Despite Operating Challenges, Carrols Restaurant Group Is Focused And Comes With A Very Reasonable Valuation

Jul. 24, 2019 8:33 PM ETCarrols Restaurant Group, Inc. (TAST)

Summary

  • Initiating coverage of the largest Burger King franchisor in the world with our top "3" rating.
  • Shares are depressed as fast food operators face intense competition and labor cost pressures.
  • Trough valuation and future growth potential seem to more than offset those headwinds.
  • Looking for more? I update all of my investing ideas and strategies to members of DSO Restaurant Analysis. Get started today »

We are continuing to expand our research coverage universe and, today, are initiating coverage of Carrols Restaurant Group (NASDAQ:TAST) with a "3" rating, our highest. Carrols is the largest global franchisee of Burger King restaurants, having amassed a collection of more than 1,000 units since 1976. They also recently acquired more than 50 Popeye's locations, which seemed logical, given that both brands are now owned by another company we follow, 2-rated franchisor specialist Restaurant Brands International (QSR).

We went back and forth on how to rate TAST initially, as the owner-operator model is facing challenges with rising labor costs and pressures to offer lower margin delivery service through third-party partners. However, given that this company has a narrow brand focus and a 40-year track record operating franchised fast food restaurants, we believe they are as well positioned as anyone to successfully navigate a highly competitive and evolving industry. As you can see, they have posted consistently positive same-store sales growth:

Source: Company SEC filings

Also a factor was the current market price of TAST shares, which, at around $8.75 each, marks a low not seen last since 2015. It appears that the challenges they face are largely priced into the stock already. We looked at year-end valuations for TAST each year going back to 2014 and found that the company garnered an EV/EBITDA multiple between 7.5x and 11.0x during the last five years. The current price translates into about 7.8x our forecast for 2020 EBITDA - at the low end of historical valuation ranges.

ChartData by YCharts

TAST has been able to post consistently positive same-store sales growth each year, which helps solidify the thesis of them being solid in-store operators. The company continues to have an appetite to acquire and/or build new locations, having grown from ~675 at year-end 2014 to nearly 1,100 today. That growth should continue, and expansion opportunities will likely present themselves as QSR acquires more brands down the road.

Source: Company SEC filings

The only other concern really was whether the company was creating any value from their growth, or if they simply were getting bigger to keep busy and justify higher and higher compensation at the management level. Since 2014, EBITDA per share has risen from $1.06 to $2.10 on 2018. Since TAST's growth has been debt-funded, we were impressed to see that net debt per share during the same timeframe has risen, but less quickly than EBITDA ($4.17 per share in 2014 and $5.98 in 2018). Growing profits faster than debt is important for an M&A-focused business, because it will result in per-share value creation. Borrowing money and extracting only commensurate value from the assets being acquired often does little for public investors.

While TAST is a small-cap company (about $500 million equity value) and takes on more operational risk than its franchisor partners, a combination of historically low valuation and solid track records of operations and growth lead us to believe the current price represents an attractive entry point for the stock. At the midpoint of TAST's 5-year average valuation range (9.25x EV/EBITDA), the stock would fetch closer to $12 per share. And, that price would not factor in any future EBITDA growth from incremental development or M&A deals in the pipeline.

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This article was written by

Dining Stocks Online (DSO) publishes investment research on the dining sector of the consumer discretionary industry. DSO's research is compiled and edited by investors with more than two decades of experience assisting in the allocation of capital to the public dining sector, both personally and for advisory clients. DSO aims to become a valuable provider of niche research exclusively devoted to publicly traded dining chains.

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.

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