All posts by Roger Lipton

SEMI-MONTHLY FISCAL/MONETARY UPDATE – STRONG DOLLAR HURTS GOLD? – NOT REALLY!

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SEMI-MONTHLY FISCAL/MONETARY UPDATE – STRONG DOLLAR HURTS GOLD? – NOT REALLY!

It is an accepted axiom, when viewing the performance and the prospect for the price of gold (in US Dollars) that a strong dollar does not allow gold to appreciate in price. Don’t believe everything you read. The following charts show the performance of gold (GLD) vs. the dollar index (DXY) over various time frames, from the last twelve months to the last ten years. The last twelve months have been particularly dramatic, and unexpected by many, as gold has moved steadily upward in spite of the DXY selling near its high. More importantly, you will see that in every case, over one year, three years, five years and ten years, the price of gold went up in terms of dollars, in spite of strength in the US Dollar vs. a basket of other currencies (DXY). Over the ten-year period, GLD was up about 30% while the DXY was up a little less than that.

ONE YEAR TO SEPT 2019

                                                             THREE YEARS TO SEPT 2019

                                                             FIVE YEARS TO 2019

                                                             10 YEARS TO 2019

In the interest of providing a complete picture: Past performance always depends on which time period you look at and different time periods can tell a different story. The ten-year period prior to the last decade, from 2000 to 2009, is illustrative. The GLD skyrocketed, up over 100% while the DXY was very weak. Gold, to be sure, did a lot better with a weak dollar, as shown below, but was still up consistently with a strong dollar, as shown above.

                                                             10 YEARS, 1999 TO 2009

Our conclusion: All other factors being equal, we would rather see a weak dollar if we are hoping for a higher gold price. However, it should be clear from the charts above that strength in the US Dollar has often been compatible with a rising dollar gold price. It is also worth noting that a relatively strong dollar provides a proportionately higher gold price in in terms of alternate currencies. To varying degrees, depending on timing and relative currency strength, gold has invariably protected purchasing power over the long term.

Roger Lipton

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A SIGN OF THE TIMES – LOOK OUT BELOW – OKTA IS THE MARKET BELLWETHER!

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A SIGN OF THE TIMES – LOOK OUT BELOW – OKTA IS THE NEW MARKET BELLWETHER!

Nobody pays me to call market tops and bottoms. However, I’ve been in the investment business for a long time, and hopefully have learned something along the way.  Sometimes the most compelling signals come along that tell us about the stage of the capital markets more clearly than the reams of economic statistics with which we are constantly inundated. This was the case in the early 1970s when “one decision” growth stocks sold at 50x earnings and more. It happened in 1987 when “portfolio insurance” was supposed to protect against market downturns. It happened in 1999-2000 when the “new paradigm” included valuations related to multiples of sales, eyeballs, or “total addressable markets”. It happened in 2006-2007 when bad mortgages were packaged up and sold to fixed income investors unaware of the continuing risk. Today….it’s happening again, as “unicorn” companies sell at valuations that discount the hereafter.

Jim Cramer, host of Mad Money on CNBC, who I credit as a brilliant short term trader, prides himself on his “rigorous” analysis. However….as an example of how his short term momentum driven decision process distorts his supposedly longer term “rigor”:  When things get tough in the market, he provides a list of 10-15 long term issues that he must see “resolved” before he will buy stocks again. Fast forward two or three weeks, after a day or two of a strong market, and he declares all the longer term issues “resolved”, or at least of no current concern, and you can buy, buy, buy once again.

Wednesday morning, yesterday, Cramer was reflecting on how a bunch of the best performing growth stocks had been hit:  Tradedesk, Ulta, Twilio, and Okta, to name just a few. His conclusion is that the best bellwether for the market, and the signal a new upturn has begun, will be the action in Okta. Now,  I am old enough to remember when “as goes General Motors, so goes the economy and the market”, and when IBM was the greatest growth company (and stock) on the planet. More recently, over the last ten years, Apple has been a great stock market leader and Cramer, to his credit, has consistently urged his followers to “OWN, DON”T TRADE, APPLE”.

I don’t know much about OKTA, except that they provide cybersecurity services. Revenues are growing, from $260M in 2018 to $399M in 2019 and an estimated $562M in 2020 (according to Bloomberg). Unfortunately, OKTA is losing money: $-.77sh. in 2018, an estimated $-.32/sh. in 2019 and $-.43/sh. in 2020. The stock more than doubled in ’19 alone, from about $60 to a high of $140, and has corrected substantially to $108 as of the moment. The current market value of OKTA is $12.5 billion, or twenty two times estimated 2020 SALES. I guess if there are no earnings to capitalize, you might as well put a multiple on sales. Not so long ago, in 2013, a company called Fireye (FEYE), also in cybersecurity, which Cramer favored at the time, was trading over $80/share, growing fast, losing money, selling at something like 25 times sales. Today the stock is $14. Fireye, by the way, has continued to grow sales, from $623M in 2015 to $872M in 2019 and has just lately turned profitable.

You might view Cramer’s comment regarding Okta as an isolated situation, and a special company, maybe the next Amazon,  not typical of the market as a whole. Before you dismiss the above discussion, however, consider Uber and Lyft, and WeWork in the wings, all of which have valuations in the tens of billions and which are billions of dollars away from profitability.

As opposed to OKTA, GM and IBM and AAPL were growing and solidly profitable when they were bellwethers. Calling market tops is a dangerous exercise and timing is of course critical, but a variety of signals indicate that we are closer to the top than the bottom of this 10 year bull market. I’m afraid that there will be lots of people saying “how did I not see this coming?”. As the old saying goes: “when they raid the whorehouse”, they take all the girls. Be careful out there.

Roger Lipton

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DAVE & BUSTER’S (PLAY) TAKEN OUT AND SHOT (AGAIN) – WHAT’S GOING ON ??

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DAVE & BUSTER’S (PLAY) TAKEN OUT AND SHOT (AGAIN) – WHAT’S GOING ON ??

This situation, as it is playing out, is no surprise to our readers. The Q2’19 release met the earnings expectations but missed on the comps, and the company lowered guidance by 5-10% for the current full year, implying a relatively weak second half. You can read all the details elsewhere, including the conference call transcript, but a summary of Q2 includes:

Operating Income was up 0.6%, Net Income  was down 4.1% but EPS was up 7.1% on fewer shares outstanding. Corporate EBITDA was up 5.3% but down 60 basis points as a percentage of sales (still an impressive 22.9%, down from 33.5%). Store Operating Income (EBITDA) was up 4.8%, but down 90 bp as a percentage of sales (still an impressive 28.9%, down from 29.8%). Food & Beverage comps were down 3.2%. Amusements & Other were down 0.8%. Amusements and Other now represents 60% of total sales, up 80 bp from ’18. It continues to be the case that Dave & Buster’s is more of an indoor amusement park than a restaurant. It  is worth noting the lackluster comps were attributed largely to the difficult comparisons with the rollout a year ago of the Virtual Reality platform.  While we can’t know how much of the Amusement comp in ’18 came from the heavily promoted Virtual Reality, the Amusement comp in Q 2’18 was down 1.2%, the Food and Beverage comp was down 4.1%.

Management adjusted guidance for all of ’19. Comp Sales will be down 2.0-3.5% (vs. -1.5 to +0.5). Net income will be $91-$100M (vs. $103-113M). The tax rate will be (unchanged from prior guidance) at 22.0-22.5%. The shares outstanding will be about 34.0M instead of 36.5M, as a result of share repurchases. EBITDA will be $272-282M ($274-284M excluding $2M in one time charges), (vs. 283-$295M previously) . Capex will be $200-210M (vs $190-200M). In summary, comps will be a point or two less than previously expected, Net Income will be about 10% less, EBITDA will be about 4% less. EPS expectations will approximately unchanged, up about 10%, protected mostly by the large stock buyback.

CONCLUSION

We have written extensively about Dave & Buster’s over the last two years, and we provide below the most recent articles. The sum and substance of this situation is that the Company is spending hundreds of millions of dollars but is barely increasing corporate EBITDA.  The chart below shows how the incremental return on the dollars spent continues to deteriorate. Management continues to do their best to get a better return from the square footage dedicated to Food & Beverage, as well as re-invigorate the Amusement offerings. The “culture” within a restaurant chain is a challenge to improve and Amusements is basically a “hit driven” business with a high level of unpredictability. Considering the above, and the information provided in our previous discussions, though PLAY is down 8% today and down about 40% from its high of 2017 and 2018, we don’t view PLAY as a bargain at $40/share.

Roger Lipton

JUNE 12, 2019

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DAVE & BUSTER’S (PLAY) – TAKEN OUT AND SHOT, IS IT REALLY THIS BAD?

Dave & Buster’s reported first quarter, ending 4/30, results last evening and their stock is trading down 22% this morning. The results were only modestly disappointing, and guidance was lowered just slightly, so the stock market reaction could be considered severely overdone. However, as our readers have been informed for almost two years now, the underlying business has been deteriorating for quite some time and that is now becoming clear to almost all observers. First, the Q1 results, not so bad:

EPS was $1.13 vs $1.04 last year. EBITDA was up 3.2%, adjusted EBITDA up 2.4%. Total revenues were up 9.5%. Same store sales were up 0.3%, a point or so less than expected, which management attributed to weather and disappointment related to sales over the Easter holiday. Seven new stores were opened, and “new store performance remained strong”. Previous trends relating to increased sales at Amusements (comps up 1.8%) and decreased sales at Food & Beverage (comps down 3.3%) continued. The details were less comforting, to be sure. Operating Income was down 1.5%, down 170bp to 15.9%. Net Income $42.4M vs. $42.2M, so EPS was higher due to a lower share count. Though EBITDA was up 3.2%, it was down 150bp to a still impressive 24.4% of revenues. Adjusted EBITDA was down 290bp to 27.0%. Store Operating Income was up 3.6%, but down 180 bp to a still impressive 31.0%.

Guidance was lowered just slightly for all of fiscal 2019, ending 2/2/20: Revenues will be $1.365-1.39B, vs. $1.37-1.4B previously. Comps will be -1.5 to +0.5 instead of Flat to +1.5%. Net Income will be $103-113M instead of $105-117M. EBITDA will be $283-295M instead of $285-300M.

So: on the surface, results were affected by weather and a calendar shift, and the full year is adjusted mostly to reflect the first quarter shortfall.

However: there is no tangible reason to think that trends will improve. As discussed on the conference call: The second quarter has started off “choppy”. Virtual Reality has not provided much of a lift, extra labor is involved, volatility is to be expected in this “hit driven” area, and pricing of this attraction is still a question mark of sorts. Food & Beverage initiatives, including a Fast Casual test, haven’t paid off yet even if customer surveys are promising. Competition was called out, once again, as a negative factor, and is not expected to abate.

There is a lot more detail we could provide, but, in the interest of getting this summary out as promptly as possible, you get the picture.

Conclusion:

PLAY may now seem like an attractive turnaround speculation since it now trades near its lowest price in several years, and the valuation does not seem expensive at about 13.5x ’19 earnings and 6.5x trailing EBITDA. New store returns continue to be attractive and the Company as a whole throws off a great deal of apparent free cash flow which can be used  for new stores, dividends and stock buybacks. However, as we have described several times over the last two years, the underlying long term trends are challenging and expected to remain so. Earnings and EBITDA have been essentially flat for several years now, the Company has spent over half a billion dollars to keep it that way, and there is no predictable reason to expect improvement. Deteriorating returns on investment do not make for a premium valuation so we considered PLAY adequately valued at the current time.

 

REPRINTED BELOW FROM 4/15/19 – DAVE & BUSTER’S (PLAY) – REPORTS Q4 AND ’18 YEAR – IMPORTANT OVERVIEW !!

We take a long term view. This management team, led by previous CEO, Stephen King, who stepped up to Chairman in August, did a fine job of refurbishing the brand prior to bringing D&B public again in late 2014. It is important to note that hundreds of millions of dollars were spent in that effort, and it would have been disappointing indeed if operating results had not improved dramatically for at least a few years.

We have pointed out in our previous commentary that the return on the incremental investment is shrinking, just as it did when D&B was publicly held the last time. We update that discussion with the following table, which starkly shows this trend.

 

 

You can see that capex was $162M in calendar 2015, and the operating results were still ramping up, to the new “plateau” of $143M in pretax income in calendar 2016.

After that improvement demonstrated by calendar 2016 results as a result of previous spending: ($181M was spent in 2016(but we assume couldn’t have affected  the $143M of Pretax Income by much), on top of $181M in 2016, an additional 219M was spent in 2017, $216M in 2018 (a total of $616M), and pretax income is projected to be the same in 2019 ($135-150M) as 2016 ($143M).

In essence: after the ramping of results through calendar 2016, presumably as a result of the last re-invention , ($181M in 2016, 219M in 2017, and $216M, a total of $616M) will have been spent, Pretax Income will have been essentially flat, and EBITDA will be up about 30M. That’s zero current return on a pretax income basis, only about 5% on an EBITDA basis, and (we have to say again) depreciation is not free cash flow.

Management could counter that three years is not the end of the story, and there is no doubt a “tail” in terms of return on upfront investment. On the other hand, it is pretty clear that continual refurbishment of this concept is a requirement. It’s also a major feature of this story that new locations have a huge first year return. That is no doubt true, but that would mean that new stores are providing a very large part of the total results, and older stores are falling off sharply. If there is a first year return of over 50% on new stores, that would be something like $100M on the last 15-16 stores, $200M on the other 110.

In any case, if earnings at PLAY are going to continue to grow, at say 10-20% annually, more new stores have to open, materially more than the 10-12% budgeted (some of them with a smaller footprint), to offset the declining contribution from the growing base of mature stores where contribution is declining.

While most analysts may not want to talk about this strategic reality, it’s possible that PLAY’s price performance, essentially flat for the last two years, is reflecting the above discussion. At only 18x projected earnings and about 8.5x last twelve months EBITDA, the stock might seem attractive when the first year cash on cash returns for new stores  are over 50%. However, the longer term view indicates that it will be increasingly difficult to build upon the current results, especially in a retail environment that is generally unforgiving.

REPRINTED BELOW FROM 9/17/18 – DAVE & BUSTER’S (PLAY) REPORTS Q2 – STOCK UP 7% – HOW IS BIG BET ON VIRTUAL REALITY DOING?

Dave & Buster’s Entertainment reported their Q2, ending 8/5/18, last Thursday, and the stock responded positively, up 7-8% on the slight sales “beat”, the more material EPS beat, and positive company commentary regarding results of the new Virtual Reality platform.

Conclusion: The upward move in PLAY stock was mostly a function of “beating” expectations for comps and EPS, which have been coming down in the last six months, and a short position among traders who are inclined to panic. Forward guidance was raised by the Company, but the amounts were modest, and were reductions in certain negative expectations, rather than inspiring confidence that traffic and margin trends will turn positive any time soon.  On the positive side, initiation of a dividend, providing a yield of about  1%, and continued stock buybacks are positive factors. However, management has distinguished itself by its unwillingness to hold shares outright, promptly selling shares acquired by way of options. On balance, we view PLAY stock as “fairly priced”, with a still strong operating model generating impressive levels of store level EBITDA. This apparent attractiveness, however,  is offset by the risk element of the “fashion driven” Amusement segment that is the main driver of profitability and cash flow.

REPRINTED BELOW FROM 12/11/2017 – DAVE & BUSTER’S (PLAY) – THE BATTLE OF THE BULLS AND BEARS !

The Positives:

  • (1) Cash on cash returns are still among the very highest in the restaurant and retail universe.
  • (2) There is a very long runway for future growth, which  has been extended by virtue of the smaller format.
  • (3) The balance sheet continues to be strong, relatively unleveraged, with substantial cash flow for unit expansion, stock repurchase, and dividends possible as well.
  • (4) There is potential improvement in the food element, separately and/or in conjunction with the new smaller format, including a Fast Casual approach to food & beverage.
  • (5) A lower corporate tax rate would improve future after tax EPS, though it obviously would not affect EBITDA.

The Negatives:

  • (1) Comps have been coming down, narrowing overall, with a continuation movement toward Amusements, now 56.9% of revenues. With less than 30% of sales from food, D&B is more of an amusement park than a restaurant.
  • (2) Average Unit Volumes are coming down, at least partially due to the increasing mix of smaller stores.
  • 3) Margins at the store level have been coming down modestly, and may not recover due to higher marketing, higher rents, higher commodity prices, and sluggish traffic trends, especially within the food & beverage segment
  • 4) Competition, and cannibalization is playing an increasing role in suppressing sales and margins.
  • (5) Depreciation, that is the useful life of Amusements,  continues to be an underlying issue. EBITDA is a valid measure of “cash on cash” return at the store level, but it seems to require increasing amounts of original (undepreciated) capital as the years go on.  Noone can be sure of the useful life of Amusements. The Company declares that it is “between five and twenty years”. We discuss this issue at more length in the full Corporate Writeup on our  website (9/14/17) at : http://www.liptonfinancialservices.com/2017/09/dave-busters-entertainment/.  We have not seen this issued addressed in either company documents or analyst discussions. If our concerns are misguided,  we welcome further discussion of this issue by the company or the money management community.

 

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WENDY’S (WEN) DOWN OVER 10% TODAY – IT’S ABOUT BREAKFAST, RIGHT?? – NOT EXACTLY

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WENDY’S (WEN) DOWN OVER 10% TODAY – IT’S ABOUT BREAKFAST, RIGHT?? – NOT EXACTLY

Wendy’s stock is under a lot of pressure today, as a result of their entry (again) into the breakfast fray. The company said that they will spend about $20M to support the breakfast initiative. Analysts are obviously reacting skeptically, since WEN has previously experimented with breakfast, in 1985, 2007 and 2012. Since $20M amounts to less than $.09/share, it seems like a reduction of $2.70/share (as this written) is a bit overdone.  This is like when your wife criticizes you for not putting the top back on the toothpaste. It’s not about the toothpaste 😊

The chart below shows the outstanding price performance of WEN over the last five years. It has recently been selling for over 30x EPS estimates for 2019, and about 20x trailing EBITDA.

The table below provides some broad financial results over the last eight years, including the Arby’s divestiture. There have been lots of “puts and takes” from the income statement, and the GAAP earnings per share have fluctuated accordingly.  We show both the GAAP results and the Adjusted Earnings Per Share from Continuing Operations.

Operating Profit, as reported, was up from 2011 to 2014, has been “flat” from 2014 through 2018. As shown on the annual cash flow statement, we view Net Cash Generated from Operating Activities  as a reasonable proxy for how a company is really progressing. Though fluctuating, up and down during the period, THIS NUMBER IS LOWER NOW THAN IT WAS IN 2011. For our purposes here, we can (charitably) call it  “flat” as well.

EPS has been up sharply from 2011 until 2018, both adjusted or by GAAP. That “progress”, however, has been, since 2014 especially, the result of borrowing $1.3 billion to buy back about 150 million shares of stock. (Ain’t low interest rates grand?? ) Setting aside the modest remaining equity, reduced from the buyback: with $2.8 billion of long term debt against calendar ’18 EBITDA of  $379M ($250M of pretax, pre-interest, continuing operating profit + $129M of Depreciation), with debt now at 7.4x TTM EBITDA, one would have to conclude that this financial lever has been pulled.

CONCLUSION

Just a week ago we wrote an article describing how the stock of lots of companies (we referenced Starbucks (SBUX) and Restaurant Brands (QSR), in the wake of the breakdown of ULTA and OLLI), are “priced for perfection”, are vulnerable to the possibility of even a small disappointment. Wendy’s now comes into play from that standpoint. Over the last five years, WEN has provided essentially flat Operating Profit and Net Cash from Operating Activities. Earnings Per Share have been increased through leveraging the balance sheet and acquiring a great deal of stock. Down over 10% as we conclude this piece, WEN still sells at 30x estimated earnings for calendar ’19 and 19x our calculation of ‘18x EBITDA from continuing operations. Setting aside the prospect of success with breakfast, which will be expensive and time consuming, and is the focus of virtually all of today’s press coverage: We are not long or short WEN common stock, because we cannot predict how long investors will embrace “asset light” and “free cash flow” companies (this one has $2.8B of debt to service), but,  by all standards we consider reasonable, WEN is more than fully valued.

Roger Lipton

 

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RESTAURANT MAIN STREET – WHAT’S HAPPENING ON THE GROUND??

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RESTAURANT MAIN STREET – WHAT’S HAPPENING ON THE GROUND??

We have long believed that the restaurant industry provides an excellent leading indicator as to consumer sentiment. It is much easier to adjust dining habits, every day, than to plan and spend for large ticket items.

Quite a few restaurant companies have reported their quarterly results, ending 6/30. The sales and traffic trends, collectively, indicate that not much has changed in terms of consumer optimism. The table below provides the reported results for comp sales, including a breakdown, mostly provided by company operated locations, relative to traffic, pricing and menu mix. Also shown on the table are the outlook, when provided, relative to commodity and labor expense.

The company operators show, with just a couple of important exceptions (Chipotle and Starbucks) modest comp gains, more than offset by pricing and menu mix, so traffic is negative almost everywhere. The only  other outlier is Diversified Restaurant Holdings, franchised operator of the Buffalo Wild Wings system, going against very easy comparisons. Most importantly,  In terms of third quarter to date, virtually no one is guiding toward a meaningful improvement. In our view, Chipotle and Starbucks (with the strongest trends) can be viewed as “special situations”. Chipotle is bouncing back from their multi-year troubles and doing a great job with mobile app/delivery, and Starbucks is the premier worldwide brand selling an addictive product by way of an extraordinary employee culture and great technology.

The franchising companies that have reported are showing a similar trend, modest sales gains in almost all cases. The franchising companies steer away from reporting traffic, but it is safe to assume that pricing and sales mix trends are similar, so traffic is no doubt down.  McDonald’s is the sales standout, and they are in a class by themselves, providing value and upgraded quality to a population hungry for price/value. Taco Bell is also an exception, for similar reasons. Even Domino’s and Wingstop, who have put up great numbers in recent years, are reporting only modest gains at the moment.

It’s important to note that, within the sales mix, delivery, curbside and in-store pickup, are rapidly increasing portions of the revenue  mix, so dine-in traffic is down materially more than the comps that are reported. We haven’t heard any restaurant company bemoan, though they could, the fact that their physical plants are only fully utilized a few evenings per week.

In addition to the sales and traffic trends, we are equally interested in the commentary relative to cost expectations, namely commodities and labor. Expectations are mostly higher for commodity costs, dramatically so for chicken wing prices. It is clear that the benefit a year or so ago from lower commodity prices is in the rear view mirror, and higher cost of goods is likely. Labor expense, predictably, is expected to move ever higher.

CONCLUSION:

The beat goes on. With prime costs, as well as other expenses such as insurance, common area charges, utilities, etc. also increasing, it takes more than two or three points of comps to improve margins. A handful of the larger premier operators such as Starbucks, McDonald’s, Darden, Domino’s and Wingstop continue to provide better the best results. However, even among these “best of breed” operators, it’s a battle for market share and an increasing challenge to generate a worthwhile return on incremental investment.

Roger Lipton

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STARBUCKS (SBUX) AND RESTAURANT BRANDS (QSR) GET HIT – A SIGN OF THE TIMES

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STARBUCKS (SBUX) AND RESTAURANT BRANDS (QSR) GET HIT – A SIGN OF THE TIMES

Two prominent restaurant companies are in the news today, both SBUX and QSR  are down materially today, and there are lessons to be learned. From a broad brush standpoint, It continually amazes me how the “wealth effect” as a result of worldwide zero interest rates has inflated stock and bond prices to unheard of multiples of cash flow and earnings per share. We have lived through similar periods of new valuation parameters, the “one decision” stocks of the early 1970s that sold (for a while) at 50-100x expected earnings, and the dotcom bubble of 1999-2000 when companies were valued based on eyeballs and multiples of sales and business plans, rather than operating results.

RESTAURANT BRANDS (QSR)

Restaurant Brands’ (QSR) controlling shareholder, 3G Capital Partners, a Brazilian company, has owned most recently 41% (190M shares, worth a cool $14B) of the fully diluted shares of QSR.  QSR has been a great investment for 3G, and Bill Ackman’s Pershing Square Capital (who currently owns owning 15M shares, worth about $1B). While earnings and cash flow  progress have slowed down in recent years, and you can read all about it within our website. The QSR stock has continued to levitate, currently selling very near its all  time high, at almost 30x ’19 EPS estimates and 20x TTM EBITDA. Considering that EPS is growing at about 10% annually and EBITDA growth closer to 5%, this “asset light”, “free cash flow” franchising company that happens to be carrying $11B of debt, not too many observers would call QSR a great bargain. It is therefore no wonder that 3G just announced the sale of 17M shares, worth about $1.3B, and of course the institutional market snapped it up. It’s worth noting that 3G sold $530M worth of shares in calendar ’18 and $330M worth in’17, and QSR bought those shares, rather than reducing their debt. For whatever combination of reasons, QSR stepped aside this time, and let the market absorb those shares. On a smaller scale, Pershing Square Capital Management, has lightened up as well, selling 4M shares in Q2’19 and 8M shares in total in the last twelve months.  We believe that the current valuation is mostly supported by “TINA” (there is no alternative) investing in equity markets when $16 trillion of sovereign debt around the world yields  nothing.

STARBUCKS (SBUX)

Starbucks (SBUX) is a different story. Just a couple of months ago the Company raised guidance for earnings over the next year or so, and combined with firming comp sales and the prospect for growth in China, the stock has hit a new high close to $100 per share, selling at 33x EPS estimates for the year ending 9/30/19 and 22x TTM EBITDA. This is a great worldwide brand, but, here too, the current valuation is far from a bargain relative to the expected growth of about 10% per year.  SBUX was down 4% today because they presented at a Goldman Sachs conference and lowered EPS growth expectations to something short of 10% in the year ending 9/20. We haven’t seen the details of the presentation yet but the headlines indicate that this adjustment of several percent is apparently the result of tax comparisons and a lower stock repurchases in ’20 vs. ’19. The fundamentals do not seem to be deteriorating, so the 3-4% stock decline seems to be a result of “uncertainty” combined with SBUX being “priced for perfection” and leaving room for disappointment. SBUX is a far stronger company, in lots of ways, than QSR, but, here again, the valuation is far from a bargain, and we believe the downside “adjustment” could be much more substantial should a further disappointment develop.

THE DOWNSIDE…

There are a couple of very recent examples of the danger of complacency relative to valuation of growth stocks. Ulta Beauty (ULTA) and Olllie’s Bargain Outlet Holdings  (OLLI) have both been outstanding investments in the retail sector for years, for good reason. In the last five years, with the EPS ramping, ULTA moved from about $100/share to $350, and OLLI went from $20 to about $100. Valuations of both companies moved up to the range of 40-50x expected earnings, “priced for perfection”, just like SBUX and QSR. Just in the last week, both ULTA and OLLI reported strong quarters, met earnings estimates, had  positive comps, but both “adjusted” guidance by a few percentage points, still projecting continued solid growth, just not so quite so solid as previously assumed. The bottom line is that ULTA sold off 25% in one day, now trading at $233, down 36% from a high of bout $365  a month ago, and 0LLI sold off about 30% in one day, now trading at $56, down 44% from over $100 several months ago.  ULTA is now selling at a much more reasonable 20x ’19 EPS, and OLLI is selling at “only” 28x ’19 EPS.  Both these companies are debt free, by the way. In our view, ULTA is a category killer in it’s space, generating a 38% ROE and 18% ROA. OLLI is not quite so impressive, but generates a 15% ROE and 11% ROA, a lot better than the 2.7% ROA generated by QSR, not as good as the 27% ROE generated by highly leveraged QSR which has bought back so much stock. In a nutshell, while ULTA and OLLI are not a close fundamental comparison to SBUX and QSR, we believe the the very recent “adjustment” in valuations illustrate the substantial risk that investors sometimes overlook.

CONCLUSION

Companies that are “priced for perfection”, as are SBUX and QSR at the current time, have serious downside price risk, even if small disappointments have been previously overlooked in a generally strong equity market.  An unexpected new chink in the armor, as demonstrated recently by ULTA and OLLI, can create an “air pocket” in the stock price that wipes out multi-year stock price appreciation. The company specific risk is in addition to that of the general market.  Be careful out there.

‘Roger Lipton

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SEMI-MONTHLY FISCAL/MONETARY UPDATE – GOLD, AND THE MINERS, CONTINUE TO SHINE – WE TELL YOU WHY, REALLY!!

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SEMI-MONTHLY FISCAL/MONETARY UPDATE – GOLD, AND THE MINERS, CONTINUE TO SHINE – WE TELL YOU WHY, REALLY!!

The capital markets were skittish in August, increasingly worried about an economy that is slowing under the influence, among other things, of trade tensions. Much of the news continues to be supportive of higher prices for gold related securities. and our portfolio benefitted accordingly. Gold bullion was up 7.9% in August and is up 18.6% for the year to date. The mining stocks were up slightly more than bullion in August, and are up approximately double the gain in bullion for the year.  While we are gratified with the gold miners’ relative performance to date, they are still down far more than bullion from the 2011 high. Gold bullion is down about 20% from the 2011 high of $1900/oz, while the two largest gold miner ETFs, GDX and GDXJ, are down 54% and 75% respectively. Putting it another way: If bullion goes up 25% from here, back to its high, GDX and GDXJ could go up 100% and 300% respectively and our broad portfolio of miners should mirror that order of magnitude. Since we anticipate that bullion has the potential to sell at a multiple of the $1900 previous high, the 100% and/or 300% move as described above could be just the beginning.

There has been an increasing amount of media attention relative to the appeal of gold related securities, not all of it especially well informed. We want our readers to be as well informed as possible, so we we reprint below our article from 8/14, “THE CASE FOR GOLD”. Most of it is not new to our readers over the last several years, but we have tried to pull it all together. It’s been said that: “In every crisis, you can either be a fool before or after”. If a crisis is indeed ahead of us, we clearly fall into the former camp with our writings over the last several years, but we like to think that our conviction is at least well founded.

THE CASE FOR GOLD – FROM THE “TOP DOWN” TO THE “BOTTOMS UP” – HOW HIGH, AND WHEN?

Our conviction regarding gold, and gold related investments revolves around our conviction that gold is the real money, has been for thousands of years, and the reasons have not changed. Gold is limited in supply, durable, and accepted worldwide as a unit of exchange and a store of value. It is true that gold is useless in terms of being consumed or generating a return such as a dividend. However, it is the indestructibility and scarcity that have made it most useful in terms of backing paper currencies that could otherwise be diluted into oblivion by the politicians of the day. This has in fact been the consistent case throughout history and it is hard to conclude that today’s politicians, worldwide, will prove to be any more disciplined than those of the past.

A second part of our premise is that without a sound currency, there cannot be a sound economy. Unless the public has confidence in the buying power of the earnings that are received as a result of their effort, they will exert less effort in that pursuit. This has been reflected through the ages, before and including ancient Rome to the 21st century.

A corollary of the paper currency dilution is the inevitable higher price of goods and services. You don’t need a PHD in economics to understand that an increasing amount of currency chasing a fixed amount of product will result in higher prices. It so happens that this result is far more acceptable from a political point of view than the fiscal and monetary discipline necessary to avoid deficit spending. This predictable outcome produces a cruel tax on the working middle class (wealth gap?) that doesn’t understand why they are taking home a bigger paycheck but it just doesn’t seem to go as far as expected.

Another way to look at gold ownership as a long-term hedge against inflation: If we view gold as a currency/commodity, which competes with other similar “asset classes”. This includes the latest asset class which consists of over 2,000 cryptocurrencies led by the headline grabbing bitcoin. The amount of gold that is produced every year amounts to about $160 billion each year, and increases by about 2% annually (which happens to be approximately the rate of long-term real growth in the worldwide economy). Compare this production of gold, requiring substantial capital investment and risk, with the creation of trillions of dollars annually of unbacked (fiat) paper currencies that are produced with the click of a computer mouse. Which asset class do you think will hold its “value” better over the long term?

THE WEALTH GAP

The “wealth gap” that is decried by politicians around the world began to rear its head in the 1970s. We believe it is no accident that August of 1971, when Richard Nixon closed the gold window, ushered in this unfortunate phenomenon. The chart below shows this clearly.

THE CURRENCY AND THE DEBT

The following charts show how public and private debt has expanded since 1971 and how the US currency in circulation has expanded exponentially. It is interesting to observe how the US public and private total debt exploded in 1930 as the GDP sank 30%, fell back through the depression, stabilized through WWII and the post war industrial expansion, before taking off in the 1970s. As above, we believe it is no accident that a 1971 dollar has retained only about 15% of its purchasing power by 2019.

Some might argue that inflation has been subdued in recent years, running under the Fed target of 2%, even though deficits are rising. In fact, many PHDs are scratching their collective heads, wondering why this is so. However, while apparel and some consumer electronic products have not risen in price, the cost of large ticket items such as education, healthcare and rent have risen sharply during this period of monetary accommodation. The paper currency creation, worldwide, with the stated intention of a “wealth effect”, has inflated stock and bond prices. That wealth has predictably largely bypassed the middle class consumer, but allowed a Van Gogh painting to sell for $250 million and co-ops in New York City and London to trade for $100M or more. The suppression of interest rates has also affected the purchasing power of the upper class and fixed income dependent savers in that you need much more savings to maintain a previously enjoyed living standard.

CENTRAL BANKERS

Central bankers have no use for gold because gold, as a governing mechanism for the issuance of the paper currency, puts the central banker out of business. However, they know where the bodies are buried so let’s follow what they do, not what they say. The following charts show the consistent accumulation over the last ten years by the central banks, notably by Russia and China, two or our greatest adversaries. It is worth noting that reported Chinese gold holdings are assumed by many to be very much understated.

 GOLD HOLDINGS vs. MONETARY BASE

The following chart shows the value of the gold held by the United States, since 1918 (shortly after the Fed was established in 1913), relative to the adjusted monetary base. You can see that from 1913 until just before the end of WWII, the value of the gold was about 35% of the monetary base. After the Bretton Woods agreement in 1944 whereby the US Dollar was established as the reserve currency, the percentage drifted down. The monetary base was growing steadily, and the US gold backing was declining, but the world was relatively unconcerned during a postwar recovery period. In the late 1960s, however, as US spending for the Vietnam War and President Lyndon Johnson’s Great Society accelerated, US trade and operating deficits became widely anticipated. Over 50% of the US gold was exchanged for dollars within eighteen months prior to August, 1971, when Richard Nixon “closed the gold window”. At that point, our gold amounted to only 6-7 % of the US monetary base. This level is important because we are back to that same level today.

We are not suggesting that the US, or anyone else, will make their paper currency convertible into gold any time soon. It wouldn’t work for long, in any event, because deficits in all major trading countries are larger than ever, and paper currencies would once again be tendered for gold. No country could back their currency with gold, unless they were “balancing their books” or, at the least, that prospect was in sight. We do, however, feel that the value of the gold “in circulation” should have a relationship to the value of alternative currencies. You might be surprised to learn that the country most able to make their currency convertible into gold would be Russia, perhaps our most prominent political adversary and a consistently large buyer of gold.

WHAT PRICE GOLD??

We refer to a couple of charts to approximate a reasonable level for the price of gold, relative to (1) a percentage of foreign exchange reserves and (2) as a percentage of paper currency in circulation. The chart just above this section shows that the value of the gold relative to the paper currency in circulation has a history, during steady non-inflationary growth, of being in the range of 25-35 %. The chart below shows the value of central bank gold holdings as a % of total foreign exchange reserves.

The chart above indicates that 7% could be 35%, or five times the current price. The chart below indicates that 7% could be 45% or 6.4x the current price. These ballpark calculations indicate what we consider to be a rational value of 5-6x the current $1500/oz, or $7,500-9,000/oz. This ballpark price range objective is at the current time. Since the upward adjustment in the gold price will likely be over a number of years, the appropriate price would be even higher by then.

THE TIMING

The following two charts provide insight into the possibility of an imminent major upward move. The first chart shows the high correlation of the gold price to the amount of worldwide sovereign negative yielding debt, now amounting to a cool $15 trillion. People, that’s a big number and even in Germany, the strongest European country, the entire yield curve is now negative. We believe that the amount of negative yielding debt will continue its upward march, and could even include some of the US debt. The continued upward trend of this indicator could be influential in breaking the gold price out above the previous all-time high of $1911. That, in turn, could ignite the price toward the price objectives noted above.

The second chart shows a nineteen-year price chart of gold. It shows the end of an 11-12-year bull market, ending in 2012, then a 6-7 year “consolidation”. The price has now clearly broken above $1400, the previous high. Chart technicians would say that the longer the base, the bigger the move. It is conceivable that a new bull market has begun that could last for quite a few years. This would tie in to our logic that the price of gold could be 5-6 times higher over a number of years.

CONCLUSION:

You get the picture!!

Roger Lipton

P.S. We produced two YouTube videos back in 2012 relative to this subject matter, each of which remains completely relevant. They are each only three minutes long. We have provided those links below:

https://www.youtube.com/watch?v=1ebZO5iMNeg
https://www.youtube.com/watch?v=ah7Y2rHuhCs

 

 

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CoreLife EATERY – DYNAMIC PRIVATELY HELD “UP AND COMER” – A SPECIAL COMPANY

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CoreLife  EATERY – DYNAMIC PRIVATELY HELD “UP AND COMER” – A SPECIAL COMPANY

 MANAGEMENT

Larry Wilson, Chairman and CEO, has a background in retail and restaurants, as a concept creator, franchisee, and franchisor. Several decades ago, Wilson co-founded Video King, building it into a regional chain of 36 locations. He became a franchisee of Moe’s Southwest Grill in 2005, where he was “Rookie Franchisee of the Year”, then “Franchisee of the Year” in 2014, growing to 21 Moe’s today. Mr. Wilson also owns and operates 11 Hoopla Frozen Yogurt stores in NY and PA.

Wilson and other “co-founder” Todd Mansfield conceived a healthy eating concept that could compete outside the major urban centers and bring clean and healthy food to more communities across the country.   In 2016 they were joined by Jeffery Coghlan (Chief Admin Officer) and Scott Davis (President and Chief Concept Officer).

Davis had been Chief Concept Officer for Panera Bread for twenty years from inception, overseeing all menu development, restaurant design and sustainability efforts. A case can be made that there was no single individual more responsible for the evolution and success of Panera than Davis. Mansfield has a 30-year long background in creative approaches to wellness, nutrition, physical therapy, and development of corporate culture that supports success in these areas, as well as community and philanthropic involvement. Mansfield has also been a franchisee of Moe’s and Hoopla. Administrative control has been led, since inception in early 2016, by Jeffrey Coghlan (Chief Administrative Officer),with 46 years of experience within the restaurant industry. Coghlan became a Wendy’s franchisee in 1969, is a Moe’s franchisee and a Harley Davidson dealer. His involvement in ministry, philanthropy and community involvement complements the similar dedication of Wilson, Davis and Mansfield. Mr. Coghlan has been supported, since inception, by Chief Financial Officer, Christopher Heiermann, who also serves as CFO for Southwest Grill of New York (Moe’s).

THE CONCEPT

CoreLife, based in Binghamton, NY, as envisioned by Wilson and Mansfield, and developed since by the team including Davis, is building a Lifestyle Brand from the inside out, considering that CoreLife Eatery embodies an intersection between “we are what we eat” and “find what works for you”. As they further describe their objective: “Food determines how you feel, how you look, and most importantly, how you perform.” While every food company would embrace these values, we’ve seen no other restaurant company that has created a menu of so many “good for you” items that also have eye and taste appeal. No doubt Scott Davis was instrumental in creating Panera’s “clean food” emphasis but he has, in comparison, far outdone himself with CoreLife’s approach. We haven’t seen everything out there, of course, but compared to concepts like Dig In (recently renamed “Dig”, now financed by Danny Meyer and no doubt doing very well), CoreLife takes a back seat to nobody. The ingredients, the suggested combinations, the photography, the service approach, and the overall price/value perception seem uniquely appealing to diners that are increasingly interested in taking care of themselves, especially if it can be done without sacrifice. This fast-casual concept provides assembly line style build-your-own bowls and plates. There are small bowls, popular for lunch, larger Greens & Grains Bowls, Broth Bowls, and entrée Plates. 60% of volume is at lunch, 40% dinner. 60% of sales is to women, 40% to men.

HISTORICAL GROWTH

2016 – Company units went from 0 – 8, there were no franchised locations opened.

2017 – Company units went from 8 -18, there were 5 franchised units opened, from 8 to 23 in total.

2018 – Company units went from 18 -27, franchised units from 5 – 22,  23 to 49 in total.

2019 – Currently around 57 locations in total. The largest states are: NY (17), OH (10), IL (5), IN (5), MI (5), PA (5) and UT (4). The company estimates that there will be approximately 63 locations at 12/31/19.

UNIT LEVEL ECONOMICS

The average store size started at nearly 4000 square feet but has been reduced to approximately 3000-3500 sq ft.  The cost of developing a location ranges from $770,000 to $1,059,000, including working capital of $25-60k, pre-opening advertising, $28-30k, training, $15-25k, and franchise fee, $30-35k. Ongoing royalty is 5% plus up to 3.5% (currently at 2%) in the “brand fund” which covers marketing expenses. Multiple unit development franchise deals have a variety of modifications to single unit arrangements (not including the 5% royalty or advertising requirement). Considering the rapid growth of units as described above, no doubt combined with concept evolution and opening inefficiencies, we consider the cost controls as described below as fairly impressive. The Company makes no representations in this regard but we wouldn’t be surprised if both CGS and Labor can be reduced at least modestly as a percentage of sales. We also consider it impressive that only 2% of sales has been spent on advertising at company stores so word of mouth has clearly been a source of sales strength. According to the Franchise Disclosure Document, the eight company stores that were opened for two full calendar years ending 12/31/2018 had average unit volumes of $1,699,927. Cost of Goods was 33.7% and labor cost was 26.5%. The eighteen company stores that were open for a full calendar year in 2018 averaged $1,480,701, had Cost of Goods of 33.5% and Labor expense of 27.6%. Comp sales are not quoted since so few locations have an 18 month history. In terms of return on investment for company stores, based on about 60% spent on prime costs, we estimate that at least 15% of sales is being generated as store level EBITDA. If we use the $1.7M as a “working” sales target, 15% EBITDA would be $255k or 27.9% on an average cash investment of $914k. Franchisees would obviously, after royalties, be generating less, but, considering how young this concept is, how much operating efficiency has yet to be  gained, how much contribution has yet to be generated from delivery, mobile app, and loyalty program, CoreLife is off to a more than promising start. It is not surprising, therefore, that there is substantial interest from potential franchisees, who have joined those already started with further interest.

THE FUTURE

CoreLife has grown quickly from 2016 through 2018, and 2019 Is no exception. At the same time, management is experienced and well aware of the pitfalls of growth that is too rapid. They do not seem driven by the need to beat the competition to this market or that. The concept seems to us to be “leading edge” relative to their fast casual segment. It is “defensible”, in that it is complex enough to be difficult to copy (as was Panera) yet (apparently) “simple” enough to be franchiseable and that seems to be validated by the initial franchise partners.

SUMMARY

We’re happy to have met this management team at a recent industry conference, glad to have visited locations on Long Island, Indianapolis and Vestal (near Syracuse). Even my wife, who has been “force fed” at a very large number of emerging concepts over the years, really liked this one. We look forward to following the progress of this young but capably driven leading edge concept. We urge our readers to visit their website to get a fuller picture of the stores, the menu, and the appeal.

Roger Lipton

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NOBLE ROMAN (NROM) REPORTS Q2 – FRANCHISING PROFIT MARGIN IMPROVEMENT IS HIGHLIGHT

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NOBLE ROMAN (NROM) REPORTS Q2 – FRANCHISING PROFIT MARGIN IMPROVEMENT IS HIGHLIGHT

CONCLUSION:

Noble Roman’s is steadily earning at an annualized untaxed rate of about $.12/share, with about $15M of tax protected earnings. EBITDA is running at around $3.5M annually, the highest level over the last several years, though a variety of “clean-up” issues have eaten into that calculation.  With a total enterprise value not much more than $15M, this established mid-west brand holds growth potential both with new company operated Pub locations as well as from franchising the Pubs and non-traditional locations. Just as a bank financing several years ago “transformed” the prospects, and allowed the company to create the Pub concept and establish the present much improved situation, a larger financing currently being negotiated promises to take NROM to the next level. Absent that, slower but steady company operated growth, while servicing the current debt, should still be possible, and franchising would take the lead.

OVERALL OPERATING RESULTS

Noble Roman’s Q2 results was consistent with Q1 in terms of increased earnings and EBITDA. Progress in the franchising segment outweighed margin pressure within the Craft Pizza & Pub operation. Net Income, which is tax protected for about $15 million, was $580k, up 5.5% for the quarter and 1.21M, up 11.0% for six months. EBITDA was $877.1k for three months, up 9.2%, and $1.724 for six months, up 9.5%. Both numbers annualize to a $3.5M annual rate (almost exactly the same as calendar ’18), and could improve to a $4M rate with a strong seasonal period ahead. Franchising revenues was essentially flat for three month and six months, with growth elsewhere offsetting a continuing decline in the relatively small grocery store segment. The extreme weather in the winter and early spring affected sales and margins in the Craft Pizza & Pub company stores in the early part of the second quarter, though to a much lesser degree than in the first quarter.

SUMMARY BY SEGMENT

The Noble Roman’s Craft Pizza & Pub remains the most promising portion of the current operations. The four existing company stores, as disclosed in the recent 10Q, generated approximately $900k of store level EBITDA margin in 2018. Considering that these locations cost about $2.4M to establish, that represents a 37.5% cash on cash return. Especially since only one of the restaurants was open more than eighteen months in Q2’19, this represents one of the most attractive returns within the fast casual restaurant industry. In Q2’19, however, the store level margin came down from 22.6% to 15.7%, much of it beyond the company control, and part of which could be recoverable over time. The good news is that prime costs were better in Q2, cost of sales 140 bp better to an impressively  low 20.9%. Salaries and wages also improved by 160 bp to 28.6%. Paper and Packaging was up 10 bp to 2.7%.  Facility costs increased by 310 bp, mostly from an unexpected increase in common area charges based on (supposedly) actual expenses in 2018 and the company has requested an audit of these numbers. While the company cannot predict the outcome of their “negotiation”, we think there could be at least some partial positive adjustment going forward and higher sales would obviously reduce this impact in any event. Other Operating Expenses increased 590 bp to 16.4%. Per the 10Q, 140 bp was an increase in insurance cost (which the company is currently renegotiating), 190 bp was advertising and 150 bp was delivery expense. The advertising expense, not a lot of dollars ($25,000) relative to $1.3M of sales, can obviously be leveraged as more company and/or franchised  locations are built within the trade area. The delivery expense burden will more likely come down than go up, in our view. From a macro standpoint, we believe that the third party delivery agents have seen their best days in terms of margin, and restaurant operators in general will carry less of a burden. Also, Noble Roman’s is doing their best to encourage use of their curbside pickup Pizza Valet service, which is increasingly being embraced by customers. Overall, we view it likely that store level margins can be improved over time, and higher sales would obviously be a big help. In the meantime, the four current operated locations at the current average annualized sales level of $1.33M, are generated an attractive cash on cash return. Relative to the franchising of the Pizza Pub, the first franchised operator, after a highly successful opening in Lafayette, IN., is exploring sites for a second location, and a second franchised operator, in Evansville, IN is expected to open late this fall.

The franchising segment, excluding grocery stores (which has been de-emphasized), reported revenues up 4.5% and 9.8% for three months and six months, respectively. Most impressively, the margin contribution from this segment increased by 850 bp to 66.4% and 960 bp to 67.6%, for three and six months, respectively. In the most recent quarter, salaries and wages came down 520 bp to 10.8%, trade show expense was reduced 80 bp to 6.5%, insurance by 50bp to 4.0%, travel and auto expense by 170 bp to 1.7%.The company noted in their quarterly release that in the period from 1/1 through 8/14, 21 new non-traditional locations have opened versus 17 a year earlier. Also: “the first two weeks’ sales of all non-traditional franchise openings in 2019 have averaged 32.8% higher than openings from previous years.”

The least important segment, in terms of revenue contribution, is the royalties and fees from grocery stores, which came down by $84k to $285k, and by $199k to $590k, for three and six months, respectively. As has been discussed previously, with the labor market tight, grocery stores have been challenged in terms of staffing deli departments, so have been reluctant to take on new products. Noble Roman’s has therefore decided to employ capital and personnel in the two other highly productive and more promising areas.

THE BALANCE SHEET

Cash improved by about $150k between 12/31 and 6/30, while paying off about $400k of bank debt and reducing accounts payable and accrued expenses by about $415k. Current Accounts Receivable went up by about $210k over six months to $1.78M but this is a seasonal factor and the amount is down by about $80k since June 30, 2018. Total Current Assets of $3.6M is 2.7x Current Liabilities. The question of the Company’s ability to repay the $1.9M remaining amount of convertible subordinated notes outstanding, which mature between November ’19 and February ’20 was raised on the Q2 conference call. $675,000 of those notes were voluntarily extended for three years. As the 10Q filing puts it: “the remaining Notes, in the amount of $1.225 million must either be converted into common stock, extended beyond the maturity of the senior debt or replaced with other like securities.” The Company has said that a new financing is being negotiated that would, if finalized, allow for repayment of all existing debt, including the convertible Notes, as well as provide funds for five additional Pizza Pubs. Should that financing not materialize, we view it as likely than any Convertible Notes remaining can be re-marketed for essentially the same terms, with an extended maturity date. It seems obvious to us that a 10% coupon, convertible at $0.50/share, with warrants attached (at $1.00) is a far better piece of paper today than when originally issued in 2017, and the general interest rate environment is even lower today than it was then.

CONFERENCE CALL

CEO and President, Scott Mobley, presided over the Q2 conference call. After financial results were provide in summary form by Chairman and CFO, Paul Mobley, Scott provided an operating summary in which he summarized operating initiatives designed to improve both sales and margins at the company operated Pubs. New sub sandwiches, combo meals and side items are being introduced, using local area marketing tactics. Online ordering, essential these days, has just been rolled out. Though the Company is not advertising the delivery option, relying on their Pizza Valet curbside pickup offering, Grubhub is now joining DoorDash as a third party vendor. A new and improved website is being introduced. Split pricing on the various pizza crusts is being added. Since the Sicilian crust is viewed as a premium product, the price is being raised by a modest $0.25 on the personal size, $0.50 for medium, $1.00 for large. Relative to the non-traditional franchising opportunity, Scott talked about a record setting location on an Indian reservation in Arizona. While no promises are being made relative to building sales at the Pubs beyond the $1.33M annualized level (Per Q2), the company clearly thinks this is possible and is bending every effort to do so.

CONCLUSION: Provided at the beginning of this article

Roger Lipton

P.S. – For more information, consult our full writeup of NROM, accessible from the Home Page @ Corporate Description, Public and Private Companies

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SEMI-MONTHLY FISCAL/MONETARY UPDATE – THE CASE FOR GOLD – FROM THE “TOP DOWN” TO THE “BOTTOMS UP” – HOW HIGH, AND WHEN?

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SEMI-MONTHLY FISCAL/MONETARY UPDATE – THE CASE FOR GOLD – FROM THE “TOP DOWN” TO THE “BOTTOMS UP” – HOW HIGH, AND WHEN?

With gold in the news again, there are lots of reasons provided by observers, most of them of minimal importance. Ask yourself what has changed recently to justify the sudden resurgence of gold related securities, and the answer is “not much”. For years now we’ve had low interest rates, a sluggish economy, geo-political concerns, rising deficits and debt, etc.etc. For us, as our readers know, it’s not been a question of IF, more a question of WHEN. The following article provides our reasons why gold related securities should be an important portion of one’s liquid assets.

Our conviction regarding gold, and gold related investments revolves around our conviction that gold is the real money, has been for thousands of years, and the reasons have not changed. Gold is limited in supply, durable, and accepted worldwide as a unit of exchange and a store of value. It is true that gold is useless in terms of being consumed or generating a return such as a dividend. However, it is the indestructibility and scarcity that have made it most useful in terms of backing paper currencies that could otherwise be diluted into oblivion by the politicians of the day. This has in fact been the consistent case throughout history and it is hard to conclude that today’s politicians, worldwide, will prove to be any more disciplined than those of the past.

A second part of our premise is that without a sound currency, there cannot be a sound economy. Unless the public has confidence in the buying power of the earnings that are received as a result of their effort, they will exert less effort in that pursuit. This has been reflected through the ages, before and including ancient Rome to the 21st century.

A corollary of the paper currency dilution is the inevitable higher price of goods and services. You don’t need a PHD in economics to understand that an increasing amount of currency chasing a fixed amount of product will result in higher prices. It so happens that this result is far more acceptable from a political point of view than the fiscal and monetary discipline necessary to avoid deficit spending. This predictable outcome produces a cruel tax on the working middle class (wealth gap?) that doesn’t understand why they are taking home a bigger paycheck but it just doesn’t seem to go as far as expected.

Another way to look at gold ownership as a long-term hedge against inflation: If we view gold as a currency/commodity, which competes with other similar “asset classes”. This includes the latest asset class which consists of over 2,000 cryptocurrencies led by the headline grabbing bitcoin. The amount of gold that is produced every year amounts to about $160 billion each year, and increases by about 2% annually (which happens to be approximately the rate of long-term real growth in the worldwide economy). Compare this production of gold, requiring substantial capital investment and risk, with the creation of trillions of dollars annually of unbacked (fiat) paper currencies that are produced with the click of a computer mouse. Which asset class do you think will hold its “value” better over the long term?

THE WEALTH GAP

The “wealth gap” that is decried by politicians around the world began to rear its head in the 1970s. We believe it is no accident that August of 1971, when Richard Nixon closed the gold window, ushered in this unfortunate phenomenon. The chart below shows this clearly.

THE CURRENCY AND THE DEBT

The following charts show how public and private debt has expanded since 1971 and how the US currency in circulation has expanded exponentially. It is interesting to observe how the US public and private total debt exploded in 1930 as the GDP sank 30%, fell back through the depression, stabilized through WWII and the post war industrial expansion, before taking off in the 1970s. As above, we believe it is no accident that a 1971 dollar has retained only about 15% of its purchasing power by 2019.

Some might argue that inflation has been subdued in recent years, running under the Fed target of 2%, even though deficits are rising. In fact, many PHDs are scratching their collective heads, wondering why this is so. However, while apparel and some consumer electronic products have not risen in price, the cost of large ticket items such as education, healthcare and rent have risen sharply during this period of monetary accommodation. The paper currency creation, worldwide, with the stated intention of a “wealth effect”, has inflated stock and bond prices. That wealth has predictably largely bypassed the middle class consumer, but allowed a Van Gogh painting to sell for $250 million and co-ops in New York City and London to trade for $100M or more. The suppression of interest rates has also affected the purchasing power of the upper class and fixed income dependent savers in that you need  much more  savings to maintain a previously enjoyed living standard.

CENTRAL BANKERS

Central bankers have no use for gold because gold, as a governing mechanism for the issuance of the paper currency, puts the central banker out of business. However, they know where the bodies are buried so let’s follow what they do, not what they say. The following charts show the consistent accumulation over the last ten years by the central banks, notably by Russia and China, two or our greatest adversaries. It is worth noting that reported Chinese gold holdings are assumed by many to be very much understated.


GOLD HOLDINGS vs. MONETARY BASE

The following chart shows the value of the gold held by the United States, since 1918 (shortly after the Fed was established in 1913), relative to the adjusted monetary base. You can see that from 1913 until just before the end of WWII, the value of the gold was about 35% of the monetary base. After the Bretton Woods agreement in 1944 whereby the US Dollar was established as the reserve currency, the percentage drifted down. The monetary base was growing steadily, and the US gold backing was declining, but the world was relatively unconcerned during a postwar recovery period. In the late 1960s, however, as US spending for the Vietnam War and President Lyndon Johnson’s Great Society accelerated, US trade and operating deficits became widely anticipated. Over 50% of the US gold was exchanged for dollars within eighteen months prior to August, 1971, when Richard Nixon “closed the gold window”. At that point, our gold amounted to only 6-7 % of the US monetary base. This level is important because we are back to that same level today.

We are not suggesting that the US, or anyone else, will make their paper currency convertible into gold any time soon. It wouldn’t work for long, in any event, because deficits in all major trading countries are larger than ever, and paper currencies would once again be tendered for gold. No country could back their currency with gold, unless they were “balancing their books” or, at the least, that prospect was in sight. We do, however, feel that the value of the gold “in circulation” should have a relationship to the value of alternative currencies. You might be surprised to learn that the country most able to make their currency convertible into gold would be Russia, perhaps our most prominent political adversary and a consistently large buyer of gold.

WHAT PRICE GOLD??

We refer to a couple of charts to approximate a reasonable level for the price of gold, relative to (1) a percentage of foreign exchange reserves and (2) as a percentage of paper currency in circulation.The chart just above this section shows that the value of the gold relative to the paper currency in circulation has a history, during steady non-inflationary growth, of being in the range of 25-35 %. The chart below shows the value of central bank gold holdings as a % of total foreign exchange reserves.

The chart above indicates that 7% could be 35%, or five times the current price. The chart below indicates that 7% could be 45% or 6.4x the current price. These ballpark calculations indicate what we consider to be a rational value of 5-6x the current $1500/oz, or $7,500-9,000/oz. This ballpark price range objective is at the current time. Since the upward adjustment in the gold price will likely be over a number of years, the appropriate price would be even higher by then.

THE TIMING

The following two charts provide insight into the possibility of an imminent major upward move. The first chart shows the high correlation of the gold price to the amount of worldwide sovereign negative yielding debt, now amounting to a cool $15 trillion. People, that’s a big number and even in Germany, the strongest European country, the entire yield curve is now negative. We believe that the amount of negative yielding debt will continue its upward march, and could even include some of the US debt. The continued upward trend of this indicator could be influential in breaking the gold price out above the previous all time high of $1911. That, in turn, could ignite the price  toward the price objectives noted above.

The second chart shows a nineteen year price chart of gold. It shows the end of an 11-12 year bull market, ending in 2012, then a 6-7 year “consolidation”. The price has now clearly broken above $1400, the previous high. Chart technicians would say that the longer the base, the bigger the move. It is conceivable that a new bull market has begun that could last for quite a few years. This would tie in to our logic that the price of gold could be 5-6 times higher over a number of years.


CONCLUSION:

You get the picture!!

Roger Lipton

P.S. We produced two YouTube videos back in 2012 relative to this subject matter, each of which remains completely relevant. They are each only three minutes long. We have provided those links below:

https://www.youtube.com/watch?v=1ebZO5iMNeg
https://www.youtube.com/watch?v=ah7Y2rHuhCs

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