AFCE is a stock I bought into for a family account in October 2008 and exited in October 2009, producing a long-term capital gain of over 40% for a one year holding period. The purpose of this post is to provide my basic financial analysis of the company to readers should another opportunity present itself in the market price of the stock.
AFC is the franchisor of Popeyes restaurants (it used to also own brands such as Church’s Chicken and Cinnabon, but via various transactions is now solely Popeyes). Founded in New Orleans in 1972, Popeyes is the second largest chicken fast-food franchise with 1,918 locations (vs. over 15,000 for KFC) and $1.7 billion in system-wide sales. Only 37 stores were company owned as of 10/4/09. The company’s investor relations website is here.
If executed well, the franchisor business model is attractive: diverse, relatively stable revenue streams, strong profit margins and very modest capital expenditure requirements lead to good free cash flow potential. An entrepreneur who would like to own a Popeyes pays the company a franchise fee ($30,000) and development fee ($7,500 domestic, more internationally) for the right to operate in a specified location. Going forward, the franchisee then pays the company a 5% royalty on sales and contributes 3% of sales to an advertising fund. They also agree to operate along company standards, adhere to the menu, and meet all other system requirements. The franchisee is responsible for all of the costs of opening and operating a location, such as the building, equipment, employees, food costs, etc.
Becoming a franchisee allows local operators to enter the market with a widely recognized brand, professionally managed menu and image, and enjoy economies of scale in food purchases, advertising, etc. Since the capital intensive ownership and relatively low-margin operation of the individual restaurants remains with the local ownership, the franchisor has relatively low capital expenditure requirements and can generate substantial free cash flow if the underlying units remain healthy over time. In the franchise world, company-owned restaurants are generally units that were taken back from franchisees that didn’t succeed as operators (the fewer company-owned units, the better is always the rule in our opinion).
Notes on the business
The management team seems to have done a capable job even during a dismal economic stretch in 2008 into 2009. Same store sales have stabilized (though expected to be flat for FY 2009 they are performing well versus their peers), the number of company-owned franchises has been managed down, and it looks like the franchise unit count should continue to rise modestly.
Excluding the company-owned locations, AFC employs only about 150 people. Based on annual franchise revenues of approximately $85 million, that works out to revenue of over $566,000 per employee, showing the strength of the franchise model. It looks like there was an upgrade in the leadership in the 2007 timeframe, and the current team does appear to have substantial restaurant experience.
The company does have almost $90 million in debt. However, its total leverage ratio was only 2.14x (total debt/EBITDA) as of 10/4/09 and has been decreasing due to debt repayments from free cash flow and asset sales (company-owned stores). There is an excess cash flow sweep and covenants on the debt restrict share repurchases if total leverage is above 1.75x.
Per Yahoo! Finance, the company is 82% owned by institutions and mutual funds. Largest institutional owners are Chilton and Columbia Wagner.
Net asset value
Based on the balance sheet analysis shown below, I peg the reproduction value of AFC’s assets at approximately $5.80 per share as of its 10/4/09 financial statement. The company only spends about $0.5 million in capital per year on franchise operations, so the majority of the PP&E is tied up in the company-owned restaurants. As AFC has reduced its company-owned restaurant count from 55 to 37 this year, it has actually generated a gain on sale (rather than recognizing a permanent loss or impairment vs. the carrying value of these assets). Based on this fact, I believe leaving the PP&E unadjusted is reasonable approximation of the reproduction value of these units.
Earnings power value
The calculation of the earnings power value will focus solely on the value of the franchise operations, then adding the PP&E in at book value at the end of the analysis for a complete sum-of-parts valuation of approximately $9.00 per share.
I have intentionally omitted a growth value analysis as revenue and earnings growth have not been displayed over the prior few years.
Valuation continuum and margin of safety assessment
The chart below summarizes the valuation work above compared to the current trading price and targeted entry level:
Summary and conclusions
AFC’s financial performance has been steady, if unexciting, over the past few years. The franchisor business model (which I calculate at well over 90% of the enterprise value in question) produces relatively stable, recurring revenue from a diverse base of customers, as well as high free cash flow requiring minimum working capital or capital expenditures. The “customers” (the franchise owners) operate under long-term agreements, and have substantial capital invested in the local operations. While the fast food marketplace is very competitive, Popeyes is an established brand with meaningful franchise value that doesn’t need to rely on any particularly trendy concept for growth. It seems that the company has the potential to produce an attractive return on invested capital over time.
While AFC doesn’t appear to be overvalued as of the date of this analysis (it closed at 8.16 on 12/31/09), a suitable margin of safety does not appear to currently exist for a value investor. I’ll be adding this stock to my current screens and look to potentially build a position should the stock fall back closer to $6.00 (it traded between $5 and $7 for most of the first six months of 2009, with a dip below $4 during the March 2009 market lows).
As of the date of this posting (1/1/10) the author had no position in the securities of AFCE.
Disclosure: No positions