Diversified Restaurant Holdings: A 6-Point Inspection
Summary
- Diversified Restaurant Holdings is too diversified.
- Diversified Restaurant Holdings grew its top line at a respectable rate over the past five years.
- Diversified Restaurant Holdings is loaded down with long-term debt.
It's 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. Today, let's talk about Diversified Restaurant Holdings (NASDAQ: BAGR).
1.) What does the company do?
When you buy shares in a company you effectively become part owner of that company. Therefore, it's important for an investor to understand what a company sells. Diversified Restaurant Holdings is what I would like to call, a split personality company. The company owns and operates Bagger Dave's, which is an "ultra-casual restaurant and bar concept" that specializes in various and sundry burgers, beer, milkshakes and salads. In addition, it is also one of the largest franchisees of Buffalo Wild Wings (NASDAQ: BWLD). I prefer companies with a focus. I also don't like companies that franchise for other businesses. Franchisees get the short end of the stick and have to foot the overhead for the name brand company.
2.) What do the fundamentals look like?
Investors should also look for companies that grow revenue and free cash flow over the long-term, while retaining 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. Diversified Restaurant Holdings has seen excellent top line growth, growing its revenue 225% (see chart below) over the past five years. Diversified Restaurant Holdings achieved this with a combination of opening new stores and expanding comparable sales.
BAGR Revenue (TTM) data by YCharts
However, the company has seen a steady decline in net income and free cash flow over the past five years (chart below). Operating expenses have outpaced the growth in revenue. In addition, the company has been taking on increasing amounts of long-term debt, which has bred more interest cost, choking out net income. Heavy investment in restaurant expansion has resulted in the expansion of free cash flow deficits over the past three years.
BAGR Net Income (TTM) data by YCharts
Diversified Restaurant Holdings' long-term debt amounted to an astronomical 167% of stockholder's equity in the most recent quarter. I always prefer companies with long-term debt to equity ratios of 50% or less. In the most recent quarter, Diversified Restaurant Holdings' operating income only exceeded interest expense by a scary 1.4 times. The rule of thumb for safety lies at five times or higher. On the balance sheet, the company possesses $19.3 million in cash and equivalents, amounting to 58% of stockholder's equity, which exceeds my personal threshold of 20%. The company is going to need its cash to help pay interest payments if operating earnings fall short.
Investors may want to consider Buffalo Wild Wings itself. It doesn't have to foot the overhead costs of its franchised locations, giving it higher operating margins in the process (see chart below).
BAGR Operating Margin (TTM) data by YCharts
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 profits, which will enhance share price and their personal wealth along with the wealth of shareholders. T. Michael Ansley, chairman of the board, president and CEO owns 42% of the company's common stock. Jason Curtis, the company's chief operating officer, owns 3% of the company's common stock. David Ligotti and Greg Stevens, both directors, own 1% of the company's common stock. This tells me that the company's senior management definitely wants to see this company succeed.
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 it maintains adequate financial controls. At the conclusion of the audit, you want to see a letter from auditors 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. Interestingly, the Diversified Restaurant Holdings' financial statements received a "fairly presents" rating based on internal controls which received an "adverse" opinion. This is something investors should keep an eye on.
5.) What types of risk 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. Diversified Restaurant Holdings operates exclusively in the United States, which means that the geopolitical risk is low. The company definitely operates in an immensely competitive environment where, in any given city, the consumer has a myriad of choices. Diversified Restaurant Holdings is operated at a net loss in FY 2014, which means that its market price is incalculable.
6.) What does its forward analysis look like?
I would like to see Diversified Restaurant Holdings focus on its Bagger Dave's business and slowly shift away from the Buffalo Wild Wings franchises. This would give the company greater focus on a core competency. Finally, the company's over-reliance on long-term debt to finance operations and expansion leaves me with the strong desire to stay away.
This article was written by
Analyst’s 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.
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