Sometimes I feel like saying "pass the pappas." After all, Luby's (NYSE:LUB) current management team (CEO Chris Pappas and his brother Harris) have been on board for the past 13 years and the stock price is lower today than it was as they took control with their 16% stake.
The good news is their share ownership proves they have plenty of skin in the game. The problem is, they have been in the restaurant business for a very long time, and to say they are, "set in their ways" is probably a major understatement. They need to be able to visualize change and then enact it, but as we all know, change is hard to do.
We all recognize the definition of insanity - Doing the same thing over and over again, but expecting different results. Why not do something radically different, like return your cash flow to shareholders in the form of stock buybacks and cash dividends? Why not reduce your cost structure so more of your top line falls to the bottom line? Employing 21 vice presidents makes the organization top heavy. Why not cut the fat?
Instead of opening new restaurants and buying existing chains, doesn't it make more sense to get your own house in order before taking on other's problems? In its latest quarter, LUB had the dubious distinction of showing increases in all four if its major cost centers as a percentage of sales (food, payroll, occupancy and other) despite a 10% sales gain from $79.4 million to $87.3 million. How does that happen?
The company currently is composed of the following four divisions:
Luby's Cafeterias: Operates 93 traditional cafeterias. In its latest quarter, the eatery saw its same store sales rise 2.4% aided by a 1.6% increase in traffic as well as average check increase of .7%.
Fuddruckers: The chain runs 62 gourmet burger locations as well as receiving franchise fees on another 93 units. The division had a weak first quarter, experiencing a 2.3% drop in same store sales. The culprit was a 4.8% loss in customer traffic, partially offset by a 2.7% jump in average customer spend. In February, LUB entered into a franchise agreement with a restaurateur that plans to open ten Fuddrucker locations in Chile.
Cheeseburger in Paradise: They bought the 23 unit chain in December of 2012 for $10.3 million. Apparently they paid too much as they have been compelled to close three locations, and the operation has been a drag to earnings. LUB management has said it will take another year to get the remaining bugs out. In the meantime, LUB is keeping Jimmy Buffett flush in margaritas, with a payment structure entitling him to a 2.5% royalty fee. Sounds like a pretty good deal for Jimmy, maybe he and Warren Buffett are relatives.
Culinary Contracts division: The company services 21 locations involving mostly educational, healthcare and corporate clients. LUB was able to raise its profit margin on the operation a very solid 43% from 9.2% of sales to 14% of sales. They were able to do this by evolving to a cost plus fee structure. The division recently was awarded a contract to service a 750 bed hospital system, starting in early March 2014, so momentum is obviously rising.
A real estate company: Believe it or not, LUB owns the structures and land on nearly 50% of its 178 locations. With a market cap of just $1 million per location, this is extremely low compared to Chipotle's (NYSE:CMG) average location value of $11 million, especially when you consider that CMG leases all its locations. The real estate represents hidden value on the balance sheet, because those properties are on the books at cost, rather than market value. Many of those locations have been owned for a very long time, meaning there has been ample appreciation - low hanging fruit just waiting to be picked from the tree by a competitor or Private Equity firm.
Capital expenditures: In its current fiscal year, LUB plans on devoting $35-40 million on capex. It has earmarked $6 million on remodels, $14 million on 6-7 new store openings, and $10 million on land purchases and restaurant development. The remaining monies will fall towards general maintenance purposes. The company's bankers must like what they see, as they recently opted to give the chain a 40% increase in its line of credit, from $50 million to $70 million. LUB currently has a balance of $24.3 million on its credit facility.
Other: Only Sidoti & Company provides meaningful research coverage, currently with a hold rating in place. It is interesting to note that the Motley Fool Caps Community has bestowed LUB its highest 5 star rating, but I am a bit puzzled why. The news that there are four 5% holders besides the Pappas could support the bullish stance of the CAP's community.
The largest holders besides the Pappas are Hodges Capital Management Fund with a 8.70% position, followed by Thomson Horstmann & Bryant at 7.86%, Dimensional Fund Advisors at 7.41% and Bandera Partners, holding 6.17% of LUB's 28,765,000 outstanding shares.
I am not sure why the top three officers (CEO Pappas, CFO Gray and COO Tropoli) total compensation package nearly doubled in 2013 when it rose 86.2% from $1,391,671 to $2,591,377, especially considering the company's income actually fell 52% from $6,854,000 to $3,285,000. Why reward management for lower earnings? Am I missing something?
Summary: tThe company needs to be fixed, and the good news is - it is fixable. The fact that it guided just 1% same store sales growth in 2014 is concerning, when considering the effects of inflation, the 1% forecasted growth is actually negative in real terms. One thing for sure, LUB's metrics still reveal bargain status, selling at just .45 times sales and 1.05 of book value, exacerbated by the stock's recent 30% bloodletting. The question is, will Mr. Market begin to recognize this undervaluation or continue to turn a blind eye?
Further weakening the stock's performance is its use of a third party investor relations firm as it restricts direct communication with shareholders and impedes its ability to reveal its blueprint for enhancing shareholder value to the investment community. Will the company change? Probably not, but since the Pappas brothers have already reached retirement age and then some, they just might be inclined to put the company up for sale in order to finally monetize their investment. The bottom line: Change is good, especially for Luby's.