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Andrew August
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  • BAB Inc, a nano cap cigar butt stock with high returns
    This is an interesting stock, because it is very under the radar and possesses many value characteristics.  The best days of this company are behind it, but it still possess a strong balance sheet and generates positive earnings.  BAB Inc. is a company that franchises bagel stores under the Big Apple Bagels and My Favorite Muffin brands.  This is a company in a very similar position to Pizza Inn, recently profiled on Whopper Investments.  It faces many of the same challenges and possesses some of the same attractive characteristics.

    BAB is small with a market cap of $3,632,00 (7,263,508 shares, $0.50 share price) and 2010 net income of $410,000 for a PE of 9.  The valuation becomes more compelling when you net out $1,242,000 in unrestricted cash for a cash adjusted earnings multiple of 6.  Due to the franchise model of the company, it requires very little cash, so one could argue the company doesn't really need any of this cash.  I'm feeling conservative today, so I will say the company needs $400,000 in cash on the balance sheet, so the excess cash adjusted earnings multiple is 7. 

    Some additional attractive characteristics:
    - Management owns 38.4% of the company, the CEO's compensation is between 3-4 times his annual salary and has been at the company for 18 years
    - Company paid out $.06/share in dividends last year, $.04 in regular quarterly dividends and an extra $.02 at the end of the year.  That's 12% on the current $.50 price.   
    - There are $6m in tax loss carry forwards, which means the company won't have to pay taxes for 15 years at the current rate of earnings
    - It is very rare for a $3.6m market cap company on the pink sheets to do so, but it is audited and files with the SEC. 

    The downside is largely going to play out with the decline of the number of franchised stores that operate under the BAB and MFM brands.  In 2004, the company had 184 locations.  By 2010, the company only had 106 locations (98 franchises, 7 licensed, 1 company owned).  There were 108, 115, 129, and 143 locations in 2009, 2008, 2007, and 2006 respectively.  Clearly the company has been shrinking over time.  

    It is dangerous to look at 2009 and 2010 and decide there has been a stabilization in the store count.  The company faces competition from Einstein Bro's bagels and Breuger's Bagels for potential franchises and tons of companies for breakfast meals.  Panera, Dunkin Donuts, McDonalds, etc all offer bagel options and wider selections.  That the company faces competition from these various sources is evident from the decrease in franchisees.  Also, in my neck of the woods none of the bagel stores are franchised and are usually family owned businesses, a few of which might have 4-5 locations.

    I'm passing on this, because the future cash flows of the company don't look like they will equate the price of the stock.  Faced with the decline in stores, earnings would have to be pretty predictable.  Accounting for the cash balance, an investor would have to get comfortable with the idea that the company will generate cash that has a net present value of $2.4m.  The company will likely have difficulty producing consistent net income, as it has declined continuously over the years, which makes any time of prediction especially difficult to make with any accuracy.

    I can imagine a scenario where the company decides to pay a special dividend of 25% ($800,000 in excess cash), but I can also imagine a scenario where the company decides to buy something to put their tax loss carry forwards to use.  While the stock will continue to generate an attractive dividend yield, I would echo Raymond DeVoe who once said, "More money has been lost reaching for yield than at the point of a gun."  While in reference to bonds, the same point applies.  The company will be able to continue paying the dividend, but you might end up with equity (principal, in the case of debt) that is not worth what you paid for it.  This stock has a few puffs left on it, but the price to pick it up doesn't offer a margin of safety.

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
    Tags: BABB
    Mar 15 12:32 AM | Link | Comment!
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