- The restaurant industry has been hit hard by the pandemic.
- Pizza restaurants are weathering the storm.
- However, Pizza Inn and Pie Five Pizza will likely not have the same success of other pizza restaurants.
While the pizza industry has weathered the storm, Rave Restaurant Group (NASDAQ:RAVE) has not. Despite being in the pizza business, their focus on dine-in and fast casual will prove detrimental for Rave Restaurant Group. We believe Rave Restaurant is a sell.
Where we stand in the restaurant industry
With the loosening of social distancing across multiple states in mid-May and early June, there will be a large focus on the restaurant industry. As one of the hardest hit sectors due to the closure of dining rooms and being mandated to provide meals through takeout, delivery or drive-through, it remains to be seen if a full recovery will occur.
Since China was the first country to be hit in the current pandemic, they will provide the best clues as to how we can anticipate what is in store for this industry. According to South China Morning Post, this is what we can anticipate when restrictions are lifted and dining rooms can reopen:
- Increased spacing between seating, thus lowering the capacity of dine-in patrons.
- Screening of patrons as they enter the restaurant.
- Low demand for dine-in restaurants as they continue to struggle to overcome health risks.
For these reasons, anyone wanting to invest in the restaurant space needs to analyze the data to see what type of restaurants will do well in the current environment. This is because the data from China tells us we are not going back to the way things were. The restaurants that are winners in the current environment will continue to outperform until consumers have confidence they won’t contract the virus going outside.
Pizza is king
Next time you are feeling cabin fever and you need a walk to get some fresh air during this pandemic, take a look at the recycling bins of your neighbors as you walk by. Don’t be surprised if you see an overflow of folded pizza boxes.
As seen in the graphic, compared to quick service (think McDonald's (MCD), Taco Bell (YUM)) and fast casual (think Chipotle (CMG), Panera), pizza restaurants outperform in terms of size and number of transactions. We believe this trend is occurring for the following reasons:
- Pizza is a cheap option to feed a family as we experience high unemployment.
- The pizza industry has always been catered towards delivery and pickup, thus avoiding any growing pains to transform their business model.
- Single-person transactions such as picking up coffee or lunch on the way to work are happening less frequently.
However, not all pizza restaurants are the same. There are two types of pizza restaurants:
- Traditional: Provide your order in advance
- Fast Casual: Tailor your customization in real time with an artisan
- MOD Pizza
- Blaze Pizza
Narrowing into specific companies, we can see that the traditional pizza chains are vastly outperforming the fast casual pizza chains. This is expected, given that person-to-person contact is discouraged, which is needed for fast casual pizza restaurants.
Where do Pizza Inn and Pie Five Pizza fit in?
Pizza Inn and Pie Five Pizza are absent from the data above. We will be diving into Rave Restaurant Group to see if they will be able to weather the pandemic like their peers. At face value, the industry trends don’t favor them, considering Pizza Inn is dine-in and Pie Five Pizza is fast casual.
Same store comps and sales mix
Pie Five has been having trouble over the past two years, and we see this trend continuing to drift lower and lower. Especially since the format of their business is similar to MOD Pizza and Blaze Pizza. We anticipate Pie Five to have a decrease of 56-63% in sales based on the change seen from their peers.
Pizza Inn same store sales, which have been hovering around 2%, have been relatively stable. However, if restaurants reopen with 25% capacity like they did in Texas, this would severely impact their buffet business. More so, if consumers are fearful that germs are easily spread in a buffet setting.
They also operate Pizza Express, which are the small kiosks inside universities and airports. We anticipate Pizza Express sales to be near zero, considering that people will take on more caution when eating on the go and commercial areas face lighter traffic.
Their sole bright spot is their delivery and carry out business. Recently, they announced that online sales have increased by over 17%.
Based on the above, we anticipate overall sales to drop 60%.
With the grim outlook for sales, we need to assess the company’s ability to weather the pandemic. Since the food industry is a low-margin business, it is very sensitive to shocks in sales. These shocks can severely impact the liquidity of a company. By adjusting the Q4 results for the above sales analysis, EBITDA drops by nearly half.
It is important to point out that long-term liabilities are mainly comprised of two items. The first being their lease obligations, which are approximately $650K per year. The second being their convertible debt at $1.5M. This could be an issue as current shareholders may face dilution if they convert. At the end of 2019, working capital was $1.8M. Thus, they should be able to be solvent in the near term. However, if the effects of the pandemic continue to stretch on, Rave could begin to face liquidity issues.
The bull case
While we believe Rave Restaurant Group is a sell, there are risks to our thesis.
- Their recent contactless buffet-to-go promotion continues to increase conversions to the delivery model.
- A vaccine/treatment is developed and everything goes back to normal.
- A rising tide lifts all boats - as the economy reopens, all restaurant stocks may experience a rally.
- The company is currently not compliant with NASDAQ’s requirements to trade above $1. The delisting risk is likely priced into the stock and may have a short-term rally if the company provides corporate actions such as a reverse stock split.
While pizza seems to be the only restaurant industry that is remaining strong, Rave Restaurant Group is not one of the pizza companies capitalizing on this. With their focus on dine-in and fast casual pizza, this company does not seem like it will weather the pandemic. Papa John's and Domino's Pizza will be safer plays than Rave in the pizza industry.
This article was written by
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