Rick’s: Still Entertaining or Ready to Slide?

The economy might be going down the proverbial toilet, and consumer stocks on most people’s radars are getting crushed, but one industry that is bucking the trend, at least up till now, is the adult entertainment industry.

I guess something about the escapism that a beautiful woman provides to those in times of stress has led PeakStocks.com portfolio recommendation Rick’s Cabaret (NASDAQ: RICK) to report pretty amazing results, despite all the turmoil going on today.

Rick’s will be posting their Q4 and full year 2008 earnings and hosting their analyst conference call after the market closes on December 29th.

But because their stock was getting hammered along with the rest of the market, and small and micro cap stocks in particular, Rick’s took the unusual step a few weeks back of pre-announcing their latest results to sooth Wall Street’s concerns over the rapid deterioration of the nation’s economy.

Aside from a brief pop in the stock, it hasn’t seemed to help.

In this post I’ll go over the important aspects that we need to be aware of before Rick’s announces earnings and then break them down into the following parameters:

• What went right in the quarter: What were some of the positive developments that occurred within the company in the last 3 months.
• What went wrong in the quarter: What were some of the negative developments that occurred within the company in the last 3 months.
• What I want to see: All things considered, what I realistically want to see from the company as it relates to their business.
• What we need to see: At the minimum, what we need to see for our investing thesis to still hold and an investment in this company to be prudent.
• What we’ll probably see: After weighing what’s been going on for the last 3 months, what we can realistically expect when they do announce their earnings.
• Bottom Line: What it all means, and what you should do.

New to the Rick’s story?

Rick’s Cabaret International, Inc., owns and operates upscale adult nightclubs serving primarily businessmen and professionals.

Rick’s differentiates themselves by providing an atmosphere where they can offer a unique quality entertainment environment that includes highly experienced and well screened entertainers, high quality managers hired from within the adult entertainment industry, and finally, providing an atmosphere and ambiance, including exclusive VIP rooms, that appeal to upscale clientele.

Rick’s also owns and operates several online and offline media properties that produce adult websites as well as cater to owners and operators of intimate apparel and adult retail stores.

Rick’s nightclubs offer live adult entertainment, restaurant, and bar operations in Houston, Austin, San Antonio, Minneapolis, Minnesota, New York, Dallas Fort Worth, Charlotte, and other cities under the names Rick’s Cabaret, XTC, and Club Onyx.

As of September 30, 2008, Rick’s operated 19 adult nightclubs.

Want more?

• Read my last company update here.
• OR: Read my initial company buy recommendation here.

Q4 and Full Year Results Should be Good

Focus will be on outlook, current quarter’s results

Rick’s had a lot happen in the last few months, not the least of which was continuing to deliver spectacular results when everyone has expected them to fall flat on their face.

Let’s take a look at the quarter that was, and what I expect in their next earnings announcement.

What Went Right In the Quarter

Rick’s continues to deliver despite tough economic times

In mid November, Rick’s took the unnecessary step of preannouncing their same store, or same-club sales for the month of October.

Rick’s surprised many, including myself, when they announced that not only did sales increase 113% year over year in October (mostly due to acquisitions), but more importantly, same-club sales which measure sales at clubs that have been operated for one year or more, rose a stunning 8%.

The top line figure was obviously goosed via the acquisitions that Rick’s has been folding into its operations, but the same-club comps are irrespective of the acquisitions since they don’t include recent purchases less than 12 months old.

Rick’s further went on to say that sales were up nearly 30 percent at the company’s flagship New York City club, which had a record month and that each of the company’s brands — Rick’s Cabaret, XTC Cabaret and Club Onyx — reported sales increases over the previous year.

Also, Rick’s recently increased their stock buyback program to $5 million, which represents about 10% of the shares outstanding at current prices.

Rick’s also recently pre-announced Q4 and full fiscal year 2008 (ended September) earnings and results which were mostly very positive, including or excluding Rick’s recent acquisitions.

In fact the company still had positive same-store (or same-club) sales growth in what is an extremely difficult retail environment.

In addition, Rick’s finalized and reopened their most recent acquisition of a club in Las Vegas, and will continue to look for acquisitions in the coming year as now is a perfect time to pounce on some well-performing competitors that might be struggling somewhat in the current environment, and while valuations are obviously going to be lower.

What Went Wrong in the Quarter

Lawsuit brings a cloud over otherwise good quarter

There was one bit of bad news in the last quarter as Rick’s was sued by the mother of a man who was killed by a Rick’s dancer on her way home from the club where she worked.

The lawsuit claims that Rick’s encourages its dancers to drink with patrons, and thus was responsible for sending the dancer home while intoxicated and without taking proper precautions to ensure that the dancer was not driving home drunk.

You can watch a news feed of the story here.

While a civil lawsuit has already been filed against the dancer in question on charges of wrongful death, the charges against Rick’s have only recently been added.

I’m no legal expert, and Rick’s won’t comment for obvious reasons, so I’m not sure what the company’s take on the whole situation is.

The monetary ramifications aren’t clear either because there were no specific amount of damages noted in the filing.

You can read my whole write-up on the situation here.

What I want to see

Continued execution in spite of downturn

It’s obvious that things are collapsing around us in certain segments of the market.

One look at this year’s Christmas shopping tells us all we need to know with bargain hunters out in droves and same-store and year-over-year sales at many retail locations coming under attack.

What has seemed to happen thus far however, is that Rick’s has been able to not only survive, but even thrive in this market.

It has been amazing that they were able to raise their same-club comps at all.

So, with all of that being said, what I want to see is the full year numbers at Rick’s, including cash flow and free cash flow are continued positive results with an eye towards the bottom line.

This includes their current debt levels, as well as their covenants for paying off the shares of stock that they traded in exchange for their acquisition spree last year.

As their stock price has declined, Rick’s will have to make up the difference on puts that it gave to the owners of the acquired clubs in lieu of cash payments up front.

I want to see this under control, liquidity not be an issue, and forward guidance to remain reasonable, even if it is on the cautious side.

What We Need To See

Probably one and the same

I think that investor’s fears will be calmed as long as Rick’s doesn’t trip us up with anything untoward.

Basically we need to see that Rick’s is still doing well, despite the economy, and if they are seeing a slowdown in their business, which frankly I feel is inevitable, that it is reasonable and manageable, and that the company will be able to meet it’s current debt obligations, and perhaps look to close or restructure any locations that are underperforming, or that aren’t cash flow positive.

What We’ll Probably See

Great 2008, uncertain 2009

Because Rick’s already preannounced their 2008 numbers, we’ll see exactly what they told us we would see, which is solid numbers for 2008.

We’ll also probably see somewhat of a moderation in their current operations as a result of the outside headwinds finally rearing their head in Rick’s neck of the woods.

Bottom Line

Small position for the past, small position for the future.

I have only allocated a small position in Rick’s because of the uncertainty of their business mode, their micro cap status and because they are typically not owned by many large institutional investors as a result of their “sin” stock status.

That being said, I believe that Rick’s is still operating profitably, in fact creating gobs of free cash flow, and if this were any other business, even one selling tires, they would be much higher in terms of their valuation and stock price.

I’m not sure what valuation metrics Wall Street uses to value a company like Rick’s, if they value them at all based on their aversion to a stock like this, but one thing is certain, whatever valuation metric they choose to use, Rick’s is WAY below fair value, and this doesn’t even include the premium valuation the company should garner as a result of their best-in-breed status in a largely fragmented market.

If you are looking for a solid long term play that might still have some rough times ahead, then Rick’s is for you.

I can promise one thing: When valuations rise for riskier stocks (they are already starting to do so), company’s like Rick’s will far outpace the overall averages and you will be well rewarded for your patience.

If you want to wait until after the earnings and conference call to see what is happening with Rick’s, that is also entirely reasonable as it will give us all some more ammunition to make a better informed investing decision.

Let’s see what type of “entertainment” Rick’s will deliver for investors in about a week.

Comments

[long_on_oil:]

How can you beat Ricks business model. All the dancers are self employed and they pay a small amount to Ricks at the beginning of every shift. Ricks pays no matching FICA and they have no fringe benefits payments for the dancers. If a club has 50 dancers,Ricks makes $5000 every night just from the dancers working there. If the numbers reported at year end match the pre reported then this stock is clearly a $30 stock just based on growth alone.
The stock needs to be in the 20's to keep the put spread down when they come due. 2008 has been a horrible year and Ricks is going to report over $1 earnings. With gas prices down how can 2009 be worse than 2008, it can't and it won't. Ricks is a real winner, I just wish I owned 10,000 shares instead of only 300...lol

2008 Dec 22 10:18 AM

[Oneslip:]

Not doing as much DD as needed, it looks to me like RICKs aggressive growth strategy may have them leveraged more then profits can support. As the economy erodes further, unless a person has a compulsion there would be no reason to pay premiums on beverages & topless dancers when the consumer is pinched. I feel that RICKs is a complete consumer discretionary co. which could have a horrible 2009. They stock could lower by 50%. I will wait before I make a trade. Good luck!

2008 Dec 22 11:06 AM

[Chris Ferna...:]

Hey guys,

That's why I have only recommended a 1/4 purchase for now. I want to hear the CEO's comments, and how the last fiscal year actually turned out, specifically the cash flow and free cash flow numbers.

I too think that the stock is perennially undervalued, but it is likely to remain so even if the market returns, because of its "sin" stock status.

Too bad people don't feel equally as ashamed of owning oil, coal, or other related stocks...

Chris

2008 Dec 23 01:29 AM

[Joe Public:]

To oneslip... I think some people DO have a compulsion. From an investor's perspective, that is one of the attractive traits of a company like Rick's.

(no position in Rick's, but am following the story)

2008 Dec 23 01:45 PM

[Zee4Money:]

Looking forward to seeing the quarterly numbers. The data is already old as the earnings are being reported as of 30 Sept. I have several concerns with RICKs. 1) Are margins going to be lower? Is the company having to provide incentives to keep sales up and are custmers going to be spending less and less as the economy continues to decline. 2) How are forward earnings going to be impacted by their method of financing growth. How much will guidance be lower. 3) How well is the company controling cost? I don't see much capability of management to control expense in a much more difficult environment. I will wait to see the earnings report and guidance to determine if I am confident that the company will be friendly to shareholders.

2008 Dec 24 02:25 PM

[Chris Ferna...:]

I think what it all boils down to at this point, is that we're all going to be waiting and listening in to Rick's conference call on Monday to see what our next move should be in regards to the stock.

I am comfortable with my 1/4 position right now, the question is, should I be buying more based on simply valuation and cash flow generation?

That remains to be seen.

Stay tuned.

Chris

2008 Dec 25 11:21 PM