Nathan's Famous: A 6-Point Inspection

Aug.28.14 | About: Nathan's Famous, (NATH)

Summary

Nathan's Famous operates a multi-channel foodservice company selling hot dogs, hamburgers, fries, etc.

Nathan's Famous sports an excellent balance sheet.

Nathan's Famous is moving past its storm damage and litigation issues paving the way for additional growth.

Investors need a guidepost for their investment research process. Over the years I have developed a 6 point list that helps guide me on my research process. Maybe you could use this list as a starting point in your investment research. Let's research foodservice company Nathan's Famous (NASDAQ: NATH) using this list as a guide.

1.) What does the company do?

It always pays an investor to understand what a company sells because when you buy shares in a company you effectively become part owner. It's also important to ascertain whether or not people will need or want the products the company is selling.

With that said, Nathan's Famous, broadly speaking, operates in the foodservice industry. Its sells hotdogs, hamburgers, chicken, fries, etc. through company and franchise owned restaurants. It originated on Coney Island, New York. It also allows foodservice companies and restaurants to sell its products through a branded menu program. Moreover, it sells its products in grocery stores.

2.) What do the fundamentals look like?

Investors should always look for companies that generate superior revenue growth, retain some of that cash for tough times, and reinvestment back into the business. These factors increase your chances of stock price appreciation in excess of the stock market as a whole.

Nathan's Famous saw its revenue and net income increase 63% and 33% respectively between 2010 and 2014. Increases in royalties stemming primarily from its branded menu program and franchisees contributed to the increases in revenue and net income. However, free cash flow swung from a positive $5 million in 2010 to a negative $1 million in 2014. Cash payouts on lawsuits and reconstructing hurricane damaged facilities contributed to the negative comparisons during that time.

Nathan's Famous sports an excellent balance sheet with its $35 million in cash equating to 74% of stockholder's equity. The company's possesses no long-term debt which represents a good thing. Long-term debt creates interest which can choke out profitability and cash flow. Investors should always look for companies with long-term debt to equity ratios of 50% or less.

3.) How much management-employee ownership is there?

Companies under the stewardship of managers and employees who own a significant stake in the business will more likely ensure its success. Resulting stock price appreciation will significantly enhance their wealth, and their interests will be aligned with yours.

According to Nathan's Famous's proxy, its directors and executives collectively own 32% of the company. The company's Executive Chairman of the Board Howard M. Lorber owns 22% of the company.

4.) How does its "Report of Independent Registered Public Accounting Firm" stack up?

Companies employ an external auditor to evaluate whether or not their financial statements remain in compliance with generally accepted accounting principles and to determine if the company maintains adequate internal controls. Every year the auditor writes a letter to the company's board of directors. If the company passes muster then the auditor offers a clean opinion. Seeing language other than an "unqualified" opinion or those statements "fairly represent" means that underlying issues such as financial manipulation may be happening.

Nathan's Famous's external auditors issued an unqualified opinion for its financial statements and stated that it maintained effective internal controls over financial reporting during the last five years.

5.) What types of risk does it have?

Investors should evaluate the different types of risk associated with an investment such as geopolitical risk, competitive positioning and market price risk. Nathan's Famous operates roughly 61 or 19% of its locations outside of the U.S. Some are located in politically unstable places such as Russia and Kuwait meaning that the company harbors some political risk.

Yahoo! Finance lists McDonald's (NYSE: MCD) as one of its primary competitors. McDonald's and its franchisees operate roughly 35,000 locations, nearly 100 times more than the approximately 350 locations operated by Nathan's Famous. McDonald's ubiquity gives the company economies of scale allowing it to profitably sell items at a cheaper price than say Nathan's Famous. In 2013, McDonald's clocked in operating margins of 31.2% vs. 17% for Nathan's Famous.

Nathan's Famous trade at a P/E ratio of 28 versus 18 for the S&P 500 and 17 for McDonald's according to Morningstar. Also, Nathan's Famous's earnings yield clocks in at 3.6% vs. 5.5% for the S&P 500 and 5.9% for McDonald's making the Nathan's Famous overvalued based on both measures.

6.) What does its forward analysis look like?

Nathan's Famous is definitely worth watching as company. Management isn't complacent in expanding its footprint. Revenue and free cash flow growth may accelerate now that it's moving past litigation and storm damage issues. However, investors may want to wait for a cheaper price before buying in.

Disclosure: The author is long MCD.

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.