Investors are often attracted to the new and exciting whether it be the newest trend or the up and coming tech stock disrupting an industry. These types of investments can certainly churn many new headlines and often offer explosive revenue growth to keep people wondering if they are leading the next billion dollar industry. I love to read and follow some of these stocks, but many will never find enough profitability to justify the multiple put on them or possibly never make any money at all. RCI Hospitality (NASDAQ:RICK) on the other hand is beginning to turn into one of the boring stocks that I absolutely love.
The most recent quarter brought about a 1.4% YOY revenue increase hardly causing an investor to be excited from the headline. Earnings per share was a good bit better rising 9.7% year over year. The outstanding part of the earnings report as many know is the free cash flow that totaled 6.4M for the quarter and 16.7M for the last nine months. The estimate of 19-21M in cash flow puts the FCF yield at 18.5-20.4% causing RICK to be one of the cheapest stocks on the market. The $19-21M figure could be even a bit conservative as demonstrated by management's recent increased focus to under promise and over deliver.
RCI has an amazingly profitable strip club business that had an operating margin of 32.4% in the last quarter and has stable profitability. Bombshells restaurants turned in a really outstanding quarter having operating income jump 145% from $369,000 to $905,000. This strong upward trend gives additional credence to the concept and may create a decent proof of concept come franchising efforts for Bombshells.
Occupancy costs have traditionally been very high as RICK as they have had limited financing options for its sin industry strip club business. RCI has been able to get better rates from regional banks likely due to corporate name change and restaurant business. Management has executed well over the last year by buying expensive real estate on their best clubs to significantly drop payments on property as well as using refinancing to drop interest expenses. This quarter RCI reported occupancy costs as a percentage of revenue dropping from 8.4% to 8.1% YOY. Money saved from reducing occupancy costs drops straight down to the bottom line leading to higher free cash flow.
The real story with RCI is that they might finally be sticking to their pledged capital allocation policy. Management stated they will be opening a new club and a new restaurant, but there is no indication of another energy drink acquisition disaster or an empire making decision. Initiating a dividend and the 5.8M spent on stock buyback so far this year show prudent capital allocation. The pledge to stick to their current capital allocation policy as well as their massive cash flow will lead to major shareholder value creation. If management can keep its word to investors by sticking to their core business and capital allocation policy, RCI could finally become a boring company that throws off a huge amount of cash and doesn't make dumb decisions. I am hopeful that management has seen the light and will stick to the boring path and finally reward the patient shareholders by not destroying shareholder value.
If RCI can become a predictable cash flow machine, they can earn the status of a consistent boring stock in a not so boring business. The key is to stick to what works and that is clubs and increasingly so restaurants although I like the club focus more. A higher multiple would then be justified as the mismanagement discount currently priced into the stock will disappear causing the stock to move higher. RICK presents a strong asymmetric risk reward at this point after another solid quarter.
Disclosure: I am/we are long RICK.
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.