RCI Hospitality Q1 Reaction: Nightclubs Fine, Bombshells A Disaster

About: RCI Hospitality Holdings, Inc. (RICK)
by: Detroit Bear

A quick update on RCI after the company posted Q1 sales.

Nightclubs are fine, but Bombshells is a disaster, with comps down over 20%.

The company continues to rely on acquisitions for growth, and I am avoiding shares.

RCI Hospitality (RICK) posted Q1 sales results Thursday afternoon. Overall, sales from nightclubs and restaurants were up 6.5% y/y to $43.4 million, with consolidated comps up just 0.7% y/y. Overall, the quarter does not really change the overall thesis, but it does reinforce my bearish view on Bombshells as well as management's waning optimism about the concept.

The Good: Solid Performance in the Nightclub Segment

Nightclub performance during Q1'19 was solid, with comps up 4.3% y/y on top of a 7.1% comp in Q1'18, for a solid two-year stack of 11.4%. This undoubtedly benefits from the removal of underproductive clubs, but the number overall was solid. I continue to expect solid results as long as the economy remains in good shape. Bonus season on Wall Street could be good, which should help bolster Rick's in New York.

New clubs contributed $1.9 million in sales from the inclusion of the club in Kappa, Illinois, as well as Pittsburgh and Chicago. While I think RCI may have exaggerated the multiple it paid for Pittsburgh and Chicago, both clubs should contribute to improving the overall club mix. RCI will be able to goose the comps at the Chicago club simply by extending hours, though it is uncertain to what extent it will improve performance.

Although this is a stretch, I try to stay balanced, and RCI did experience some insider buying. CFO Philip Marshall bought $7K worth of stock, and EVP Travis Reese bought about $9K worth of stock. I wouldn't call this a huge statement, but it was insider buying.

The Bad and Ugly: Bombshells

As readers know, I have long been bearish on Bombshells, and Q1'19 helped reaffirm some of this negativity. Comps were down 20.5% y/y, and management attempted to save face by saying this was an improvement compared to the 21% comp in Q4'18. Clearly there was some benefit from the Astros in the comparable quarter of 2018, but I think the Bombshells issues run deeper than just comping a playoff run. Bombshells comped up 5.6% y/y in Q1'18, so it is not as if Bombshells had an impossible comparison.

Rather, I think Bombshells is suffering from reputational issues. Over the summer, the Gulf Freeway location in Houston was shut down for being a "crime factory." Months later, a man was shot in the parking lot at the Bombshells on 290 in northwest Houston. Houston, admittedly, is a large metropolitan area, but it is hard to imagine that the Bombshells reputation for violence and crime has not spread.

No need to fear - RCI will have prizes for its giant parking lot beer pong. Nevertheless, CEO Eric Langan "hopes" comps are only down single digits in Q2'19 - not exactly an encouraging sign, especially considering it's a fairly easy 2.7% comp that RCI is lapping

Furthermore, management seems ready to abandon the Bombshells growth strategy. One might argue this is all about the capital allocation strategy with the stock trading at lower levels, but if you listen to Langan, you can see that there is some doubt in the overall strategy. Langan noted on the call:

"We want to ensure we are performing in line with our expectations. We then want to look at the market and the growth trends and we want to gauge the return on our strategy of owning and developing the real estate ourselves."

Of course, he later cited the capital allocation strategy - that buying back equity at current levels is "risk free." But he also noted that Nightclubs are now the clear #2 use of cash, and the priority if the stock price increases. He says later on the call:

"The Nightclub acquisitions have been very hot. We've had some great location we've just recently picked up. We're looking at several more great locations right now. So, I'd be more inclined to do those Nightclub acquisitions before I would even think about of Bombshells. So, I'd say in the best case of all worlds, if we couldn't find acquisition, club acquisition, we had tons of cash, stock price went back up, then we start maybe look at Bombshells, you might see something in April-May of '20. Otherwise, you're probably right, probably won't see anything till probably the end of '20."

Just a few quarters ago, Bombshells was a growth asset. RCI seems to have moments of clarity when it realized Bombshells is a mediocre concept, but then it got tempted to reinvest in the concept. Overall, I think this has been a waste of capital, and though it is a small part of the total mix, it signifies RCI's propensity for misallocating capital.

Continue to Avoid Shares

Overall, the quarter was about as expected - nightclubs were fine and Bombshells was bad. Even the much vaunted Pearland Bombshells location has slowed. In order to drive mid-single-digit growth, it is clear to me that RCI must continue to acquire clubs; therefore, its free cash flow claims are greatly overstated. In addition, corporate governance remains lacking, and there is no reason to invest in this company.

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.