Fast Casual Pizza Segment
MOD Pizza, based in Bellevue, Washington was founded in 2008 by Scott and Ally Svenson, who had built two successful food service companies while living in England. The first, Seattle Coffee, was sold to Starbucks in 1998, and Scott stayed on as President of Starbucks Europe. The Svensons were also involved with the founding of Carluccio’s Ltd, a chain of Italian restaurants, which went public in the UK in 2005 and grew to 35 locations by 2008.
After returning home to Seattle with their four children, the Svensons foresaw the emergence of “fast casual” pizza, a segment which didn’t previously exist. To our knowledge, MOD was the “first mover” in this regard. The Svensons started MOD pizza with the intention of “making a difference” in terms of employees, customers and communities served. The MOD experience provides customers the opportunity to create and customize their own pie for one price as they move through the ordering line choosing their ingredients. The pies are rapidly cooked in a 700 degree oven, and served super-fast in about 8 minutes (including both preparation and cook time).
The first location opened in Union Square, Seattle in 2008. The second location opened in early 2010 and there were five locations, in a variety of settings by Late 2011. With about $7 million of expansion capital provided by the Svensons and other early stage investors over the 2012 and 2013 fiscal years, expansion took the chain to 14 locations by yearend 2013. MOD raised an additional $15 million in March of 2014, and by yearend 2014 there were 31 stores in AZ, CA, CO, OR, TX, and WA, all but one (franchised in CO) are company operated. During calendar 2015, MOD closed an additional funding round of $45 million and grew to a total of 92 locations, 80 company operated and 12 franchised (having signed a small group of experienced multi-unit operators). During calendar 2016 $74 million of additional capital was raised and 100 locations were opened, bringing the total to 192. During calendar 2017, $33 million additional equity was raised, led by previous investors, and a $40 million credit facility was established, bringing the total equity raised to $185 million. Openings in 2017 totaled 110 systemwide, building on its prior year base by an impressive 57%.
Within the 302 total units, the Company operated 225 locations with franchised partners operating 72 and their UK JV partner operating 5. MOD is now represented in 27 states and the U.K., after entering 7 new states (IN, MT, UT, DE, FLA, NEV and GA) during 2017. Systemwide sales were $275 million in 2017 (a YTY increase of 81%), netting MOD $219 million (a YTY increase of 68%) from company store revenues plus initial franchise fees and ongoing royalties. Same store sales at company stores were a positive 5.2% in 2017, bringing its two-year same store sales growth to almost 11% and the three year “stack” to over 23%. Two new multi-unit franchises were awarded, and recently opened locations in Florida, Georgia, and Alabama (Roll, TIde!).
The Company has been dedicated to building a strong corporate operating team, prepared to make the necessary investment in people to support the very rapid expansion of (primarily) company operated units. The Company expects to continue it’s strong store growth in 2018, consisting of mostly company operated locations. There are currently about 215 corporate employees at headquarters to support the rapid growth and this number is expected to expand further during 2018. The Company has been dedicated to building a strong corporate operating team, prepared to make the necessary investment in people. In terms of executive talent, Bob Barton, previously CFO and VP of operations at drugstore.com, was named CFO at MOD early in 2016. While he was at drugstore. com the company went from a startup through the IPO process to more than $400 million in revenues. Additional executives added were Lisa Luebeck, senior vice president of legal and general counsel, and Megan Hansen, senior vice president of people. During 2017, Paul Twohig (COO), Tracy Cioffi (CMO), Robin Hamm (VP Culinary), Robert Notte (VP Technology) were added, all with outstanding credentials, and Kate Jaspon (CFO of Dunkin Brands) was appointed to the Board of Directors.
Scott Svenson has built and inspires an operating team that is dedicated to “making a difference”, building an operating culture where every employee is working for a cause bigger than themselves. “Spreading MODness”, the idea of using the business as a platform for positive social change, was demonstrated in 2017 by, among other things, a contribution over $1M to support local communities and Squad members in need, and franchisees’ donation of over $364,000 to Generosity Feeds, which helps create half a million meals for hungry children. MOD’s strong connection and social impact with Squad members, consumers, and the community at large were reflected by various awards during the year. MOD continues to be the largest and most rapidly growing – primarily company operated – chain within the fast casual pizza segment. This dynamic leadership team, supported by deep pocketed financial backers, has built an admirable company to this point, and provides every indication of continued success.
Noble Roman’s is a 45-Year-Old Brand, Well Regarded in the Midwest – Poised For Unprecedented Success
Social media reviews, along with sales, confirm the brand’s reputation in Indiana core market
Balance Sheet is profoundly improved over the last twelve months
Three new company operated Craft Pizza & Pub locations are highly successful, setting the stage for more company units as well as productive franchising.
The earnings and cash flow generation should steadily increase from this point forward
We wrote a little over year ago with the stock at $0.40/share that “Noble Roman’s was attempting to Re-establish a Growth Trajectory”. We acknowledged at the time that stocks don’t trade at $0.40 for no reason, and we talked about the historical problems as well as the weak balance sheet. In the fifteen months since, the balance sheet has been profoundly improved and most of the problems of the past have faded (or been written) away. Most importantly, a seemingly predictable, and relatively low risk path forward to grow cash flow and earnings, rebuilding (and expanding upon) the brand’s Midwest roots has been established. The plan revolves around replication of the now well demonstrated Noble Roman’s Craft Pizza & Pub (NRCPP).
The Legacy Businesses
While the last half dozen years have been burdened by an unsuccessful effort to build a “Take ‘N Bake” version of Noble Roman’s, and the Company has paid a predictable price for the failure, at the same time they have built a network of 2,768 franchised/licensed grocery store and “non-traditional” locations (e.g.convenience stores, gas stations, etc.) that sell Noble Roman’s branded products. Of that total, 2086 were grocery stores, which generated royalties and fees of $1.8M in calendar ‘17 (down from $2.1M YTY). The balance of stores, about 700 non-traditional locations, generated royalties and fees of $4.5M, up from $4.4M YTY. The exact number of grocery stores selling NROM products is a bit uncertain, since individual locations within a licensed chain come and go without notice, and NROM gets paid through the local raw ingredient distributor. We do not intend to go into great detail about these businesses here, since the major future potential for NROM is the Craft Pizza & Pub initiative. Overall, we view the grocery store/non-traditional “legacy” business to be fairly stable, not without its challenges, but also with remaining potential. Growth in the grocery segment has been hampered by the industry wide labor issue at the store level, since individual deli departments have to assemble the pies. NROM management is exploring ways in which the pies can be assembled at the distributor level, removing the burden at the deli counter. Should this effort be successful, a new round of grocery growth is possible. The non-traditional business has its own set of problems, not the least of which is collection of fees from licensees. Substantial legal expenses have been incurred in the collection effort, though those fees have been reduced lately. While the individual amounts to be collected are not large, writing them off without a collection effort would send the wrong signal to other licensees. On the positive side, a new “prototype” has been developed and more new locations of this type were opened in ’17 than in recent years. Collection results seem to have stabilized, and successful units have been opened within Walmart and Circle K stores, both with obviously larger potential. Viewing the “legacy” business as a whole, we consider it to be fairly predictable in a statistically reliable way, since no individual licensee or affiliated group controls a material portion of licensed locations. We consider that growth in this segment will be a plus if it happens, and have no reason to expect a material downturn.
The Balance Sheet
In late ’16 when we wrote our last report for Seeking Alpha, the Company was burdened with short term debt carrying a simple interest rate over 20%, especially burdensome when the company was still reporting operating losses from termination of the Take ‘N Bake adventure. $2.4M was raised in late 2016 and early 2017 in the form of 10% debentures, maturing in December 2019 and January 2010, convertible at $0.50/share, with 1.2M warrants attached @1.00. It is worth noting that both Paul Mobley, Chairman, and Marcel Herbst, Director, participated in this private placement. While the terms were not pretty, they are lot better than what had been in place. More importantly, in September ’17, the Company put in place $4.5M of conventional bank debt, maturing in September 2022, at an interest rate of LIBOR plus 4.25%. Additionally, a $1.6M Development Line of credit facility was established to fund three new company operated locations. Each tranche of the Development Line will be repaid starting four months after being drawn, on a seven year amortization schedule. As described later when discussing the CPP stores, the rapid cash on cash returns from the new locations appear to be easily capable of servicing the Development Line and generating excess cash as well. Overall, the new financing arrangements have provided NROM with adequate financial flexibility, allowing steady, even fairly rapid development of CPP locations, building a franchise operation, also protecting and building upon the legacy businesses. The Company has stated that annual interest savings will be on the order of $650k annually versus the burden carried prior to late 2017. Calendar 2018 results should benefit from about $500k of cash interest savings YTY.
Noble Roman’s Craft Pizza & Pub (NRCPP) was but a “plan” back in November 2016 when my previously article was written. The plan seemed sound, but the risks were also obvious. The first location opened in January ’17, the second in November ’17, the third in January ’18, all in greater Indianapolis.
The concept as I would describe it is: similar to Blaze, MOD, Pieology, and so many other participants in the fast casual pizza segment, but “evolved” and “differentiated in major ways. NRCPP serves personal size pies as well as family sized, serves traditional crust as well as Sicilian (for the same price), serves a limited (and tasty) number of salads, sandwiches, and desserts. Wine & Beer is served at a modest but comfortable bar, where you can also dine. Half a dozen TV sets create a low key sports bar “vibe”. Most importantly, I have personally been to all three locations, several times to the first of them, and can attest to the quality of operations that has been taking place. Social media commentary, including Yelp and Facebook, confirms my reaction, and public’s view of The Brand is a combination of nostalgia from their youth combined with admiration of the current updated concept. The hospitality quotient provided so far should be replicable in the foreseeable future because the company operated stores will be in NROM’s “back yard”. It is clear to this observer that, in Indiana, at the very least, the Noble Roman’s Brand, as represented by NRCPP is “money”.
Unit Level Economics
Tthe locations are about 4,000 square feet, cost about $500,000 to build (give or take $50,000), are averaging upwards of $35,000 weekly as confirmed by company public statements. Cost of Goods combined with Labor (including fringe benefits) is averaging about 50% of sales. EBITDA at the store level is on the order of 25% (24.1% for the first twelve months of the first store, from a standing start). At that level of EBITDA generation, $1.8M ($34.6k/wk.) would be about $450k, annually, the store paying for itself in just over a year. While acknowledging that three locations does not create a worldwide empire, and the success away from Indiana may not be nearly as dramatic, there are very few concepts in the restaurant industry that have generated that kind of return. Sales could build further as the market is penetrated, or perhaps be cannibalized, but there has been no effort at delivery, or introduction of a mobile app or many other typical operating and marketing initiatives. We believe that greater Indianapolis alone could support 30 or more locations, the State of Indiana many more, so an obviously unlimited growth runway is in place, and continued successful operation so close to their forty five year old home base should be manageable. The Company, led by President and CEO, Scott Mobley, has done an admirable job of getting NRCPP off and running.
The Corporate Earnings Power
Operating results over the years, including the last few, have been muddied with lots of unattractive moving parts. While the apparent EBITDA has been over $3M annually in each of the last several years, the free cash flow has been much less due to losses from the aborted Take ‘N Bake operation, exorbitant interest charges, and legal expenses associated with license fee collection. Since the Take N’ Bake location is gone, the interest savings from the newly structured balance sheet should save about $650k annually in interest, and legal fees are coming down, we think a reasonable base of EBITDA should conservatively be $1.5M-$2.0M before allowing for cash flow from new company operated stores or franchising of same. Calendar 2018 will include the contribution from the first three new NRCPP locations for virtually a full year, plus over half a store year from the fourth (Carmel, IN., to open in late May), EBITDA of 24% on average sales of $1.8M, for 3.5 store-years would generate an incremental $1.5M of EBITDA in calendar ’18. The Company has made no comment regarding further openings, but we believe that at least two more company locations could open by early ’19, perhaps another store or two by late ’19, which would allow for a contribution of at least six store-years for calendar ’19, or a total EBITDA addition of $2.6M on the ’17 base. Additionally, based on the very attractive store level economics as demonstrated, we view franchising of the NRCPP model to be an attractive opportunity, both for NROM and franchisees. The stated strategy is to sign up either multi-unit or individual operators (with experience and capital) in markets close to home. Further away, only highly experienced, very well capitalized operators, fully committed (psychologically and financially) to building out markets, will be enrolled. Since an operating organization is in place at NROM that can support local franchisees in their startup phase, and multi-unit franchisees will pay non-refundable up front franchise fees that should more than adequately offset support services, we expect that the franchising effort will contribute incremental profits and cash flow to NROM at even the earliest stage. Over time, we believe the franchising potential can match, and even exceed the profit and cash flow generation of company operated locations.
The Current Balance Sheet and Capitalization
There is currently about $7.5M of total debt, and about 21M shares currently outstanding. The debt consists of the $4.5M five year debt, $2.3M of convertible debt (at $0.50/share), and the Development Credit Line (for store development). Between now and late 2019 and 2020, the $2.3M of convertible debt will either turn into 4.6M new shares or be refinanced (which we believe will be practical, considering the current successful development of NRCPP locations). There are 2.4M warrants, that were attached to the convertible debentures, at $1.00 per share, which would obviously bring in $2.4M of equity if exercised. There are about 1M additional shares due to various options and warrants, which would bring in roughly $500k if exercised. In total therefore, about 27M shares would be outstanding, fully diluted, but that would have brought in over $5M of equity, obviously reducing the current $7.5M of current debt very substantially. We can therefore consider that the total enterprise value of NROM is something like ($0.70/share x 27M shares) plus $2.5M of remaining debt after cash generated from exercise of all options and warrants, or a total of 21.4M.
We need not make precise projections in terms of cash flow and earnings, other than presenting the rough parameters above. It is obvious that the potential for substantial growth of revenues and cash flow is in place, and the enterprise value is modest relative to that potential. A tremendous amount of progress has been made over the last year or so, both in operationally and in terms of balance sheet restructuring. At this point, the potential for this “microcap” to play on a much larger stage seems to be in place. Time will tell as to how quickly the fundamentals develop, and to what extent this management team, with an admittedly checkered history, capitalizes on the opportunity, but NROM management must be given credit for an impressive “re-launch” of The Brand.
COMPANY OVERVIEW (2017 10-K):
Dunkin’ Brands Group is one of the world’s leading franchisors of Quick Service Restaurants (QSR) serving hot and cold coffee and baked goods as well as hard ice cream. They franchise restaurants under the Dunkin’ Donuts and Baskin-Robbins brands. They have over 20,500 points of distribution (retail stores) in more than 60 countries worldwide.
Dunkin’ brand is 100% franchised business model and believe that this model offers strategic and financial benefits; such as being able to focus on menu innovation, marketing, franchisee coaching and support, and other initiatives to drive overall success of their brand. Financially their franchised model allows them to expand points of distribution (retail stores) and brand recognition with limited capital investment by the Corporation.
Dunkin’ divides its business into four segments: Dunkin’ Donuts US, Dunkin’ Donuts International, Baskin-Robbins US, and Baskin-Robbins International.
Dunkin’ Donuts – U.S.
Dunkin’ Donuts is a leading U.S. QSR concept and is the QSR leader in donut and bagel categories for servings. Dunkin’ Donuts is also a national QSR leader for breakfast sandwich servings. Since the late 1980s, Dunkin’ Donuts has transformed itself into a coffee and beverage-based concept and is a national QSR leader in servings in the hot regular/decaf/flavored coffee category and the iced regular/decaf/flavored coffee category, with sales of approximately 1.7 billion servings of total hot and iced coffee annually.
Baskin-Robbins – U.S.
Baskin-Robbins is one of the leading QSR chains in the U.S. for servings of hard-serve ice cream and develops and sells a full range of frozen ice cream treats such as cones, cakes, sundaes, and frozen beverages. Baskin-Robbins U.S. segment has experienced comparable store sales growth in six of the last seven fiscal years.
SOURCES OF REVENUE (2017 10-K):
For year ending December 2017, Dunkin’ brands had $12,506B global system-wide sales which generated a total of $860,501,000 in revenue (see chart of segment breakdown).
Dunkin’ generates revenue from four primary sources: (1) royalty income and fees associated with franchised restaurant, (2) rental income from restaurant properties that they lease or sublease to franchisees, (3) sale of ice cream and other products to franchisees in certain international markets, and (4) other income including fees for the licensing of the Dunkin’ Donuts brand for products sold in certain retail channels (such as Dunkin’ K-Cups’ pods, retail packaged coffee, and ready to drink bottled iced coffee), the licensing of the rights to manufacture Baskin-Robbins ice cream products to a third party for sale in US, franchisee, refranchising gains and transfer fees from franchisees and online training fees.
This analysis focuses largely on Dunkin’ Donuts US segment since it is by far the largest segment by store count, revenues and it is management’s principle focus.
DUNKIN’ DONUTS STRATEGIC PLANS (Updated from Dunkin’ Brands 2018 Investor Day Presentation – February 8, 2018)
The Dunkin’ Brands Analyst Day offered a deep dive into operational initiatives embedded in the outlook for the Dunkin’ Donuts U.S. business, and guidance for longer-term financial targets. The Company’s plan balances near-term operational initiatives with a longer-term strategic outlook in an effort to modernize the Dunkin’ brand while protecting what is already a strong brand/organizational culture.
Plans Outlined at Analyst Day – Management presented their Dunkin’ Donuts U.S. blueprint for growth plans aimed at driving operational efficiency at the store-level, menu innovation platforms and digital efforts.
New Unit Growth – Dunkin’s new unit growth plan was updated at the Analyst Day Conference for Dunkin’ Donuts.
- US New Unit Growth Plans:
o 1,000 new units by 2020
o 90% outside core markets
o 275 for 2018
- SSS growth of 3% by 2020
- Strategy Blueprint – beverage led and Grab & Go initiatives
- NextGen Store – The Company recently opened the first iteration of its NextGen restaurant in Quincy, MA. Designed to cater to the on-the-go customer, the new Dunkin’ Donuts restaurant features innovative in-store technologies and design elements and is 25% more energy efficient than previous design. New technology includes a beverage bar tap system serving premium pours of cold beverages such as Nitro Coffee. The store also features grab-and-go snacks and a double drive-thru with preview boards and order confirmation screens. The crew members in the restaurant wear new uniforms and headwear designed in partnership with lifestyle brand Life is Good®. Dunkin’ Donuts plans to have up to 50 NextGen restaurants by the end of the year.
Menu Innovation – The Company recently hired Ms. Katy Latimer as Vice President of Culinary Innovation in an effort to support innovation of core products and supplement the Company’s already strong pipeline of culinary innovation. Going forward, menu innovation is expected to be led by beverage innovation. From a food perspective, value messaging around sandwiches and wraps is resonating with customers in test markets, and also supporting beverage attachment rates are helping to drive higher average tickets. The recent introduction of “Dunkin’ Duos” is helping to drive awareness and traffic.
Unparalleled Convenience – Dunkin’ recently hired Mr. Tony Weisman into the role of Chief Marketing Officer is working on an upgrade to drive-thru experience that seeks to improve guest convenience. The Company’s digital efforts also focus on driving members into the Perks Loyalty Program (which grew by 2 million incremental members in 2017 and now sits at approximately 8 million total members accounting for 11% of total sales. On-the-Go mobile ordering will also remain a focus going forward. During 3Q17, 3% of total transactions were driven through the mobile ordering channel.
Brand Accessibility – Dunkin’ aims to increase consumer accessibility to its brands through the continued development of points of distribution (including traditional franchise store locations and asset-light partnerships). The growth of branded products sold in the consumer-packaged goods channel is an important point of discussion as it relates to brand accessibility (noting that 6 out of 10 cups of Dunkin’ coffee are actually purchased outside of the retail Dunkin’ store).
Restaurant Excellence – One of the vital components of restaurant excellence is menu simplification. Dunkin’ is testing a simplified menu in approximately 5,000 locations in an effort to improve customer throughput while also driving top and bottom-line growth for franchisees. This initiative also helps to manage labor turnover as it reduces the complexity of in-store preparation for a wide range of sandwich and beverage products while also creating a buffer for menu innovation.
The Company has rolled out a simplified menu in many of its core markets and plans are in place to continue this roll out over the course of the first quarter. A 1% improvement in COGS (largely driven by lower waste), a 1% improvement in labor margins, and a 2% increase in order accuracy were seen. The reduced menu test simplifies operations and saves approximately 90 minutes/day/store.
The Company also discussed a plan for G&A optimization/rationalization to lead to G&A decreasing 5% in 2018 before growing in the 2%-3% range going forward.
New store equipment and technology – At the store level, the Company highlighted opportunities to help ease the impact from operational bottlenecks and ongoing labor inflation through the introduction of label machines for drinks, machines that help to calibrate coffee equipment, and other speed/accuracy solutions. Other technology solutions include point of sale system improvements that support conversational ordering (improving speed/accuracy of order taking), cloud-based pricing, seamless integration with delivery partners, and zero footprint training in addition to improved labor forecasting, inventory/cash/labor scheduling management.
BASKIN-ROBBINS – STRATEGIC PLANS:
The Company’s goals for Baskin Robbins, similar to the plans for Dunkin’ Donuts U.S., aim for product innovation – introducing digital (mobile app) tools and delivery. To that end it has overhauled marketing plans and is experimenting with more attractive franchise offers, including multi-unit offers to its top performers. However, the Company’s principal challenge with BR is to return its U.S. segment to growth, and so far, results have been disappointing. Store growth has been barely positive, revenues are flat to down slightly and segment profits are also basically flat.
Consumer Convenience – Baskin Robbins plan to continue to expand delivery options with almost half of all Baskin-Robbins locations in the U.S. now offering delivery through DoorDash.
Improved BR App and Online Orderings – Early in the second quarter of 2018, Baskin-Robbins plans to launch an improved app and online ordering system. This is expected to improve the guest experience, especially on mobile devices.
New Store Image – Late in the fourth quarter of 2018, Baskin-Robbins U.S. plans to unveil a new store look designed to appeal to guests of all ages.
Product Innovation – The brand is expanding its focus on beverages in 2018, including an increased emphasis on milkshakes, as well as focusing on ice cream cakes.
Dunkin’ Brands continues its work to stabilize its international businesses and, along with its franchisees, is focused on driving traffic through value offerings, product innovation, and making the brands more easily accessible through digital technologies.
Dunkin’ Donuts International is encouraged by the early results of its new restaurant design, which positions the brand as a coffee-focused chain. With 40 of the newly-designed international restaurants located in eight different markets, the stores are experiencing an increase in overall average weekly sales and, importantly, an increase in beverage units.
Baskin-Robbins International is focused on ice cream gallon consumption across the business: through stores, delivery, and consumer packaged goods. Sales outside of the restaurants have expanded the brand’s touchpoints, making Baskin’ more accessible and driving incremental ice cream sales throughout the year.
Delivery continues to be an opportunity for both brands, and the Company is working with its partners to roll out delivery programs in as many markets as possible based on the success that its Middle East and Asia franchisees are experiencing.
UNIT LEVEL ECONOMICS:
The Company plan is to double DD US stores to about 19,000. The plan envisions growth in store count to expand westward from its most mature region in the Northeast states (the core region) where its penetration is about 1 store per 8,600 residents through successively less penetrated regions to the Western region where penetration is just 1 store per 282,100 residents. To achieve its ambitions, it expects it can grow its footprint in every region, with the least in its core region (to 1:8, 100) and the most in the Western region (to 1:23,800).
DD domestic PODs range in size from 1,200 square feet to 2,600 square feet (source: 2017 FDD), from which is listed estimate average unit volumes of $930K, or about $547/sq.ft. assuming 1.7K sq.ft. average size.
In the 17Q3 Earnings Conference Call (most recent information) management reported the average capex for the domestic DD stand-alone traditional stores opened in 2015 in the least penetrated (and key to the growth strategy) “West and Emerging” markets (essentially the Midwest) was $500K and first year AUV’s and cash on cash returns were $900K and 20%, respectively; implying a cash contribution margin of about 11.1% of sales. While these returns are a slight improvement over the units opened in prior years, they are not compelling, before regional G&A. Perhaps they will grow to more attractive levels as the stores mature, but they may also explain the slowing pace of franchise investment in the past two years. Perhaps franchisees are awaiting the introduction of a new store prototype – NextGen. It said that a large number of stores are reaching their 10-year mark which will require remodeling under the franchise agreement. It also stated it was examining ways to help franchisees allocate capital between new stores, remodeling and the investments in new digital initiatives. In this regard, the Company appears to be contemplating co-investing with franchisees of both brands to accelerate development; but had not announced any initiatives yet.
Baskin Robbins domestic units range in size from 600-1,200 square feet, from which they estimate AUV’s of $235K or about $260/sq.ft., assuming 900 sq.ft. average size according to the 2015 FDD. BR units opened in the last 18 months generated AUV’s of $385K, the cash outlays for the units ranged from $200-$225K and the cash on cash returns ranged from 20-25%. At the midpoint the implied store level EBITDA margin was about 13% of sales. These margins are only slightly more attractive than DD U.S., but the Company has not provided more current returns as it has with DD U.S. BR does not appear in any FDD after 2015 except as a combo unit with Dunkin’ Donuts.
SHAREHOLDERS’ RETURN (Source – 2017 10K):
During fiscal year 2017, the Company repurchased a total of 513,880 shares of common stock in the open market at a weighted average cost per share of $52.90 from existing stockholders. The current dividend affords shareholders a current yield of 2.31%.
On October 25, 2017, the board of directors authorized a new share repurchase program for up to an aggregate of $650 million of its outstanding common stock. This repurchase authorization is valid for a period of two years and replaces the Company’s existing share repurchase program.
In February 2018, the Company entered into two accelerated share-repurchase agreements (the “February 2018 ASR Agreements”) with two third-party financial institutions. Pursuant to the terms of the February 2018 ASR Agreements, the Company paid the financial institutions $650.0 million from cash on hand and received an initial delivery of 8,478,722 shares of the Company’s common stock on February 16, 2018, representing an estimate of 80% of the total shares expected to be delivered under the February 2018 ASR Agreements. Subsequent to these repurchases, after buying back about 9.5% of the prior shares outstanding, debt will be approximately 5.5x which will be at the top of the range where management is comfortable.
RECENT DEVELOPMENTS (Per Q4’17 Release and 2/6/18 Conference Call)
The comments below should be read in conjunction with the update from the 2/8 Analyst Day as described above.
Q4 highlights included Dunkin’ US comps of 0.8%, BR comps of 5.1%, 141 net new restaurants added worldwide, including 126 net dew DD stores in the U.S. Total revenues were up 5.3%, or 9.8% on a comparable 13 week basis, while diluted adjusted EPS was unchanged at $0.64. It should be noted that adjusted operating income was up 3.6% in Q4, up 7.0% for the full year, with adjusted EPS up 7.5% for ‘17. The company emphasized that morning comp store sales at DD were up each quarter sequentially, and the fourth quarter was driven by iced coffee and frozen Dunkin’ Coffee. Customer counts improved in the last three quarters of the year, presumably still negative in Q4. More than two million people were added to the loyalty Perks program during 2017, bringing the total to about 8 million. A simplified menu was rolled out late in 2017, to be completed in Q1’18. Baskin-Robbins had comp sales of 5.1% in Q4, driven by a higher average ticket, offset by a slight decrease in traffic. The G&A expense target was reduced in two percent in January, which will be a 5% reduction from the ’17 level.
At DD, Q4 saw record breaking sales of breakfast sandwiches, for the fifth straight quarter. However, transaction counts declined in the pm daypart, accounting for over 75% of the full day declines. It is hoped that the simplified menu will reverse this decline. New enhancements of the digital platform and mobile app have been introduced in January. During Q4 the total of CPG products grew by over 30%. CPG products, across both brands, generated $850 million of retail sales, including $150M in ready-to-drink sales for the year. In addition to the 126 net new DD stores in Q4 (vs. 190 LY), 88 remodels were done in the quarter. For the full year, 313 net new DD restaurants were added, versus 397 LY. BR had 22 net new openings for the year, a record since going public in 2011. DD International was “stable”, with comps up 1.6% in Q4. BR International was relatively strong in Q4 with a 3% comp.
Management discussed that franchisees were continuing to respond favorably to the term renewal program offered in 2017, allowing renewal back to 20 years. At 12/31, about 75% of all Dunkin’ restaurants in the US had more than 10 years remaining.
Meaningfully, Management reiterated their previous indication that 2018 will be a year of “foundation setting, simplifying our menu and improving the restaurant experience, rolling out a superior restaurant back office system and building back up our innovation pipeline”. This means: reduced operating margins this year (our interpretation), which will be at least partially offset by fewer shares outstanding.
SEMI-MONTHLY FISCAL/MONETARY UPDATE – GDP GROWTH SLUGGISH, FED BALANCE SHEET COMES DOWN-BUT BEHIND SCHEDULE, GOLD PRICE READY FOR UPSIDE BREAKOUT?
It now seems clear that Q1’18 will not demonstrate a pickup in the economy. After 2.9% real GDP growth in Q4’17, lagging the much heralded 3% plus in Q2 and Q3’17 (Q3 aided by reconstruction activities after the storms), it now seems clear that Q1’18 will be closer to 2% than 3%. Recall that Q4 consumer spending, which included the best Christmas season in at least five years, included record high consumer credit card debt (with an increasing incidence of default) and a reduction of the consumer savings rate down to about 3% of household income, not the healthiest combination for longer term spending expectations. Sure enough, the first quarter of ’18 seems to be characterized by slightly higher consumer savings, as the public is still burdened with high health care, rent, and education costs. We saw a chart recently that indicates that about 33% of 25-29 year olds are living with parents or grandparents, up from about 26% in 2010. No doubt many of these Millennials are coping with the burden of student loans. Surveys indicate that many consumers are going to apply savings from the new tax bill against debts, rather than increase spending. Economic spokespersons (i.e.Kudlow, Mnuchin, etc.etc.) continue to predict that the tax bill will stimulate faster GDP growth and much higher tax revenues, in time reducing the federal debt burden. Time will tell, obviously, but the jury is still out, and the signs are not convincing so far.
FEDERAL RESERVE NORMALIZATION PROGRAM
The US Federal Reserve continues to “normalize” the bloated balance sheet, but is running behind schedule. Recall that the plan called for $10B/month reduction in Q4, $20B/month in Q1, $30B/month in Q2, $40B in Q3, $50B in Q4’18, and that’s as far as described. The plan fell behind schedule by $23B in Q4, fell another $4-10B behind plan in Q1 (depending on whether you use 3/28 or 4/4), so was $27-33B behind schedule as of 3/31, a significant percentage against the $90B that was scheduled. In the first week of Q2, ending 4/11, the Fed’s balance sheet was essentially unchanged. The rubber meets the road now with a reduction of $30B monthly. Since the Fed’s activities affect short term interest rates rather than longer term, it could be instructive to look at what the bellwether ten year treasury note has done over the last six months. During Q4, as the Fed got $23B behind their $30B objective, the ten year traded between at 2.35% to 2.45%. The Fed stepped up their selling in Q1, meeting their quarterly objective (though not catching up) and the ten year moved dramatically, from just above 2.40% to as high as 2.95% and closed Q1 at about 2.75%. So far in Q2, the ten year has traded back up to 2.85% as this is written. The more volatile two year treasury, which bottomed around 1.3% in midSeptember, has moved in a straight line to 1.9% at 12/31, 2.27% at 3/31, and 2.38% today. These are very dramatic moves, and the pace of “normalization” continues to quicken. Time will tell what affect $30B/month of Fed “runoff” has on interest rates, but the possibility exists that rates could spike higher, especially if the Fed tries to catch up with the shortfall to date of about $30B. If interest rates spike upward in Q2, as they did in Q1, it could be unsettling to capital markets that are already showing volatility that we have not seen in years
Gold has been “consolidating”, around $1350/oz., up 3-4% for the year, fairly firm day to day, seemingly threatening to break out on the upside. No doubt the increasing visibility of federal debt accelerating to over $1 trillion annually as far as the eye can see, is contributing to the interest, as well as the possibility of increased inflation. Since Central Banks, worldwide, are trying to stimulate inflation, it stands to reason that they would be continuing to purchase gold bullion, which they are. Market technicians, chartists, point to $1,375 and $1,400 per ounce as “breakout” levels on the upside. After a 4-5 year consolidation, some observers think gold bullion could make a move to new all time highs, above $2,000/oz. From our standpoint, the gold miners seem to be the most advantageous way to participate, since the gold mining stocks are even more depressed in price than the metal itself. The last time gold bullion was around $1,350/oz., in mid 2016, the gold mining stocks were about 35% higher. If the price of gold breaks out on the upside, the gold mining stocks should do even better.
FAST CASUAL PIZZA SEGMENT
Blaze Pizza LLC
Blaze Pizza, based in Pasadena, California, was founded in 2011 by Elise and Rick Wetzel of Wetzel’s Pretzels. As others within this segment have done, Blaze provides a made to order approach to the pizza segment. Blaze attracted a prominent sponsorship group early, including LeBron James, Maria Shriver, American film producer John Davis and Tom Werner, co-owner of the Boston Red Sox. Most recently, as LeBron’s contract with McDonald’s expired in 2016, he became a spokesperson for Blaze Pizza. Jim Mizes was recruited in July of 2013, as President and COO, after being in leadership positions at several successful foodservice chains. Promoted to CEO in May, 2017, he leads a team of seasoned executives. Executive Chef, Brad Kent, a CIA graduate with outstanding credentials was recruited early, created the recipes and cooking procedures, and his Blaze pizzas were lauded by the Zagat Guide, among others, in 2013. Since Blaze is 99% franchised, expansion capital beyond the initial raise has not been necessary to fund the growth. The Company has been profitable and cash flow positive since 2015.
In terms of differentiating their concept, Blaze offers fresh made dough that is proofed for 24 hours, while some competitors use frozen dough. For Millennials and those with dietary preferences, Blaze also offers fresh made in house gluten free dough as an option, as well as vegan cheese, and emphasizes the uniquely “clean” ingredients that have no artificial colors, flavors, additives or preservatives. After choosing their type of dough, customers move down the assembly line as the staff add ingredients, and the completed pizza is cooked in the stone-hearth oven in only three minutes. Blaze’s oven is “oversized”, and combined with their “back line”, should have the necessary capacity to build delivery and on-line ordering as customers increasingly choose these options. Salads, S’more pies and blood orange lemonade are among other products offered. Blaze offers 8 signature pizzas, designed by Chef Brad Kent, or guests can “build their own” pizza all for one price. Therefore customers can choose any or all toppings, purchasing a pizza that could sell elsewhere for $12 to $15, for about $8.00.
Expansion has been rapid for this predominantly franchised chain, and volumes have been among the highest in this segment. Over 50 franchise groups have been signed up within the U.S. and Canada. Blaze is now also focused on selling franchises in smaller cities through the country, while also starting its international expansion. Blaze finished 2017 with 237 total restaurants, including 5 company operated units, in the US and Canada. The footprint is about 2500 square feet, the total startup investment is about $700,000/location, cost of goods runs around 28% and fully loaded labor approximates 30%. Newest restaurants are projected to open at approximately $1.2 million, usually building to about a $1.4 million rate in the second year. The 117 restaurants in the system that were 18 months or older generated an average unit volume of $1.424 million. The 5 corporate owned restaurants over 18 months old averaged $2.063 million. The ongoing royalty is 5% and the creative fund is 2%. The initial franchise fee is $30,000. The operating model for franchisees projects to a 35-40% cash on cash (EBITDA at store level) return by the third year, after royalties. The average check is $14.00 and the average price/pizza with attachment is $9.00. Lunch (46%) and dinner (54%) provide a fairly balanced daypart appeal. 75% of the customers dine in the restaurant, 25% off premises and 7% is ordered online. Blaze is leveraging technology and connecting to Millennials, as seen by their followers on Facebook, over 1 million email subscribers, app downloads and more. The company sees additional sales opportunities with 3rd party delivery, drive-thrus, new products and line extensions and leveraging technology.
During 2017, 64 stores opened, and the Company projects that about 85 new stores will open this year, which would bring the 12/31/18 total to 325. In 2016 “Flagship” locations were opened at DisneyWorld in Florida and Universal CItyWalk in Los Angeles as well as Houston International Airport. Similar high profile locations will have opened during 2018 in Kuwait, Bahrain, Saudi Arabia and over 10 in Canada. The Company expects that over 100 locations will open annually in 2019 and beyond. In addition, the Company has begun development of non-traditional locations, an area with obviously very large incremental potential, having signed agreements with HMS for airports and Sodexho for schools/universities.
Clearly, with the franchising experience of the Wetzels, the culinary skills of Brad Kent, and the seasoned executive team, Blaze is equipped to capably lead their franchised expansion. Once a franchised chain reaches the critical mass necessary to support its franchise system, well positioned franchise companies most often prove to be excellent long term investment due to the free cash flow characteristics. From what we see, Blaze is one of the highest quality companies serving fast, artisanal pizza, and the unchallenged leader in terms of a franchised model within this segment.