Nathan's Famous Could Hit New All-Time Highs After Earnings

Jul.31.14 | About: Nathan's Famous, (NATH)

Summary

Nathan's Famous will likely report quarterly earnings next week.

I expect blowout numbers for a variety of reasons.

With no analyst coverage, a strong report could lead to a fierce rally.

Nathan's Famous (NASDAQ:NATH) has been selling hotdogs for almost an entire century including 430 million of them last year alone. It's easy to overlook and dismiss it as a likely mature, no-growth company. However, that couldn't be further from the truth. For reasons detailed below, I expect Nathan's Famous to start to show explosive earnings growth.

Nathan's Famous generates revenue from three major areas (in order of least to most exciting):

  1. Branded Product Program for sale to the foodservice industry
  2. Chain of Nathan's Famous restaurants, some company-owned and most franchised
  3. Royalties from manufacture and sale of its products to retail outlets

Branded Product Program

The Branded Product Program includes "restaurant systems, convenience stores, travel centers, sports stadiums, entertainment venues, colleges and universities and vending." These include many clients who themselves are famous such as Subway, New York Yankees, New York Mets, Auntie Anne's, Sunoco Gas Station, Regal cinemas, major casinos, and others who want to use the brand to increase the perception of quality.

For the fiscal year ending March 30, 2014, sales of this segment were up 20.7% to $51.9 million even with the fiscal year being one week shorter than the comparison last year. This program services over 15,000 clients in all 50 states offering wide diversity. For many of its clients, Nathan's Famous grows as they grow. I expect this growth to continue.

Restaurants

The company owns 5 restaurants and has 324 more franchised. Sales last year were basically flat to down a little bit for both the company-owned spots and the franchised spots. Part of this was due to the harsh winter, which is now obviously cleared up. Another reason is the closure of its flagship restaurant during eight weeks of the peak seasonal summer months or sales would have been up by a decent amount of around 14% according to the company release.

The fiscal first quarter report coming up with be compared to this year-ago period which contained most of the eight weeks of closure. When the flagship restaurant was open, sales were up 16.8% on a year-over-year basis so I would expect the company-owned restaurant sales and profits to be up significantly with this report. According to the year-ago period report, the temporary factors caused a 27% hit to the company-owned sales. This time around that will be reported as growth plus any additional growth realized.

Franchise revenue and profits should be up significantly as well now that the weather is better and also because Nathan's franchisees opened an additional 56 locations over the last year or an increase of 21%. New franchise agreements have been signed for international locations in Costa Rica and Portugal.

Royalties from retail distribution: the best for last

For years, Nathan's has been successfully selling its branded hotdogs, sausages, and other products into now over 35,000 locations which mostly includes grocery stores, warehouse clubs, and convenient stores.

The agreement in place has been with a company referred to as "SMG" but now but has been replaced as of March 2014 by a company called "John Morrell & Co." The quarter about to be reported includes the first full quarter of royalties under the new agreement.

The old agreement had a 4.5% of net sales royalty fee. The new agreement is for 10.8% of net sales with a minimum annual guarantee of $10 million and going up annually from there. Nathan's believes $10 million will be surpassed compared to $5.3 million for the trailing 12 months under SMG.

If John Morrell & Co. does the same volume that SMG did, it should be significantly higher than $10 million. The neat thing about a royalty fee arrangement like this is John Morrell & Co. essentially does all the work, takes all the risk, and Nathan's just collects the royalty checks

John Morrell & Co. is undertaking "full-scale marketing efforts" all summer long to kick off the new agreement which includes NASCAR sponsorships, hotdog eating competitions, mobile sample vehicles across the country, social media, etc. All of this will be on John Morrell's dime for which Nathan's gets its cut.

With a net income of just over $8 million last year, this one agreement alone could potentially double earnings.

Obviously the risk here is if John Morrell drops the ball and isn't as successful as SMG was, perhaps even costing the brand sales or being slow in the rollout. I have to think though - SMG probably wasn't exactly pushing hard and stocking inventory when it knew months in advance that its marketing agreement was going to end.

It seems quite possible that John Morrell could significantly produce and sell much higher volume that are again at much higher royalty rates paid to Nathan's. It doesn't hurt that John Morrell isn't exactly a stranger to Nathan's.

According to the 10K, Morrell & Co. has had a license and has been selling branded Nathan products to foodservice accounts for 8 years including $1.594 million this past fiscal year or an increase of 10.5% over the year prior. John Morrell already apparently has a long, familiar, and trusted relationship with Nathan's.

Biggest risk

Earnings appear to be about to explode from all angles. I've taxed my brain trying to come up with realistic risks, and the biggest one I can think of is the rise in beef costs. It certainly isn't the economy - during bad times people tend to still be able to afford a hot dog. If you look at sales from 2005 to present, you see nothing but steady annual sales growth.

According to the 10K, beef prices have been continually on the rise due to the "lingering effect of the drought in the Midwest during 2012." In 2012, the price of hotdogs rose 12.9%. In 2013, they rose another 0.1%. For the last year, they were up another 7.8%.

Nathan's says it cannot figure out where beef prices are headed and half-warned, "We have taken steps to pass the recent cost increases on through price increases, but there can be no assurance we will be successful in doing so."

If it fails to pass along the price increases to consumers, or consumers are price sensitive (which is hard to imagine over a hotdog to be "frank," pun intended), then it will eat into profits a bit. On the other hand if Morrell & Co. raises prices successfully Nathan's gets royalties straight off the top of higher sale prices without taking on any of the cost.

Overall, Nathan's Famous seems poised to see earnings explode, sustainably, to the upside. It's a big, world-famous household name that everybody has heard of but few people pay attention to the stock.

I think this one is well under the radar as an investment and that could change with the next earnings report and beyond. I think realistically a $100 price target could be achieved over the next year based on four quarters of proven increased sales and earnings growth of 100% or even higher.

Disclosure: The author is long NATH. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.