Shares of RCI Holdings (NASDAQ:RICK) have been on a roll after a strong capital allocation plan announcement, increasing roughly 30% since mid-February. Q2 results have reinforced management's commitment to smarter capital allocation and superior expense management to optimize operating margins. I am increasing my fair value range to $14-16 as my confidence increases that the management team is able to maximize the per share value of the company.
Q2 results rebounding after a weak Q1
RCI's Q1 was relatively weak, in part due to deteriorating oil economics in the Texas market. Q2 represented a sequential increase of 2.8%, though sales were down about 1.7% y/y. More importantly, operating margins in the core nightclub segment increased sharply to 33.7% of revenue, up 200 basis points y/y. While some of this can be attributed to moving some rent expense to interest expense, the nightclubs segment also benefited from the closure of underperforming clubs. The segment generated only $800K less in revenue than the year ago quarter with four fewer clubs.
Bombshells performed fairly well in the quarter, with sales up about 4.5% y/y, driving operating income up 39% as higher sales disproportionately impacted the bottom line. Still, the segment's 13.9% operating margin greatly lags the core nightclub business.
Going forward, I think operating margins are poised to grow in this segment as the company prepares to engage in franchising. RCI has secured legal approval for franchising in all 50 states and made its first ever franchise expo appearance this weekend. While I feel the business model is undifferentiated, the rapid growth of Tilted Kilt and Twin Peaks proves that there is ample demand for this sort of concept. I am confident that franchising is the right move for Bombshells as franchising will generate higher ROICs and operating margins than owning the restaurants outright.
Real estate sales will generate cash for repurchases and dividends
In a quest to better manage its balance sheet, the company is selling off some of its unused real estate. CEO Eric Langan anticipates the sale of this real estate will generate $7-9M, which, after taxes, should be at least $3.5M. This does not factor into the company's forecast of $16-19M in free cash flow, and it should help to fund dividends and repurchases going forward.
RCI is finally committed to maximizing shareholder returns
With its stock trading at well-under 10x earnings, RCI has already repurchased $5.4M worth of stock-over 5% of the float. In tandem with share repurchases, the company paid out a dividend of $0.03 per share. At current prices, the annual dividend yield is about 1.1%. I think the company will also continue to evaluate potential acquisitions, though management noted that it would only accept return thresholds in excess of buying back stock.
It took several years, but RCI's management team finally has it right. The company is focusing on optimizing returns and is no longer being run in the same undisciplined style that plagued the company in the past.
Several catalysts, including large sporting events being held in core RCI cities, will help drive growth in 2017 in spite of a weak oil market. Given lower share count assumptions and less risk-adjustments to free cash flow, I am increasing my fair value range to $14-16. I think shares are a solid buy under $11 and very attractive under $10.
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in RICK over the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.