Stagflation is as good as it gets:
From a macro standpoint, the worldwide economy is in a holding pattern. Interest rates, heavily influenced by Central Banks, have stabilized at rates that seem high compared to the minimal level of the last dozen years but are in a fairly normal historical range. The politicians and bankers are relatively calm for the moment, “data dependent” as the rate of inflation has receded to the 3-4% range while pundits (including ourselves) debate the state of the economy. We have trouble ignoring the fact that virtually all the job “creation” is part time in nature, a function of the need by lower and middle class families to maintain two or three jobs to pay the household bills that are up 20-30% from several years ago. Even under the doubtful assumption that the Fed can control interest rates, the most appropriate path is far from clear. The enormous continuing supply of government debt, refinancing the maturation of very low interest rate paper as well as new deficits, precludes materially lower interest rates, and last week’s slightly higher CPI reading doesn’t help. Even the current “normal” rates exacerbate the deficit spending since Interest on the US debt was $76B in the month of February alone, $433B through 5 months of the current fiscal year, well on the way to a trillion dollar annual interest expense. In essence, there is no graceful way out of the fiscal/monetary mess that is four decades in the making. Don’t forget: this is still an election year, so the Fed will be careful not to appear to play politics in one direction or another. As business operators, investors and consumers, ongoing stagflation is as good as it is likely to get.
Two Situations too Interesting to Ignore
Equity valuations, both public and privately held, are mostly far from peak levels. For example: Bloomin’ Brands (BLMN), here to stay for sure, and in spite of activist Starwood Value’s involvement, is trading with an Enterprise Value (EV) of little more than 5x TTM Adjusted EBITDA. The One Group Hospitality (STKS) planned purchase of Benihana (a sixty-year-old “iconic” brand) at just over 5x TTM Adjusted EBITDA is another current examples of today’s “show me” environment. If you are not Wingstop or Chipotle with very strong recent growth, or Darden or McDonald’s or Texas Roadhouse with “Best of Breed” long term credentials, you need a long-term growth plan that offers investors too much upside to ignore. Since traffic growth is non-existent for almost everyone, if the valuation is modest enough, analysts may even overlook lackluster same store sales, even modestly negative traffic, and allow for a re-rating. Dave & Buster’s (PLAY) is an example of just such a situation. We suggested PLAY as our “stock recommendation of the month” back in August, and the stock is up 75% because margins have begun to improve though same store sales and traffic are still negative. So management’s long-term plan seems credible, cash flow has allowed for retirement of almost 20% of the shares and the Enterprise Value has improved from under 5x TTM Adjusted EBITDA all the way up to 7x. A numerically interesting part of the PLAY equation is that there were only 50M shares outstanding, with over $500M of annual EBITDA, so every “turn” of EBITDA multiple would be worth $10/share. If investors were to take PLAY’s EV from 4x to 5x, the stock would go from $36 to $46, which it has, and then some.
Opportunistically — two similar situations today are Driven Brands (DRVN), the stock depressed for short term reasons, and The One Group Hospitality (STKS), which is in the process of acquiring Benihana Inc. Both companies are trading with EVs at low multiples of Adjusted EBITDA, and EBITDA is a large multiple of the shares outstanding. Driven Brands, currently at about $15/share has over $500M of EBITDA and 164M shares outstanding. The story revolves around the growth of their Take 5 Oil Change concept, with 700 company locations (growing at 60/year) and 300 franchised stores (growing at 100/year). Unit level economics at Take 5 are attractive, which combined with the uniquely progressive franchising structure, have created an award-winning franchised concept. Every “turn” of EBITDA (currently about 10x, a modest multiple for a growing franchisor) is worth over $3/share to DRVN’s $15.00 stock. The One Group Hospitality (STKS), currently in the process of merging with Benihana, will have about $117-137M of EBITDA (1), compared to 33M shares to be outstanding. We view Benihana as a long established well positioned brand, selling a relatively healthy menu with a modest average ticket price, while providing an experiential dining experience. We have been impressed with STKS’ dramatic improvement of their STK brand over the last five years, and their successful absorption of the best of the Kona Grill brand. If STKS management can build upon Benihana long history, every “turn” of EBITDA at STKS (currently under 6x), will be worth about $3.84/share on top of STKS’s $5.70 stock. As with PLAY, the large opportunity as suggested by management puts the “Fear” into the “FOMO – Fear of Missing Out” – investment equation. See our website for additional information.
Roger Lipton
(1) The article, as published below, mis-stated the combined EBITDA. The numbers a shown above ($117-137M), translating to $3.84/share for each “turn” of EBITDA valuation, are correct.
