I Am Adding Monro Muffler Brake To My Watch List, Here's Why

Summary

• Monro Muffler Brake needs to bring more customers into its established stores.
• The company has expanded heavily via store openings and acquisitions.
• It possesses relatively low amounts of 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. This represents a good starting point before doing more in-depth research. Right now, let's talk about Monro Muffler Brake (NASDAQ: NASDAQ:MNRO).

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. Monro Muffler Brake operates and franchises a chain of car repair and tire service locations in the United States. It operates under many different names, including Tread Quarters Discount Tires, Autotire, Tire Barn and Car-X, to name a few.

2.) What do the fundamentals look like?

Investors should also look for companies that grow revenue and free cash flow over the long term, 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. Monro Muffler Brake expanded its revenue, net income and free cash flow 47%, 58% and 43%, respectively, over the past five years (see chart below). Over the past five years, acquisitions and the opening of new stores have served as catalysts for expanding fundamentals. However, it hasn't seen any growth at its established stores since FY 2012. While opening and acquiring new stores are nice, I like to see companies grow revenue at established locations as well.

MNRO Revenue (TTM) data by YCharts

The pattern for Monro Muffler Brake continues to a degree so far this year. In the most recent quarter, the company saw its revenue and net income increase 9% and 11%, respectively, year over year. Its free cash flow declined 12% year over year. Newly opened and acquired stores accounted for all of the gain in revenue and net income. Its same-store sales decreased 0.4% in the most recent quarter. Unfavorable inventory balances, accruals and capital expenditures contributed to the decline in free cash flow.

Monro Muffler Brake sits on an okay balance sheet. In the most recent quarter, the company possessed $7.7 million in cash, which equates to a meager 2% of stockholders' equity. This partially stems from Monro Muffler Brake's desire to acquire other companies. I like to see companies with cash equating to 20% or more of stockholders' equity to get them through tough times and to help them self-finance initiatives.

However, on the plus side, the company only possessed long-term debt amounting to 24% of stockholders' equity. Long-term debt creates profit-choking interest costs. I like to see companies with long-term debt amounting to 50% or less of stockholders' equity. Last year, Monro Muffler Brake's operating income exceeded its interest expense by 10 times. The rule of thumb for safety lies at five times or more.

Monro Muffler Brake does pay a dividend. I like to see companies pay out less than 50% of their free cash flow in dividends and retain the rest for other purposes. Last year, Monro Muffler Brake paid out a very prudent 18% of its free cash flow in dividends. Currently, the company pays its shareholders $0.60 per share per year, translating into an annual yield of 1%.

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.

According to its latest proxy, Peter J. Solomon, a board member for Monro Muffler Brake, owns 3.8% of common shares and equivalents. John Van Heel, the company's CEO, president and board member, owns 1.2% of common and equivalent shares. Catherine D'Amico, the company's chief financial officer, treasurer and secretary, owns 1% of common and equivalent shares. The management of this company possesses some incentive 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 the 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. Last year, Monro Muffler Brake's auditors said that its financial statements were presented fairly, and that the company maintained effective internal controls.

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. Monro Muffler Brake operates in the United States, meaning that political risk is minimal.

Monro Muffler Brake competes with many different companies, including the myriad of independent repair shops operating in the United States, as well as publicly traded competitors. This partially explains the company's struggle to get customers to return to established locations. Monro Muffler Brake can only expand so far and for so long. The company needs repeat business to maintain financial viability over the long term.

Monro Muffler Brake trades at a P/E ratio of 33, versus 18 for the S&P 500 as a whole, according to Morningstar, making the company overvalued.

6.) What does its forward analysis look like?

Monro Muffler Brake's management just upped its revenue guidance, and expects positive same-store sales in its FY 2016. They also expect earnings per share growth during that time. I would like to see the company maintain a trend of positive same-store sales and a lower valuation before I would consider investing. However, I will definitely watch this company for those two things to occur.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within 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.

Comments

[30372955]

t-roy

Thanks for your article on Monroe Muffler and Brake. I like to learn about anything that has to do with automotive.

[William Bias]

I appreciate your readership!

William

[gonji]

Thanks for highlighting companies that are honestly not on my radar. I too place a high emphasis on very low long term debt.

[William Bias]

Hi gonji,

Thanks for reading.

William