On Oct. 30, Frisch's Restaurants (NYSEMKT: NYSEMKT:FRS) which, along with its franchisees, operates 126 restaurants under the name "Frisch's Big Boy" came out with its Q1 fiscal year 2015 10-Q. This followed up on the earnings statement released on Oct. 22. At first appearance, the results seem good. However, there appears to be a wolf in sheep's clothing. Here's why.
Fundamental expansion not as good as it looks
In the most recent quarter, revenue, net income and free cash flow all increased 2%, 37%, and 17% respectively. The same stores sales increase of 1.8% contributed to the increase in revenue. However, customer count declined 1.1%, meaning that the same store sales increase came from price increases imposed on a dwindling customer base. When a restaurant or any business loses customers, it loses the opportunity to make a sale. A dwindling customer base is not a good sign.
Net income and free cash flow gains mostly came from a one-time gain on, and disposition of, the real estate that was formerly occupied by a Big Boy restaurant. It is not good to see net income and free cash flow expansion come from the downsizing of a business. Net income and free cash flow should come from location expansion and higher traffic at established locations. Lower capital expenditures also contributed to free cash flow generation.
Balance sheet lacks cash but doesn't harbor significant debt
Frisch's Restaurant's $3.4 million in cash only equated to 4% of stockholder's equity. I prefer that companies possess plenty of cash for tough times at 20% of stockholder's equity or better. However, long-term debt which can create profit draining interest expense, only amounted to 4.5% vs. 5% in June of 2014. Interest expense also declined 48% providing some aid to net income expansion. Operating income exceeded interest expense by 35 times. The rule of thumb for safety here lies at 5 times or more.
Dividend appears to be sustainable
Frisch's Restaurant does pay a dividend. The company's dividend to free cash flow ratio, the best measure of dividend sustainability, equated to 35%. In fiscal year 2014, the company paid out 50% of its free cash flow in dividends. Its dividend has been pretty sustainable over the past year and three months. Currently, Frisch's Restaurants pays its shareholders $0.80 per share per year and yields 3% annually.
Looking ahead
Frisch's Restaurants only trades at a P/E ratio of 14 vs. 19 for the S&P 500, and 15 for Frisch's Restaurants' five year average, giving this company low market price risk and offsetting some of the fundamental risk highlighted above. Income investors may want to give the company some consideration, as it has a 50 plus year history of paying a dividend on top of its decent payout ratio, keeping in mind the risks highlighted.
However, my thesis from an earlier article still stands. Frisch's Restaurants needs to start bringing customers back through the door as the company possesses no expansion plans for fiscal year 2015. Raising prices as well as liquidating company assets will only take the company so far. Finally, if Frisch's Restaurants doesn't start seeing more customers, the company along with the dividend will fade into oblivion.
