RCI Hospitality Holdings (NASDAQ:RICK) posted strong numbers yet again as the company continues to sharpen its focus on free cash flow and generating value for shareholders. More importantly, the company announced a few new capital allocation decisions that should dictate how the stock performs in 2017 and determine whether management is able to create some incremental value. Due to a few small assumption changes, I am increasing my fair value range to $17-19. I will remain on the sidelines for now, but I continue to appreciate how CEO Eric Langan has morphed into a strong willed CEO capable of making smart capital allocation decisions.
Q1 - Quick Overview
Q1'17 was pretty strong overall for RCI, although the company technically fell short of consensus expectations on the top and bottom lines. Overall, revenue was up about 0.8% y/y to $33.7 million driven by an increase in service revenue that was partially offset by weaker food and alcohol sales. Service revenues are about as high margin as a revenue stream that RCI possesses, and operating income thus grew about 11% y/y to $6.3 million, which gave the company an operating margin of 18.8%.
For Q1, same-store sales growth was relatively solid in RCI's primary segments, with nightclub comp sales growing 2.8% y/y and Bombshells comps up 9.6% y/y as the company closes and sells underperforming locations. I appreciate management's more active control of its business portfolio, and I think 2017 comps will come in relatively strong, improving the RCI operating margin.
$10 million in property sales and a high stock price will lead to more M&A
On the conference call, management noted that they currently have 7 properties worth $10 million that are not producing income. Although I anticipate that cash proceeds will be lower than the $10 million price tag and timing is tough to predict, I think the RCI balance sheet can be improved significantly whether the capital is deployed to share buybacks, debt reduction, or M&A-which I believe is the most likely use of capital right now.
Langan signaled a renewed appetite for acquisitions on the call, saying:
"I think you're going to see both. We're actively looking at acquisitions again. With the stock in the range it's at we didn't really, we weren't in the market in January. So we're letting our cash build-up. As that cash builds up, we're going to start looking for place, but it was really easy before. We just put it into our stock. But the key is we're not looking at top-line growth. We're looking at growth in free cash flow. We want to see our free cash flow grow at 10% to 15% clip annually. And so we're being very picky on acquisitions. There's plenty of stuff out there I can run out and buy right now. But all that doesn't necessarily -- at least the standard I want of basically a three to four-year cash on cash pay back."
The issue with acquisitions in the space is generally two-fold: price and owner goodwill. A lot of businesses in general in the range of EBITDA ($2-10 million) that RCI looks to acquire are now receiving higher multiples than the 2-3x that the company enjoyed in the mid-2000's. Additionally, businesses in this range tend to pose a considerable amount of "owner goodwill" risk in the sense that the founder/owner creates most of the value. Overall, I expect RCI to be much more selective, but I also have confidence that management will find interesting assets at decent prices that they are able to improve.
Increasing Confidence in the "Outsider" CEO
Our good pal Darren McCammon made a guest appearance on the call asking Langan if he had readThe Outsiders as he hypothesized in December. Darren was right: Langan is a fan. When asked on the call if he read the book, Langan replied:
" Certainly. I've read the books a couple of times. I even have an audio -- an audio book in my phone. I guess the big thing was -- I'm from the strip club business. I'll be honest. I started out as a manager of strip clubs, and we went public and we built into this company and we've kind of grown and grown. And so we have financial advisors that were telling us you have to have the growth, you need to get the top-line growing keep this going. And so we are focused on those things. And I think we did well with what our focus was. And the difference in that book has really taught us that the top-line is really not important. What's important as how much cash can we generate? And how are we reallocating that cash? How are we either returning to shareholders or creating more value for the shareholders with that cash? And what it really taught it me, we were always told, our paper is cheap, you can write stock checks all day long. Well of course, the investment banks love that, because they're making fees. And we were learning as I start looking at it -- wait a minute, this is the most expensive money and outsiders look really taught me how expensive those stock checks were."
I appreciated Langan's candor and admission that he was able to mature as a CEO. As time goes by without mind-boggling decisions being made, I become more confident that Langan will be able to create long-term shareholder value. In fact, I think if shares pull back below my $17-19 fair value range in the next 12-18 months, I may be willing to start a positioned geared towards long-term ownership.
Overall, RCI is improving and value creation path is becoming clearer
Langan continues to grow as a CEO and demonstrate the discipline that he has lacked earlier in his career. I think the company continues to hold a nice platform for value-creation in the adult nightclub space, though I continue to question the viability of Bombshells as a nationwide franchise. After slightly increasing my long-term view of free cash flow growth, I am increasing my fair value range by about 15% to $17-19 from $15-17. I currently do not have a position , but I am going to be tempted to add on any weakness.
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.