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Introduction

Think you can spice up your portfolio with a seasoned fast food stock such as AFC Enterprises (AFCE), operator of Popeye's Louisiana Kitchen? Of course, you're aware that so-called "fast-casual" restaurants like Corner Bakery Cafe, Five Guys and Panera Bread are the trendy choice of diners these days as they eschew the lower quality food available from fast food chains. Over the past several years, fast food or "Quick Service Restaurants" (QSRs) have lost market share to fast-casual restaurants. Based on data compiled during Q2 2013, analysts consider conditions favorable for fast-casuals at the expense of QSRs. Yet we think AFCE is a "winner winner, chicken dinner" for those investors who closely examine its numbers.

If you're looking for growth in the software-application industry, should you invest in AFCE to reap solid benefits in the future? In this article, I aim to deliver a clearer picture on where AFC Enterprises stands to expose possible risks you might face in the future. Our argument makes a largely fundamental case for suggesting whether this stock is a right bet for your future profits.

Stock Valuation Model

Before reaching any final conclusion, let's analyze key statistics for AFC Enterprises in detail. Here I'm going to use the "Stock Valuation Model" to find out whether AFCE stock is a right bet for your future profits.

The stock valuation model rates stocks from 1 to 10, with 10 being the best using a system of advanced mathematics to determine a stock's expected risk and return. I am using different fundamental and technical factors in order to rank a stock.

1. Value Test

The bars below the metric indicate which value test components the company fails when compared to the whole market. For example, if a stock has 2 bars colored for Earnings Yield, the company's earnings yield is between 20% and 40% in the market.

(click to enlarge)

Data from YCharts on 1 August, 2013

We can see that AFCE has a poor value score (1/10), far below the average value score. Earnings and assets are very low compared to price. The market is paying handsomely for value that may or may not be realized.

2. Fundamentals Test

Fundamental test is the process of looking at a business at fundamental financial level. This type of analysis examines key ratios of a company to determine its financial health and gives you an idea of the value of its stock. In addition, the fundamental analysis helps investors expose positive and negative factors. Let's look closely if AFCE fails any of ten tests shown below.

(click to enlarge)Based on data from YCharts on 1 August, 2013

AFC Enterprises currently has a strong fundamental score (7/10). Evidently, the company looks strong, but investors should keep an eagle eye on the failed tests carefully for possible weakness.

3. PE Valuation Method

This valuation method corrects for any recent price appreciations for discounts by suggesting that the value of the company will be in line with its historical valuations based on PE ratios. It will indicate companies that have recently increased in price, without an accompanying increase in earnings, to be overvalued, and it will show companies with a recent decrease in price, without an accompanying decrease in earnings, to be undervalued.

Formula: Value = PE5 x EPSTTM

Where:

PE5 = The 5 year historical average of annual median P/E ratios, allowed a maximum value of 35

EPSTTM = The trailing 12 months of earnings per share

PE Method Valuation = $19.22

Based on AFCE's financial data taken from Ycharts, calculation of the company's value according to PE Valuation Method makes us suggest that a current fair value for AFCE stands at $19.22.

4. PS Valuation Method

The PS Valuation technique estimates stocks by applying a historical average of median Price to Sales Ratios to current trailing 12 months sales numbers. Investors should always check to ensure that they are comfortable with the estimated historical Price to Sales Ratio given information today before investing based on this valuation.

Many investors prefer to use sales numbers to estimate stocks since they are slightly more difficult than earnings to correct using accounting practices. This technique tends to overvalue companies (growth firms) that have historically traded at very high PS ratios, and tends to undervalue companies that historically traded at low PS ratios.

In order to help investors avoid unreasonable valuations, there is a set of maximum Price to Sales multiple at 10, even if the company historically has traded at higher values. If the intelligent investor has good reason to apply a higher multiple, they may choose to do so, but we will not publish numbers that high because they are rarely sustained.

Formula: Value = Price/Sales3yr x SalesTTM

Where:

Price/Sales3yr = 3 year historical average of annual median Price/Sales Ratios, maximum of 10

SalesTTM = The trailing twelve month sales per share

PS Method Valuation = $21.04

Based on AFCE's financial data taken from Ycharts, calculation of the company's value according to PS Valuation Method makes us suggest that a current fair value for AFC Enterprises stands at $21.04.

5. Valuation based on Historical Multiples

The valuation based on historical multiples calculates the average of PE Valuation Method and PS Valuation Method. Since the method is an average, it will tend to be less volatile than either of the individual valuation methods. As a result, it would be helpful to check the values given by each of the methods discussed above.

Formula: Valuation (Historical Mult.) = (PE Valuation + PS Valuation)/2

Valuation (Historical Mult.) = ($19.22 + $21.04)/2 = $20.13

We can find out that current AFCE 's stock price of $37.86 is 88.09% over its historical valuation.

Future Risks and Prospects

The big question for AFCE: Can the company continue to make inroads into the suburban Anglo market while scoring consistent overseas gains? Executive VP Bob Goldin of Technomic Inc, a Chicago market research company, has his doubts. "Popeye's has its work cut out to suburbanize. 'Burb dwellers are more likely to frequent the likes of Panera Bread Co. (NASDAQ:PNRA)," he said. Yet AFCE shows no signs of relenting as restaurants as far flung as Sparks, NV, Salem, NH and Woodland, CA are opening - half a continent away from the traditional urban black clientele of the American South Popeye has served for 40 years. AFCE franchisee Rob Parsons claims that his five Popeye's in Massachusetts are among the most successful in the nation. AFCE franchisees have used social media tools such as Facebook pages to cultivate a loyal, almost cult-like clientele along the lines of In-and-Out Burgers and Chick-fil-A. The result has been growth in locations previously thought to be outside their traditional market demographics.

Recognizing the uneven performance of restaurants overseas, AFCE has made strides in building a stronger financial international model. Franchisees are encouraged to shutter underperforming restaurants and find optimal real estate locations that maximize sales and profitability. The 17 international restaurants that closed in Q1 2013 scored 45% lower than the average of the international system.

Final Findings

AFCE's stock appears poised for steady growth looking forward into the future. Their management has assembled a playbook for expansion that thus far has succeeded admirably. As long as AFCE can continue to find quality franchisees and keep its management team intact, the opportunity for future growth looks bright.

Keep in mind that at a price of about $37.86, AFC Enterprises's stock is significantly overvalued. Fair stock price valuation indicates that currently overvalued AFCE stock trades at a 88% premium over its historical value. That is a reason why the present time is not the best time for obtaining AFCE to gain in the future.

Source: AFC Enterprises: To Buy Or Not To Buy?