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Bojangles’ Inc. (BOJA) Overview  (2016 10-K) (ICR Slides Jan’17)

Charlotte, NC based Bojangles operates and franchises a chain of 740 southern-themed  QSR restaurants (426 franchised, 314 company) in 11 surrounding states as well as 3 in Honduras at the end of 17Q2.  In the TTM through 17Q2, the restaurants generated system-wide sales of nearly $1.3B.

Company Strategy On the basics (quality product, value, service, technology) BOJA’s goals are not that different from its competitors, although it appears to be a little behind the pack in some respects (e.g. delivery and mobile order/pay). As a chain in the early stages of expanding beyond its North Carolina roots, the company’s principal challenge is growing comps and AUV’s in its core region and penetrating adjacent markets with a mix of company and franchised stores (currently about 40%/60% respectively). Like many forerunners, it primarily relies on word of mouth on entering a new market to stimulate discovery and build a loyal customer base.  Successfully executed, unit and AUV growth create a virtuous cycle of increased customer awareness, higher sales which in turn supports higher marketing expenditures even higher sales over time.

However, BOJA is discovering the limits of this strategy, especially in a generally unforgiving discretionary spending environment.  Comps and AUV’s have been slowing rather than building, not necessarily only because of the general economy.  While the company has not made detailed disclosure, it concedes that franchise stores outside of its core area have stronger AUV’s than company stores.  Moreover, the AUV’s of the 2016 class of new stores are trending towards $1.5M, which, though the class doesn’t have a full year of history yet, is below the year one $1.6M AUV’s generated by the classes of 2014 and 2015. This indication applies to both core and new markets, and of that, company stores are trending lower than the average at $1.4M.

Management is clearly rethinking its strategy.  It has slowed the growth of company stores, and has guided to slower franchise unit growth.  The slowing of franchise growth may have been due to expectation of a new BOJA prototype rather than a reluctance build out franchise territory. Predictably, analysts and investors are asking whether re-franchising might be warranted, but the Company has not yet indicated a move in that direction.

Menu and Dayparts  BOJA southern-themed specialties are its freshly baked breakfast biscuits (baked from scratch every 20 minutes) and its steeped-in-the-store iced tea.  It is proud that most dishes are prepared on a griddle (e.g. eggs) or stovetop (such as its side “fixin’s” Dirty Rice and Cajun Pintos).  Nothing is microwaved—there are no microwaves in its stores.  The company has long made breakfast available all day, but pre 11 a.m is still its biggest daypart, with about $650K of a company store’s annual sales occurring before 11 (about 38%).  The company positions itself as having many of the quality attributes of fast casual operators but the value of QSR.  BOJA’s average check in 2016 was $7.08. The company has confronted its flagging comps, no doubt affected by heavy breakfast promotions by competitors such as MCD, with its own LTOs, as well as premium offerings.  However these initiatives have been disappointing. To date, however, this effort has met with only limited success.

Unit Level Economics  In 2016 full size company and franchise stores open the full year averaged $1,724K and $1,895K, respectively.  Systemwide the average was $1,818K.  The table below, with data drawn from the company’s Franchise Disclosure Document (FDD), details the distribution of AUV’s in tranches, as well as the percentage of the company or franchise store total represented by each tranche.

A typical full size BOJA restaurant is a free-standing unit which is about 3900 square feet in size with seating for about 70 customers, parking for 45 vehicles and equipped with a drive-through window.  There are also about 36 Bojangles Express units (5 company, 31 franchised) which are co-located with establishments such as grocery stores, gas stations or mall food courts.  They range in size from 800-3800 square feet.  The full (unlevered) cost for a full size store is about $2.4M ($0.7M land, $1.4M building construction, $0.3M equipment).  To finance its new stores, the company favors build-to-suit leases and equipment financing which requires very little upfront cash, typically only a $85K upfront payment for the equipment lease.  On this minimal outlay the company targets 129% year-1 cash-on-cash return, which seems an eye-popping return until realizing that this implies store level EBITDA of about $110K or about 7% EBITDA margin on a year-1 AUV of $1.6M AUV (the 2014 and 2015 new stores).  The modest store level cash flow is no doubt dragged down because of the rents that include the capitalized tenant improvements as well as equipment lease payments. As stores mature, and sales build, management has indicated that EBITDA margins move up close to 20%, although they’ve dropped into the 16% range in 17H1 as the comps and AUV’s have deteriorated.

As mentioned, the company has slowed its unit level expectations in the face of the deteriorating AUV’s of its new stores, and has introduced a new store prototype.  The “Bojangles of the Future” features a major redesign of the interior and exterior of the store, but the principal elements are a “Biscuit Theater” so guests can watch the 48 step biscuit making process; charging stations and wifi in a revamped dining area and a “Kitchen of the Future” enabling greater efficiencies, better throughput and increased transactions.

With only two of the new prototypes in operation, the company is still finalizing the design.  However, it is incorporating certain of the design elements, such as the revamped kitchen, in new units and in remodels.

Operating Metrics  BOJA’s ratios of debt to TTM EBITDA and lease-adjusted debt to TTM EBITDAR at 2.3X and 4.2X, respectively, is the highest of its 50%-60% franchised peers (LOCO, PNRA, RUTH, SBUX and BWLD) which average 1.4X and 3.1X, respectively. The higher balance sheet debt is a residue of its IPO and has been steadily paid down.  The high lease-adjusted debt is the result of the lease-heavy financing of its restaurants.  In the TTM through 17Q2, free cash flow was $6.4M ($9.8M CFO, $3.5M Capex) or a FCF margin of 7.6%.  The company does not pay a dividend and has not repurchased any of its stock.

Shareholder Returns In the 3 weeks after its IPO at $19 May 7, 2015, BOJA’s stock jumped to $28.01, which has proved its high point, after which it has traded in a $13-$22 range, though the trend has been down to a recent low of $13.05 August 2, 2017.  Since the IPO, shareholder return has been a negative 27.6% (-13.4% CAGR).

Current Developments (17Q2 Release) (17Q2 Conf Call) (17Q2 10-Q)

Second quarter results disappointed the Company, analysts, and investors. As shown in the tables accompanying this article, company and franchise comps were negative, as was net income, earnings per share. Adjusted EBITDA was also down, from $23.2M to $19.5M in the quarter. In terms of unit development, 7 new company stores were opened, 7 franchised locations as well, and 5 company stores were refranchised. Details behind the negative company comp of -3.5% included negative traffic of 6.5% partially offset by positive “mix” of 0.6% and 2.6% of price. There is not expected to be any further price increase in 2017.

In terms of operating details, company restaurant contribution margin (EBITDA) decreased by 370 bp to 16.0%. Cost of goods was 31.5%, up 20bp. Labor was 29.1%, up 140 bp. Operating Costs were 23.4%, up 250bp, due to “higher marketing, utilities and occupancy costs”. “Operating Costs” run higher here than at most companies, no doubt due to the higher rents from capitalized landlord Tenant Improvements. Offsetting the higher rents, to some extent, is D&A which ran 2.7%, up 20bp (about 200 bp lower than we normally see, since the Company has had lower than normal investment per store. The comparative income after taxes would have been worse, except that the tax rate in Q1 was only 24.4% vs. 36.7% a year earlier.

Guidance for 2017 was lowered in a number of ways. Total revenue expectation was brought down from $560-$569M to $549-$553M. Systemwide comps were lowered from neg.LSD -flat to neg.LSD. Company openings went from 27-28 to 25-26. Franchised development from 30-34 to 28-30. Contribution margin (EBITDA) at company stores from 17.0-17.5% to 16.-16.3%. Adjusted EBITDA was lowered from $84-$89M to $78-80M and Adjusted Diluted Net Income was reduced to $.81-84 from $.87-.93. Labor pressures will continue, while ongoing inflation in Cost of Goods.

Plans include increasing the emphasis on franchised, rather than company operated locations. Management is enthused about the potential of the new prototype, though not yet providing any operating details or conclusions. Franchisees are described as sharing that enthusiasm, so it is expected that the pace of franchised development will pick up accordingly. The Company will concentrate on core markets, allowing franchisees to develop adjacent territories.

Sales improvement will be pursued by way of emphasizing to a greater degree the value related portion of the menu, selectively discounting proven traffic drivers. Management is also working on sales building opportunities such as takeout, delivery and mobile order/pay, since these capabilities are apparently not yet in place.