It's always important for long-term investors to develop a guide for doing their investment research. Over the years I have developed questions to guide me in my thinking when researching the publicly traded universe. It's especially important when researching under covered small cap companies. With that said let's talk about Frisch's Restaurants (NYSE: FRS) which has a market capitalization of roughly $133 million.
1.) What does the company do?
It's important for an investor to understand what a company sells. After all, when you buy shares in a company you effectively become part owner of that company. Frisch's Restaurants and its franchisees operate 121 family style restaurants under the Frisch's Big Boy name in the states of Ohio, Kentucky, and Indiana.
2.) What do the fundamentals look like?
Investors should always look for companies that grow revenue and free cash flow over the long-term and retain some of that cash for reinvestment back into the business and for economic hard times. Excellent revenue and free cash flow growth serve as catalysts for superior long-term gains.
Since 2009 Frisch's Restaurants saw its revenue and net income decline 29% and 10% respectively. However, free cash flow increased 300% during that time stemming from relatively lower capital expenditures in the last three years. Part of the reason for the negative comparisons for revenue and net income stems from the sale of the company's remaining Golden Corral restaurants in 2012. Also, the decline of same store sales stemming from general economic conditions contributed to the negative comparisons during that time.
Frisch's Restaurants' balance sheet resides in a cash poor and debt light state. Its most recent balance sheet showed cash and long-term debt to equity ratios of 2% and 5% respectively. It would be nice to see the cash to stockholder's equity ratio above 15%. However, the low long-term debt to equity ratio represents a good thing. Long-term debt creates interest which chokes out profitability and cash flow over the long-term. Investors should always look for companies with long-term debt to equity ratios of 50% or less. Operating income exceeded interest by 11 times. The rule of thumb for safety resides at five times or more.
Frisch's Restaurants pays its shareholders a dividend. Last year the company paid out 50% of its free cash flow in dividends. Currently the company pays shareholders $0.72 per share translating into a yield of 3.1%.
3.) How much management-employee ownership is there?
Investors should always look for businesses where the managers and/or employees own a lot of stock in the company. Managers with a great deal of stock in the company will take better care to maximize company profit which will enhance share price and their personal wealth along with it. In other words, their interests are aligned with shareholders.
According to Frisch's Restaurants' latest proxy, Craig Maier and Karen Maier who serve as Frisch's Restaurants' CEO and Vice President of Marketing own 10% and 6% of the company respectively giving them an incentive to keep the company going in the right direction.
4.) How does its "Report of Independent Registered Public Accounting Firm" stack up?
Every year a company employs external auditors to audit financial statements and evaluate whether the company maintains adequate financial controls. At the conclusion of the audit, you want to see a letter with the language unqualified or fairly presents which generally means that the financial statements and internal systems in constructing them were clean or adequate. If you see qualified or adverse in the auditing letter's language then deeper issues in a company's financial statements may exist.
Last year Frisch's Restaurants' external auditors gave the company's financial statements an unqualified opinion on both the financial statements and internal controls meaning they are ok based on the audit.
5.) What types of risks does it have?
It's always important for investors to weigh the various risks such as exposure to political risk in parts of the world where war is the norm, competitive positioning, and market price risk. Frisch's Restaurants operates exclusively in the United States which means it faces little political risk.
However, Frisch's Restaurants operates in an immensely competitive environment. Frisch's Restaurants also lacks the scale of bigger competitors such as Denny's (NASDAQ: DENN) which sports 1,693 locations globally meaning that Frisch's Restaurants lacks the purchasing power to purchase material at a lower cost per unit. Frisch's Restaurants operating margins clocked in at 5% vs. 10% for Denny's. Frisch's Restaurants trades at 14 times earnings versus 19 for the S&P 500 according to Morningstar meaning the company is somewhat undervalued.
6.) What does its forward analysis look like?
Frisch's Restaurants needs to overcome its negative same store sales trend stemming from declining traffic. The chain can recoup some of the loss from raising prices but that will only go so far. The company is undervalued which means the market price risk for this company resides in the low range. However, investors interested in this company as a dividend investment should watch the trends toward declining traffic. Also, the company possesses little cash to get it through tougher times. Until these headwinds reverse investors may want to take their investing dollars elsewhere.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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.