May 13, 2013, I wrote about Ark Restaurants Corp (NASDAQ:ARKR): a medium rare value stock with a nice dividend on the side. I want to highlight this small company again because in recent years it faced numerous challenges and adversity - aside from those posed by the general economy. Now these are dealt with. Free cash flow will enjoy a significant uptick in the next two years.
My original story is still intact and the stock even declined a little from $21.45. Subsequently an Alpha-Rich article on Seeking Alpha discussed the stock as well.
ARKR owns and operates 19 restaurants and bars, 22 fast food concepts and catering operations in the USA.
This is not a chain that can roll out their concept or brand nationwide and enjoy terrific growth of their franchise. They chose not to build up brands and instead operate under trade names that suit the value locations they prefer.
ARKR Total Return Price data by YCharts
Reasons earnings have been temporarily depressed
In 2011, the company faced non-recurring expenses in the amount of $500,000 recorded in the quarter ended December 31, 2011 related to the resignation of the Company's former President.
In 2012, the company was negatively affected by Hurricane Sandy because of its businesses located in New York, Atlantic City, NJ and Washington, DC and the losses associated with the closure of its properties Red and Sequoia located in New York, NY as a result, totaling approximately $900,000 which includes approximately $256,000 of assets written off that were destroyed as a result of the hurricane.
In March 2012, the company signed a lease on a property in New York and started Clyde's but it experienced huge pre-opening expenses because the permits were very much delayed going through the city process. The company meanwhile had full staff there for months, thinking the permits would be issued any day.
Over time earnings are likely to recover from the temporary headwinds by themselves. However there is also an important value driver that I'd like to highlight.
Ark's management is not after prime locations. You could call them value restaurateurs. Michael Weinsten (CEO) says it like this:
We see ourselves as opportunists trying to find yields where the rent allows us a very good risk-reward ratio.
Clyde's is a new, large location in New York city. The company acquired a lease on the property during the crisis (2009) and this low rent location can be an important revenue generator for them until the lease ends in 2029.
The lease on the property of Clyde's that is situated in Manhattan was secured in 2009 for $35 / square foot. Management reported a property only 1 block south for the same amount of space recently went for $75 / square foot. Numbers by DTZ, a global property provider, seem to back up that $35 / square foot is a very advantageous deal.
Update Earnings Outlook
An important update that I would make to the article due to the CEO's comments on the q2 2013 earnings call is that EBITDA likely to end up flat for the year, it's not likely the stock will meaningfully appreciate on the short term:
We still think we're positioned for a very good EBITDA number for this year. We think we can make it up. One of the things I should say, and I'm sorry for, in my little oratory, not having said it: Clyde's is doing better. And the fact that Clyde's is doing better from last year is good, but the fact that it's doing better also indicates how poorly the weather has been for the other restaurants, because last year, we were just opening and we took a big hit for -- to EBITDA. Clyde's really did badly well into the fall of last year. So we're going to pick up EBITDA just on that differential. Clyde's, I think, last year, cost us about $1.7 million in negative EBITDA. It's -- so we've got $1 million sitting there, from now going forward to the end of the year, that we're going to benefit by to a good extent in comparisons. So we're sort of confident that with that, and with a break in weather, which we still haven't had, it's cold today here, we should be fine on EBITDA. And we should approach last year's EBITDA.
That is a disappointment as I initially hoped earnings would recover sooner.
Why the idea hasn't worked out so far
In my original article I assumed a period of 1-2 years would be required for the turnaround story to gain traction. Meanwhile the market performed very well and this stock is significantly behind. The most important reason of the underperformance is the weather as explained by the CEO on the latest earnings call:
Our big problem in this quarter was weather in the Northeast. We have several thousand outdoor café seats that were pretty much in full use last year. In March this year, we've had no utilizations of outdoor café seats at night and very little utilization during the day. The weather has just been too cold, too rainy, not at -- climatized for us to do good business. When we do have some nice weather in the afternoons, our outdoor cafés are full, the restaurants are vibrant. We just don't see any problem, economically, affecting our restaurants. This is all weather. We've had some -- we made some efforts to have some small price increases. They've been taken well. Restaurants that are not weather-oriented, like Robert at the Museum of Art and Design; Canyon Road, which is small; Thunder Grill; and then Center Café in Washington D.C., where there are very few outdoor café seats, their business is robust. What's dragging the earnings in New York down, EBITDA down, is the Bryant Park, which has 800 outdoor café seats; Sequoia in Washington, D.C., 600 outdoor café seats.
ARKR EPS Basic Quarterly data by YCharts
On February 6 Landry made an offer for the company of $22 a share. This is discussed in this article on Seeking Alpha. To a business that operates in the same industry there may be some synergies, this still indicates there is significant value in Ark Restaurants.
Management shrugging the offer off implies confidence the offer was too low, or confidence the offer will be upped in the future, or confidence the stock will more accurately reflect the business value.
There haven't been any more rumors. However the market is up a lot and the stock is flat, while business is decent. I'd say it is still an attractive target.
I think Ark can rise to $30 in one or two years. If the weather cooperates for a few seasons and the company doesn't run into any more regulatory trouble earnings will go up. When that happens, the stock is likely to appreciate quickly. Watch out for the earnings announcements. Once the stock is fairly valued, I would exit because I don't think this is a business to own for life.