The company has faced a very high tax burden.
The company fixed what had previously appeared to be a crippling debt problem.
The company’s book values of leverage in previous years were absurd, and removing unattractive debts held down net income for 2013. The newer levels appear sustainable.
Fiesta Restaurant Group, Inc. (NASDAQ:FRGI) has been volatile over the last year. When looking at the company's financial statement in a DuPont Analysis, some of that volatility makes sense. The company's values in each category have been fairly inconsistent which may produce some uncertainty for investors.
Table 1 contains all the metrics calculated in the DuPont Analysis.
To keep it easy to follow, I'll break down what we learn from each metric. For those of you that are already familiar with DuPont Analysis, some parts may feel a little slow. For anyone that didn't study Finance extensively, it may be a refreshingly easy to follow analysis.
The tax burden label can be counter-intuitive. Because the formula is supposed to multiply out to ROE neatly, the tax burden has to be stated in the format of "How much money did the company keep after paying taxes?" For investors, the tax rates reaching around 38% may be a little more uncomfortable. The company is predicting that taxes through 2014 will remain higher than 2013 because of the expiration of the work opportunity tax credit.
The same system applies with the interest burden column. It is a measure of how much money FRGI is keeping. If you're thinking, "Did they really pay out most of their operating income in interest for a couple years"? Yes, that is exactly what happened. However, in 2013, the figure actually improved dramatically. During that year, the company overhauled their debt position. They recognized a significant expense on closing out the position, which was reflected as an interest expense. So even though the value looks worst for 2013, they got it turned around during the year.
The operating margins have been improving for FRGI which is very positive. The last couple of quarters have been a brutal period in the restaurant industry, as intense competition and fighting for market share, combined with increased ingredient costs, cut margins for most companies. FRGI performed very well in that battle and increased their sales and margins.
Asset turnover is calculated as sales divided by assets. The measure helps us see how well, or poorly, a company is utilizing its asset base to generate sales. In addition to improving their operating margin, FRGI has become better and better with utilizing their assets to create sales. That's great news for investors as it indicates the company is not keeping bloated asset values on the balance sheet.
The leverage ratio and return on equity look absurd. The company's first financial statements show the company in a very tough position. The value of equity was negative, and that negative value of equity destroys the results. Rather than omit them, I included them so it would be clear what happens to the data when equity values go negative. The negative value of equity causes the values for the leverage ratio and ROE to both appear negative. Further, by being a value near zero, it distorts the calculation in the next year as well. By the end of 2013, the company appeared to be transformed. The leverage ratio was still very high, but at least the company's financial statements were more comparable with other companies. During that year, we also saw the price of the stock take a huge jump up. It's not too surprising that their earlier financial statements may have scared off many investors.
To get a better feel for the leverage, Table 2 will help us see the market values of equity.
The values here make far more sense. We can see the company was still using a fairly high amount of leverage when compared this way, but it wasn't an absolutely absurd amount. We can also see the company's stock price did very well in 2013. The management of the company was being very prudent in their decisions. You can see that they sold quite a few shares of stock in 2013, as the company took off. Despite their leverage ratios, they were reducing the number of shares outstanding from 2011 to 2012. Those shares were later sold during 2013 for significantly more money. The management, apparently, predicted the transformation that was going to take place and took actions to maximize the value of that transition for the investors that were holding them through that rough period.
Return on equity
The return on equity took a hit in 2013 compared to the most recent quarters. That isn't entirely surprising given that 2013 was the year of debt restructuring. The company's loss on closing out unattractive debt positions was expensed in the year and held income down below the sustainable levels. For comparison, net income was $9,257,000 in 2013 while the loss on closing out that debt position was $16,411,000.
With the exception of taxes, FRGI has been a tale of pretty much constant improvement. As an investor, the tax burden is a little worrisome. While some companies may legally move their operations overseas to dodge taxes, it would be difficult for the company to recognize earnings in a different country when it is obvious that most of their locations are in America. On the other hand, if their franchising business continues to grow abroad, they may want to separate that from the rest of the company for the benefit of shareholder. If they did that, I'd favor distributing the shares of the second company directly to their existing shareholders and creating a stream of dividends with the income from operations abroad. Still, I find that unlikely, so the high tax rates may be around for a long time.
The improvement in their debt structure was enormous. I feel that the new debt ratios may be too low given the relatively low interest rates on the debt, the strong margins, and the high tax rates. According to statements from management, their new debt is at 2.25%. Remember, that interest is tax deductible, so the effective after tax rate on their debt is around 1.42%. However, given the company's former experience with debt, they may be more cautious about using it.
The company's biggest strengths, in my opinion, are their ability to grow rapidly and their ability to improve margins during a very competitive period that reduced margins for most of their competition. That is an enormous feat that speaks to a clear vision of the company. When management has spoken to analysts, they have been focused in their message. They set a price point, they decided on a value proposition for the customer, and they decided to rapidly expand in the markets they know. I'm cautious about the valuation of the company, but I'm impressed with the leadership shown over the last few years.