. Although the concept has only been in existence for about three years, it was recently named a top 25 burger by USA Today. This month, GTIM opened its first location in Colorado and plans to open 3-4 more this year.
If you built it, they will come: Why it pays to focus on the food
GTIM is the only QSR chain in Colorado serving all natural beef and chicken from humanely raised animals with no hormones, steroids, antibiotics or animal byproducts in the feed while primarily using premium local and regional ingredients. This single-minded focus on serving high quality food drove 14 consecutive quarters of same-store sales growth (PDF alert) and nine consecutive months of double-digit growth. Moreover, this growth is driven by increasing demand for its high quality food rather than $1 menus or aggressive promotions. This refusal to participate in a "race to the bottom" preserves operating margins and generally results in better franchisee relations*.
This growth highlights the critical difference between the QSR "haves" and "have nots". For example, McDonald's posted a 3.3% decline in same-store sales last month due to severe weather while GTIM posted a 14.1% increase (PDF alert). To state the obvious (and only to prove a point), people don't stop eating because it's cold (people actually eat more) although they are clearly becoming more selective in what and where they eat. GTIM is less vulnerable to the second most popular excuse for lower sales (weak consumer confidence) as its locations are primarily in higher income and faster growing demographic areas.
New product introductions should gain a larger share of customer spending and drive additional growth. For example, breakfast now represents >9% of sales compared to nothing prior to November 2012 while chicken sales doubled after the introduction of all natural, hand breaded chicken tenders. The latter should compete favorably against the recent introduction of a lower quality product (PDF alert) by two large burger chains. Although GTIM remains focused on the core business, offering seasonal favorites such as pumpkin pie frozen custard is a unique attraction and one of the most inexpensive ways to introduce customers to its overall brand.
While customers clearly care most about the food, investors ultimately care about the financials. In the mrq, same-store sales increased 17.4% while restaurant-level operating profit increased 112% and the operating margin increased 610 basis points to 14.9%.
Additional margin expansion should be driven by the following four factors. First, there is high operating leverage as the infrastructure needed to support growth is largely in place. Second, GTIM should be able to continue to modestly raise prices (e.g. 2.8% in FY12 and 2.2% in FY13) due to its high quality offerings. Third, "blocking and tackling" of critical (but often overlooked by investors) operational issues should help contain any rising cost pressures. For example, its online screening and hiring tool reduced hourly employee turnover by >50%, a new point of sale computer system should reduce food waste and a new distribution agreement should reduce distribution and purchasing costs. Fourth, a new prototype design (2,000 square feet from 2,400) should reduce development costs and generate a higher return on investment.
*Consumers love the $1 menu for obvious reasons (I can get 5 double cheeseburgers for $5!). Franchisees have an equally intense but opposite feeling.
The best defense is a strong offense: What Darden could learn from GTIM
Companies complaining about the increasing power of activist investors should remember that if they were doing the right thing in the first place (maximizing shareholder value) then activist investors would leave them alone.
For example, although Darden Restaurants agreed to spin off its Red Lobster chain, this move does not go nearly far enough as it fails to monetize the significant real estate assets. However, GTIM is now virtually debt free after completing multiple sale leaseback transactions while one transaction is expected to provide a ~100% return on investment per year.
In the last two years GTIM sold three underperforming restaurants and purchased two high volume restaurants from franchisees, which generated cash and increased operating margins. While there was no specific reason cited for the underperformance, this attention to each individual store, and not just the overall growth rate, highlights the focus of management on growing smartly. Moreover, these growing pains are natural during an expansion and provide valuable lessons that can be used in future location selection. For example, the second Bad Daddy's store has a rooftop bar and patio with mountain views.
In September 2013, GTIM added two new directors in order to fill the vacancy created after a director stepped down due to an illness and to expand the board, which is now comprised of a majority of independent directors.
Finding the next Panera Bread before it's the next Panera Bread
In April 2013, GTIM began plans to develop and operate Bad Daddy's Burger Bar restaurants by purchasing a 48% stake in Bad Daddy's Franchise Development for $750,000, which provided exclusive development rights in Colorado and the first right to purchase the remaining 52%. A secondary offering (PDF alert) in August 2013 will help fund the expansion (and the remodeling of older Good Times stores).
Bad Daddy's should nicely compliment (rather than cannibalize) Good Times for five reasons. First, it has a different target market (full service, upscale casual, fast growing and small box format) with the average check being "materially higher" than Good Times. Moreover, based on the results of the three restaurants open for more than a year, management projects it to generate higher sales per square foot than Panera Bread and Five Guys Burgers & Fries.
Second, by offering a full bar specializing in craft microbrews, it should generate high margin alcohol sales.
Third, the existing Good Times infrastructure can be used to support and efficiently grow Bad Daddy's.
Fourth, although the initial restaurants will be company-owned, management intends to follow a similar model as Panera with a mix of company-owned and franchised stores, which should reduce capex requirements. Moreover, GTIM hired Bill McClintock to head up franchise development, who has 27 years of franchise sales experience including 10 years at Buffalo Wild Wings where he grew the brand from 50 to >500 restaurants.
Fifth, Bad Daddy's is extremely attractive from an investment standpoint (e.g. >40% cash on cash return) given the small footprint, high average sales per store ($2.5 million) as well as faster and easier development.
Although the recent turn to positive operating cash flow is encouraging, the current low level of EBITDA results in an extremely high multiple, which should rapidly come down given that management projects EBITDA to more than double this year, especially as new Bad Daddy's stores add significant cash flow. However, GTIM will probably never be cheap from an absolute standpoint as the multiple may remain at a higher level supported by rapid growth.
Investors are effectively getting Bad Daddy's for free as the chain is still in its infancy. Several years from now and after growing from a small local chain to a large national one, the $750,000 paid for the 48% stake may seem like a bargain (putting it mildly). At that point, it could be sold for multiples of the current market cap to a larger company such as Dunkin Brands.
This hidden yet potentially significant catalyst provides investors an opportunity to participate in the projected rapid growth over the next several years. This opportunity does not come around often for two reasons. First, typically the only people even aware of these local and fast growing chains are just that - locals. If you don't live in Colorado you probably haven't heard of GTIM. Second, many of these chains (e.g. Five Guys and In-N-Out) are private so you couldn't participate even if you have heard of them.
GTIM is a textbook asymmetric investment given the extremely low market cap and the fact that its best days are clearly ahead. However, in 3-5 years the market cap could easily have risen 5-10x, at which point it would only begin to gain analyst coverage but probably not even then. Only after multiplying again will it gain any meaningful investor attention, at which point a sell side analyst will publish a report saying it could be the next Panera. Meanwhile, a significant portion of the gains will have already accrued to current investors who would probably sell into this euphoria.
The downside is limited by the virtual lack of debt and net cash balance that represents ~24% of the market cap, which includes retiring the preferred stock. Moreover, the previously discussed secondary included warrants, which if exercised would provide another ~$10 million of cash. While this would obviously increase the share count, it would further strengthen the financial position and help accelerate Bad Daddy's development. This cash, along with the rapidly rising cash flow, should allow GTIM to fund growth internally going forward. Furthermore, the remaining real estate assets are probably carried on the balance sheet at below market value and may eventually be monetized given the history of value extraction.
The following are the primary risks to the investment thesis, in order of importance:
- There is intense and increasing competition in the restaurant industry, especially from "better burger" chains.
- A decline in consumer spending would most likely result in lower sales given the discretionary nature of the restaurant industry.
- Although the results have improved recently, GTIM has a long history of losses.
- An increase in food prices may result in margin compression although this risk is mitigated by the strong pricing power and fixed price contracts for chicken.
Given the continued strong growth at Good Times and projected rapid growth at Bad Daddy's, a 50% gain over the next 18-24 months is a reasonable projected return. The pullback to support at the ~2.85-2.95 area provides a natural place for a stop loss.