Carrols Restaurant Group's Earnings Leaves A Bad Taste In My Mouth

Summary

• Non-organic sources such as price increases and acquisition of Burger King locations boosted revenue only slightly.
• Customer traffic declines don’t bode well for Carrols Restaurant Group or its investors.
• Year-to-date operating losses mean that interest expense isn’t being covered, increasing chances of default.

On Nov. 5, the world's largest Burger King (NYSE: BKW) franchisee, Carrols Restaurant Group (NASDAQ: NASDAQ:TAST), came out with its Q3 2014 quarterly statement and earnings announcement. The company's results left a bad taste in my mouth. Let's take a look to see what's going on with this company.

Year-to-date revenue increased but just barely

Carrols Restaurant Group saw its year-to-date revenue increase a mere 0.4% vs. the same time last year. Its year-to-date same -store sales decreased 0.4% year over year driven by a 5.8% decline in customer traffic. Non-organic contributions, such as price increases and acquisition of Burger King locations, put Carrols Restaurant Group's comparison into the positive. However, I don't like seeing a decline in customer traffic. A decline in customer traffic translates into lost opportunity for a sale.

Net loss and free cash flow deficit improved

Carrols Restaurant Group turned a year-to-date net loss of $11.1 million which actually represents a 3% year-over-year improvement. The price increases highlighted above as well as lower advertising costs as a percentage of revenue contributed to this net loss shrinkage. Moreover, Carrols Restaurant Group turned a year-to-date free cash flow deficit of $21.8 million which represents a 10% year-over-year improvement. Lower capital expenditures, due to less remodeling, contributed to the positive change.

Balance sheet still in lousy shape

Carrols Restaurant Group's balance sheet remains in lousy shape. Thanks to a secondary offering, Carrols Restaurant Group's cash amounts to 32% of stockholders' equity. I like to see companies with cash amounting to 20% or more of stockholders' equity to get them through tough times. However, this cash will most likely be used for the purchase of new Burger Kings and their subsequent remodeling efforts.

Carrols Restaurant Group's long-term debt amounts to a staggering 117% of stockholders' equity. Long-term debt creates interest which chokes out profitability and cash flow. I prefer companies with long-term debt to equity ratios of 50% or less. The company turned an operating loss of $4.5 million so far this year which means its interest expense of $14 million isn't covered. I like to see companies with operating income exceeding interest expense by five times or more.

The takeaway

Its red ink, declining traffic, cash flow deficit, and lack of interest expense coverage should scare any long-term investor. Instead, investors may want to consider investing in Burger King itself since it doesn't have to foot the overhead of its franchisee stores. This leaves Carrols Restaurant Group and its investors in the disadvantageous position of having to foot the costs for rent, wages, and food which are subjected to swings in commodity prices.

Management guidance also doesn't give much hope as it expects same store sales to break even or nudge ahead by a mere 1% in fiscal year 2014. They also expect to spend more than previously estimated on capital expenditures which will heighten the company's cash flow deficit. It also wants to buy more Burger King locations which will deplete its balance sheet and increase the likelihood of default on its long-term debt. With all that said, investors should stay away from this company.

Analyst’s Disclosure: The author is long BKW. 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.