All posts by Roger Lipton

SEMI-MONTHLY FISCAL/MONETARY UPDATE – THERE IS NO GRACEFUL WAY OUT OF THIS MESS!

SEMI-MONTHLY FISCAL/MONETARY UPDATE – THERE IS NO GRACEFUL WAY OUT OF THIS MESS!

The capital markets were quiet in June compared  to April and May, but still productive for owners of gold related securities.  The general market was up slightly in June, but all indexes except Nasdaq are still down for the year. Gold bullion was up 2.7% (now up 17% for the year. The gold mining stocks, with their cash flow and earnings leveraged to the price of gold, are still cheap statistically and are moving at a dramatic rate. Most impressively, in the last three month, from the low point, gold bullion is up 13% and the gold mining stock indexes are up well over 50%.   As our discussion below shows, the trends are more than adequately clear, all supportive of much higher prices for gold bullion and especially for the gold mining stocks .Moreover, there is no graceful way out of this fiscal/monetary mess.

Pictures can efficiently provide a summary of what has been going on from a fiscal/monetary standpoint over many years, leading us to a considered opinion of what the financial world will look like in the future.

The chart just below shows the current 30 year yields in various countries around the world. It is an axiom that the bond market supposedly prices in some sort of a “real” yield on top of allowing for inflation.  With the US 30 year yielding close to an all time record low of 1.44%, hardly anybody expects inflation to be zero over the next 30 years, which would provide a 1.44% “real yield”. It is a better assumption that the pricing represents expectations of a weak economy as well as the US Fed’s intention to increasingly support the long end of the yield curve.  The 30 year is “bid” to represent a safe haven as well as a short term trade, rather than a 30 year investment.

We can also assume that interest rates will stay very low, if the US Fed has anything to say about it (and so far they have), because it is only the ultra low rates that allow the US to carry the sharply increasing debt load.  The charts below show the ongoing annual budget deficits as well as the increase in the Federal Reserve’s balance sheet, whereby the Fed has been financing an increasing amount of the US operating deficit. Lest you think that this will all change once the economy gets going, and the operating surplus will reduce the cumulative debtt: Since 1981 there have been a grand total of four surplus years, the last three under Bill Clinton and the first under GW Bush, before the two wars started. The total surplus in those four years was about $760B, so you can judge for yourself how much of a dent  a stronger economy will make in the current $26 trillion growing debt federal debt burden.

We can also assume that interest rates will stay very low, if the US Fed has anything to say about it (and so far they have), because it is only the ultra low rates that allow the US to carry the sharply increasing debt load.  The charts below show the ongoing annual budget deficits as well as the increase in the Federal Reserve’s balance sheet, whereby the Fed has been financing an increasing amount of the US operating deficit. Lest you think that this will all change once the economy gets going, and the operating surplus will reduce the cumulative debtt: Since 1981 there have been a grand total of four surplus years, the last three under Bill Clinton and the first under GW Bush, before the two wars started. The total surplus in those four years was about $760B, so you can judge for yourself how much of a dent  a stronger economy will make in the current $26 trillion growing debt federal debt burden.

You have now seen how the bond market is predicting slower growth, at least in part due to the growing debt burden (around the world), which has been financed largely by worldwide Central Banks.

The last chart shows the steady decline in GDP growth in almost every post-recession expansion since 1981. The most recent ten years is fresh in our mind. A business friendly outsider passed one of the largest tax reductions in history, allowed for repatriation of almost one trillion dollars that had been frozen overseas, reduced the legislative burden on businessmen and encouraged the Federal Reserve Bank to print trillions of new dollars and keep interest rates near zero. The result was a grand total of 2.3% real annual GDP Growth over the last ten years, perhaps 0.1% to 0.2% more in the last three years under President Trump than under President Obama. This can be best described as a minimal “marginal return on investment”.

The coronavirus pandemic will be in the rear view mirror at some point in the next six to twelve months. The trends as described above will not. Rates will still be low, as signaled by Jerome Powell just recently, through 2022. This is because (1) the economy needs the support and (2) the US budget cannot afford higher rates on $26 trillion of growing debt. The annual deficits and cumulative debt will continue to step up by record amounts because that is essentially baked in the cake at this point. Just yesterday Fed Chairman, Jay Powell, reiterated the intention to invest a trillion dollars in all kinds of corporate bonds and ETFs. Also under active discussion is a trillion dollar infrastructure program.

As a result of the domestic debt burden, amplified by similar trends in every major worldwide trading nation, our expectation is that, after the sequential improvement from depression level economic activity, average real GDP growth will be no better, most likely materially worse, than the meager 2.3% average real GDP growth of the last ten years.

We fully expect that gold bullion will outperform equities in the next ten years, just as it has in the last decade. The bond market has outperformed both, as the entire yield curve was repriced downward, but that is less likely, from current levels, in the future.  Gold mining stocks have substantially underperformed the price of gold bullion over the last ten years and we continue to believe that they will be the best performers of all.

Roger Lipton*

*Roger Lipton is the managing General Partner of RHL Associates, LP, a Limited Partnership  that is 100% invested in gold mining stocks.

DARDEN RESTAUARANTS, INC. (DRI) REPORTS Q4 – ALWAYS A LOT TO LEARN!

DARDEN RESTAURANTS, INC. (DRI) REPORTS Q4 – ALWAYS A LOT TO LEARN!

SALES SUMMARY

Darden Restaurants, Inc. (DRI) reported fourth quarter and yearend, 5/31/20 results late last week. The fourth quarter was predictably dismal, with total sales down 43.0% to $1.27 billion, obviously as a result of the coronavirus pandemic that directly affected March, April and May. Same store sales were down 39.2% at Olive Garden, down 45.3% at Longhorn Steakhouse, down 63.1% at Fine Dining (62.5% at The Capital Grille and 65.25 at Eddie V’s) and 65.4% for Other Businesses (58.5% at Cheddar’s, 70.7% at Yard House, 69.9% at Season’s 52, my favorite, and 66.1% at Bahama Breeze).

The Company lost $1.24 per share ($154.6M), after excluding non-cash items of $2.61 per share primarily relating to goodwill, trademark, and restaurant level  impairments.

It’s no surprise that Darden lost a fortune in Q4 ending May, reducing  operating costs wherever possible, focusing on off-premise sales activity to minimize losses, etc. We consider Darden to be one of the premier multi-concept full service casual dining operators on the planet, admirably transparent in  disclosure and commentary. Rather than rehash the financials, which our readers can access elsewhere, we prefer to discuss the highlights of the conference call. Many of our readers are full time restaurant operators. For their purposes, it’s more convenient and less expensive to listen carefully to CEO, Gene Lee and his capable  team than to retain highly paid, and, probably  less qualified, consultants.

To start with, sales after firming from the lows of late March through April and May, continued increasing the last week three weeks into June.

THE BUSINESS STRUCTURE HAS EVOLVED

Online ordering has increased more than 300% at Olive Garden, more than 400% at Longhorn, 58% and 49% of which is TO GO, respectively. Off-premise is obviously a major ongoing emphasis, in the hope that an important part of it can be retained after dining room activity has been rebuilt. It was disclosed that 10-15% of the restaurants are already comping positively, where there was a solid off-premise business, mid-week and mid-day business.

Darden has transitioned to accepting delivery orders as small as $50 (averaging well above that), ordered by  5pm the day before, delivered by third parties. The pandemic accelerated the consumers’ desire for convenience, in particular through digital engagement and Darden focused on helping the guest easily order both in and out of the restaurant, improving the wait to be seated, streamlining the order pickup and payment process . Contactless curbside pickup creates almost a “drive through in our parking lots”, and may be the future core of off-premise consumption.

Menus have been streamlined. Advertising and promotions have been reduced, because (as we interpret it) customers are more interested, for the moment, in convenience than “value”. As the business remains in a major state of flux, Darden will go slow in reintroducing their loyalty program, adding back menu items or re-engaging with the extreme value oriented customer. As they put it: “we’ve improved productivity in our restaurants through more streamlined menus. We’ve got to really go through that discovery process. I think the big work that needs to be done is to think about what we need to do inside the box to better support and stage curbside if it’s going to be that big part of our business….right now we don’t think it’s prudent to be promoting people into our restaurants ….. long waits to get into the dining rooms…. would just be creating more frustration for our guests to get in…..taking this opportunity to cleanse our marketing spend to understand as we put it back in what works better, what gets us the highest return on investment……don’t think this is the right time to be advertising. We think this is the right time to pull it back….then we’ll start to layer some advertising back in and promotion back in….the most significant thing we’ve done is streamline the menus and our processes and procedures and that’s forever.”

THE Q4 PANDEMIC RELATED COSTS WERE SUBSTANTIAL

The pandemic related expenses were discussed at length. New labor related expenses  include permanent sick leave, emergency pay, child care costs, pay and  benefits for furloughed employees, as well as previous Q4 targeted store manager bonuses. Health and safety programs for team members include health checks, personal protective equipment, enhanced sanitation processes, social distancing and frequent hand-washing. Frequent  paid sick leave is provided at the same time that guests are cautioned to not enter the restaurants if they are symptomatic. In addition to the permanent paid sick leave, a three-week emergency pay program  provided nearly $75 million during the fourth quarter to hourly team members who could not work.

THE RE-OPENING PROCEEDS (HOPEFULLY)

Management commented on the call that, as the opening phases progress, the 6 foot social distancing comes into  play more than whether the restaurant is 50%, 75% or 100% “open” for inside dining. Different seating configurations are being evaluated for maximum efficiency, including  partition erection. At the current time, Hourly Labor and Cost of Goods combined are better than a year ago, but the occupancy expense burden is yet to be determined based on seating and the off-premise vs. inside dining breakdown, and the Store Level  Management cost will deleverage while sales are lower.

Q1’21, ending AUGUST’20, AND BEYOND

As Yogi Berra put it: “Predictions are always difficult, especially about the future”.

Management is optimistic about getting back to 2-3% unit growth and the possibility of better real estate deals as competitors fall by the wayside. They stated that the Company is currently Operating Cash Flow positive, as of last week, with sales down 30%. Guidance was only provided for the current quarter, at approximately breakeven, with $75M of EBITDA. Just too many uncertainties beyond the next couple of months. They reiterated the planned  $250-300M of total capex in the current year, which includes $100-120M of maintenance  capex and 35-40 new locations. As we have often pointed out, D&A is not free cash flow.

There’s nobody better than Darden. We look forward to the next installment of “Dining with Gene”.

Roger Lipton

FRANCESCA’S HOLDINGS, INC. (FRAN) – INITIAL WRITEUP – RISKS, OF COURSE, BUT HUGE UPSIDE POSSIBILITIES!

FRANCESCA’S HOLDINGS, INC. (FRAN) – INITIAL WRITEUP – RISKS, OF COURSE, BUT HUGE UPSIDE POSSIBILITIES!

CONCLUSION:

Francesca’s Holdings, Inc. (FRAN) is a Company I have followed for many years. It was considered, just a few years ago, as a differentiated young women’s apparel retailer with strong store level economics, well positioned strategically to provide a unique shopping experience. As described below, and as shown in the table above, FRAN has gone through about three dismal years. The operating results, prior to the pandemic, drove away most investors. Interim management stabilized the situation in 2019 and the pandemic hit just as new, highly qualified, management was installed. In the wake of investor disillusionment with “anything retail”, FRAN stock has declined to the point that virtually no possibility of fundamental recovery is implied. There are, to be sure, many unanswered questions, as described below. However, we are impressed with the credentials and the initial efforts of new CEO, Andrew Clarke. If Francesca’s can return to even half of its previous peak earnings power of $13.18/share, FRAN could trade at 10-20x its current value. Longer  term, if CEO Clarke’s turnaround and omni-channel expertise combines well with Francesca’s nationwide physical presence, the upside could be even more impressive.

THE COMPANY

Houston based Francesca’s Holdings, Inc. operates a nationwide chain  of just over 700 apparel boutiques, averaging about 1450  square feet in size, selling modestly priced, fashion driven merchandise (apparel- 46% of sales, jewelry-27% , accessories-16%  and gifts-10%)  to a core market of women, aged 18 to 35. The Company had a solid history of success from the time it went public in 2011 until calendar 2016, growing its number of stores, building same store sales to a peak of $545/square foot with high margins, generating a high return on invested capital, managing a strong balance sheet, with the stock often selling at 20-30x expected earnings and 12 to 18x trailing twelve month EBITDA. The personalized approach at the store level, selling a curated selection of modestly priced, fashion following  (rather than leading) merchandise allowed FRAN to compete successfully with much larger (both brick and mortar and on-line) companies and presumably ensured a strategically well positioned future. It is noteworthy that Francesca’s on-line presence has not, until very recently, been more than 10% of sales, so that remains an important opportunity.

All of this went awry several years ago when new management, with “big box”credentials, allowed the Company to become slower to react, over-inventoried in the wrong items, less fashion sensitive, in effect  straying from the “read and react, fashion following” strategy that had been the core of Francesca’s success. In late calendar 2018, Alvarez and Marcal (a well regarded retail turnaround consulting firm) was retained to study and then manage the business.  A&M’s agent, Michael  Prendergast, was installed as interim CEO early in 2019 and stabilized the business during  2019, as shown in the statistical table above. In February, 2020, a permanent  CEO, Andrew Clarke, was recruited. He is experienced with turnaround situations, has negotiated with vendors and suppliers In the course of flowing new product  while managing working capital. His experience with women’s “fast fashion”,  successfully applying omni-channel distribution and marketing, is especially applicable to Francesca’s. Time will tell, of course, but the Board’s choice of Andrew Clarke seems well considered.

Sales and earnings peaked in calendar 2016, the fiscal year ending 1/31/2017. We interject here that there was a one for twelve reverse split in mid-2019, so the reported peak earnings shown in the table above of $13.18 per share were reported at the time to be $1.10. Accordingly, the stock peaked in late 2016 at about $250 per share based on the current capitalization. The all time peak of over $400/share was in 2012.  The result today is that the stock, now under $5.00/sh., down from an all time high of  $400 and  with only  three million shares outstanding, provides a total equity value under $15M for a company that just last year, was still doing over $400 million (with a GAAP loss but still positive Adjusted EBITDA. It is also crucially important that, even today, as the pandemic (hopefully) winds down,, the Company has no net debt. The challenge, of course, is to manage the balance sheet as stores are reopened, inventory is refreshed and seasonal needs are met, but at least the Company is not in a hole as the process begins.

The statistics in the table above show historical  peak earnings of $13.16 per share, FRAN still doing close to $400M of annual sales, no current net debt, an enterprise value today at 1.4x trailing twelve month depressed Adjusted EBITDA, and an Enterprise Value under $15M. As you might expect, there are more than a few risks to be considered, including:

THE NEGATIVES

Almost half (342 at 2/1/20, of which 91 are in outlet centers) of the 700 boutiques are located in shopping malls, obviously not the best place to be in a post-pandemic world. The fashion driven sales per square foot have declined to $390/ft. in the latest fiscal year, and it was more promotionally driven than hoped. New management, led by Andrew Clarke, has just recently been installed. Though the credentials are impressive, the results are yet to come. The latest balance sheet, as stores reopen, discussed below, could prove to be inadequate to support the operating plan. More debt could be expensive and equity issuance could be very dilutive to existing investors. Negotiations continue with landlords and future traffic in malls is uncertain. Vendors have apparently worked constructively with the new management team as post-pandemic plans are implemented but this might not be the case for long, depending on results. Relative to FRAN stock, there is no current apparent coverage, and the small capitalization could discourage future institutional investors. There is a 22% equity owner, Cross River Management, who could potentially sell their stock. Alternatively, Cross River could increase their position, even to the point of buying the entire Company, perhaps to the detriment of other public shareholders.

On the other hand:

THE POSITIVES

The potential of FRAN must be based on store level economics, potentially enhanced by materially higher online sales. Peak sales of $545/ft. (under 10% of which were on-line) declined to $390/ft. most recently. The objective of the new management team is obviously a recovery in AUVs, with a much broader omni-channel approach. The relatively small footprint of 1,462 square feet provides a personalized boutique shopping experience and is unique relative to competitive apparel retailers.  From the landlord standpoint, FRAN remains attractive as a tenant, as capable as any to pay a fair rent. The physical presence of 700 locations can prove to be a unique asset for the Company, even as the omni-channel approach is pursued. The opportunity for a customer to see and feel the product before purchase, and return or exchange in a nearby location can help FRAN differentiate their commodity.

The balance sheet seems adequate, for the moment at least, discussed further below under “Recent Developments”. There appears to be the possibility of raising debt capital on attractive terms under the pending US government Main Street Lending program.  Should that prove to be the case, there would be less need for more expensive debt or dilutive equity capital.

Our observation from personally visiting dozens of locations over the last year is that the store level sales culture is one of the most important long term assets. The stores have almost invariably been staffed by sales personnel that are age appropriate, knowledgeable and enthusiastic about their,product, prepared to be helpful without being intrusive in the sales process. We had many conversations with store level personnel who had been with FRAN for several years at least, who reflected on the improvements in merchandise and the fact that “corporate is listening to us again”. Very successful retail companies, such as Lululemon, Ulta Beauty, and Starbucks have successfully weathered difficult periods, with their store level operating culture providing the foundation of the effort. While it is obviously “a reach” to compare FRAN to these much larger very  successful companies, if Francesca’s turns the corner, the store level culture, which doesn’t happen by accident, will have been a critical necessary ingredient.

POSITIVE ADJUSTED EBITDA, IN THE WORST OF TIMES

There has been a positive Cash Flow from Operations and Adjusted EBITDA even in the last two disastrous years.

In the year ending 2/2/2019, Net Cash from Operating Activities was $9.5M. Aside from working capital changes, the largest non-cash addbacks to the $40.9M GAAP loss were $24.5M of D&A and $20.1M of Asset Impairment charges.  Adding back the D&A, Asset Impairment, Interest of $426K and $7.5M of taxes would have provided Adjusted EBITDA of $11.6M.

In the most recent  year, ending 2/1/2020, Net Cash from Operating Activities was $2.8M.  Aside from working capital changes, the largest non-cash addbacks to the $25.0M GAAP loss were $21.4M of D&A and $11.9M of Asset Impairment charges.  Adding back the D&A, Asset Impairment, Interest of $1.2M and $125k of taxes would have provided Adjusted EBITDA of $9.6M.

 THE BALANCE SHEET  – Year End, 2/1/20,  and 5/2/20 (Q1’20)

Cash at 2/1/2020 was $17.8M, down from $20.1M a year earlier. A/R had been reduced by $13M, Inventories were up by $1.2M, Prepaid Expenses were up $2.0M, A/P was down by $13.5M, Current Portion of LT Debt was $8.9M vs. 0, Long Term Debt was zero, down from $10M.

Total cash and cash equivalents at the end of the first quarter were $14.3 million compared to $17.5 million at the end of the comparable prior year period. As of May 2, 2020, the Company had a $15.0 million of combined outstanding borrowings and a combined borrowing base availability of $3.1 million under its Amended ABL Credit Facility and Term Loan Credit Agreement.

SUMMARY Q1’20  (5/2/20) OPERATING RESULTS – Per the 8-K filing on 6/18/20:

“As the Company’s boutiques began to reopen, its cash position increased to approximately $21.0 million as of June 12, 2020 from $14.3 million as of May 2, 2020 (the end of Q1). This increase was primarily due to the Company’s efforts to drive sales and monetize existing inventory, aggressively reducing costs and managing cash flows, including deferring payments for rent, inventory and other accounts payable, subject to discussions with landlords and vendors. Additionally, the Company also expects to receive an income tax refund of $10.7 million related to certain provisions under the Corona Aid, Relief and Economic Security Act during the second quarter of fiscal year 2020. This refund is required to be used to repay the approximately $5.0 million in outstanding borrowings under the ABL Credit Agreement as of May 2, 2020 along with any other then outstanding borrowings under the ABL Credit Agreement in accordance with the letter agreement entered into between the Company and the ABL Credit Agreement lenders. As of June 12, 2020, the Company had no borrowing base availability under its ABL Credit Agreement.

“Net sales decreased 50% to $43.8 million from $87.1 million in the comparable prior year quarter primarily due to the mandated boutique closures beginning on March 25, 2020 and continuing through the end of the first quarter related to the COVID-19 pandemic. This decrease was partially offset by strong performance in ecommerce as all of the Company’s efforts subsequent to March 25, 2020 were focused on driving ecommerce sales during the temporary boutique closure period. The Company permanently closed eight boutiques during the first quarter, bringing the total boutique count to 703 at the end of the quarter.

“Gross loss, as a percent of sales, was (6.6%) as compared to gross profit, as a percentage of sales, of 34.8% in the prior year quarter. This unfavorable variance was primarily due to lower deleverage in occupancy costs as a result of lower sales. Occupancy costs include the full lease expense for all boutiques for the month of April 2020 (editor Note – which was not paid, presumably deferred and/or abated). Additionally, merchandise margin decreased due to aggressive markdowns and promotions as well as increased higher inventory reserves due to the COVID-19 pandemic.

“Selling, general and administrative (SG&A) expenses decreased $15.0 million or 38% to $25.0 million from $40.0 million in the prior year quarter. Adjusted SG&A in the first quarter of fiscal 2019 was $38.0 million and excludes $1.2 million of consulting expenses associated with the Company’s review of strategic and financial alternatives and turnaround strategy, $1.1 million in severance benefits and other payroll costs also associated with the turnaround plan, and $0.3 million of stock-based compensation reversal associated with the departure of certain employees. There were no non-GAAP adjustments to SG&A in the first quarter of fiscal 2020.

“The $13.0 million decrease in adjusted SG&A versus the comparable prior year period was primarily due to a $10.7 million decrease in boutique and corporate payroll costs as a result of the temporary furlough of substantially all of the Company’s employees, a $0.9 million decrease in boutique and corporate bonus expenses and $0.6 million decrease in professional fees.

“The Company ended the quarter with $34.8 million of inventory on hand compared to $32.2 million at the end of the comparable prior year period. Average inventory per boutique increased 11% at May 2, 2020 compared to May 4, 2019 due to the mandated boutique closures as a result of the COVID-19 pandemic. (Editor Note – Inventory management on a quarter to quarter basis has been less than ideal in the last several years, presumably providing opportunity for improvement under new management.)

RECENT DEVELOPMENTS – as boutiques reopen

Per the 6/18/20 earnings release and conference call:  The operating loss for Q1, as provided above, was obviously due to the required closing of the entire chain. At the same time, Andrew Clarke, CEO since 3/9/20, made clear his optimism for a successful long term recovery and new growth for the Francesca’s Holdings brand. 85% of the stores are now reopened, the balance to operate by the end of July.  Q2 will be a process of liquidating store level inventory to make room for new product. Online sales were up 85% during the Pandemic. While that gain has moderated as stores have reopened, a far larger omni-channel presence for Francesca’s is a long term opportunity. Stores that have reopened have shown encouraging sales. As stated on the call:  “On average, retail sales are running at similar levels to the same prior year period. The significant increase in conversion and average units per transaction indicating acceptance of promotional and engagement strategies and have offset negative traffic trends.” Purchasing is through fewer vendors, and relationships are apparently improved. Better inventory management is a particular opportunity and a number of new hires, including a new SVP of Merchandising, have been made. Rent was not paid in April, May and June and negotiations have resulted in reductions and/or deferrals into calendar ’21 and beyond. The existing fleet of about 700 locations is expected to be largely maintained.

CONCLUSION – Provided at the beginning of this article

SEMI-MONTHLY FISCAL/MONETARY UPDATE – DEBT, DEFICITS, SPENDING EXPLODE UPWARD – CAN’T WORRY ABOUT IT NOW !

SEMI-MONTHLY FISCAL/MONETARY UPDATE – DEBT, DEFICITS, SPENDING EXPLODE UPWARD – CAN’T WORRY ABOUT IT NOW !

Pictures can more efficiently provide a summary of what has been going on from a fiscal/monetary standpoint over many years, leading us to a considered opinion of what the financial world will look like in the future.

The chart just below shows the current 30 year yields in various countries around the world. It is an axiom that the bond market supposedly prices in some sort of a “real” yield on top of allowing for inflation.  With the US 30 year yielding close to an all time record low of 1.44%, hardly anybody expects inflation to be zero over the next 30 years, which would provide a 1.44% “real yield”. It is a better assumption that the pricing represents expectations of a weak economy as well as the US Fed’s intention to increasingly support the long end of the yield curve.  The 30 year is “bid” to represent a safe haven as well as a short term trade, rather than a 30 year investment.

We can also assume that interest rates will stay very low, if the US Fed has anything to say about it (and so far they have), because it is only the ultra low rates that allow the US to carry the sharply increasing debt load.  The charts below show the ongoing annual budget deficits as well as the increase in the Federal Reserve’s balance sheet, whereby the Fed has been financing an increasing amount of the US operating deficit. Lest you think that this will all change once the economy gets going, and the operating surplus will reduce the cumulative debtt: Since 1981 there have been a grand total of four surplus years, the last three under Bill Clinton and the first under GW Bush, before the two wars started. The total surplus in those four years was about $760B, so you can judge for yourself how much of a dent  a stronger economy will make in the current $26 trillion growing debt federal debt burden.

You have now seen how the bond market is predicting slower growth, at least in part due to the growing debt burden (around the world), which has been financed largely by worldwide Central Banks.

The last chart, below, shows the result, a  steady decline in GDP growth in almost every post-recession expansion since 1981. The most recent ten years is fresh in our mind. A business friendly  President passed one of the largest tax reductions in history, allowed for repatriation of almost one trillion dollars that had been frozen overseas, reduced the legislative burden on business and encouraged the Federal Reserve Bank to print trillions of dollars and keep interest rates near zero. The result was a grand total of 2.3% real annual GDP Growth over the last ten years, perhaps 0.1% to 0.2% more in the last three years under President Trump than under President Obama. This can charitably be described as a minimal “marginal return on investment”.

The coronavirus pandemic will be in the rear view mirror at some point in the next six to twelve months. The trends as described above will not. Rates will still be low, as signaled by Jerome Powell just recently, through 2022. This is because (1) the economy needs the support and (2) the US budget cannot afford higher rates on $26 trillion of growing debt. The annual deficits and cumulative debt will continue to step up by record amounts because that is essentially baked in the cake at this point. Just yesterday Fed Chairman, Jay Powell, reiterated the intention to invest a trillion dollars in all kinds of corporate bonds and ETFs. Also under active discussion is a trillion dollar infrastructure program.

Almost all observers, on all sides of the economic and political and social argument , agree that the recent magnitude of fiscal/monetary support has been justified to survive the healthcare crisis. The most realistic commentators point out the long term dangers, saying “we will worry about that later”. Our discussion is designed to show what “later” looks like and why.

As a result of the domestic debt burden, amplified by similar trends in every major worldwide trading nation, our expectation is that, after the sequential improvement from depression level economic activity, average real GDP growth will be no better, most likely materially worse, than the meager 2.3% average real GDP growth of the last ten years.

We fully expect that gold bullion will outperform equities in the next ten years, just as it in each of the last two decades. The bond market has outperformed both, as the entire yield curve was repriced downward, but that is less likely, from current levels, in the future.  Gold mining stocks, while higher,  have substantially lagged the price of gold bullion over the last ten years and there are many reasons to think that the gold miners will be the best performers  of all. They are, after all, custodians, in their underground vaults, custodians  of the “real money”.

Roger Lipton

DAVE & BUSTER’S (PLAY) – UPDATED WRITEUP – DOWN 75% FROM HIGH – A BUYING OPPORTUNITY?

DAVE & BUSTER’S (PLAY) – UPDATED WRITEUP – DOWN 75% FROM HIGH – A BUYING OPPORTUNITY?

We have written about Dave & Buster’s many times over the last few years, mostly concerned about the lack of productivity  of the hundreds of millions of capex dollars that were spent with minimal “marginal return on investment”. Readers can access those discussions by way of the SEARCH function on our HOME page. (plug in “PLAY”).  We believe this sort of analysis applies  to many restaurant and retail companies, that (before we ever heard of Covid-19) leveraged their balance sheet (with low interest rates) to buy back stock, while pretax operating earnings and/or EBITDA were not making much progress. PLAY,  by nature of the fashion driven nature of their Amusement  segment, as well as the declining portion of normally more stable food sales, just happens to be a good object lesson.

The table below summarizes the last six years since PLAY came public (again) in 2014.

Several financial trends are apparent. The first two years after coming public were very productive, as EBITDA grew from $165M to $262M.  Subsequent to that, however,  though hundreds of millions of dollars were spent on capex between 2015 and 2020, EBITDA, EBITDA grew only from $262M in the Y/E 1/17 to what was estimated (before the pandemic) to be about $335M in the current year.  Notice also that the shares outstanding were reduced from buybacks  from 42.2M at 1/17 to 30.6M at 1/20 while net debt went from $264M to $608M.

We compared each year end Enterprise Value with the Adjusted EBITDA in the following year and found that the multiplier was consistently in the 7-8x Expected EBITDA range, as shown in the far right hand column. That multiplier contracted most recently, at 1/20 to 5.8x, when the flat results in recent years discouraged investors from valuing PLAY quite so highly. So, in the “best of times”, PLAY was valued at 7-8x expected EBITDA. Followers of PLAY know well that overall comps flattened and finally turned down in the last year or so, as Amusement revenues stagnated and Food & Beverage never got traction.

Which brings us to the current broad based economic disaster. As almost all chains have done, PLAY has drawn down their lines of credit, cut back overhead, temporarily closed down the entire system.  Per last week’s conference call, they were burning $6.5M operationally plus $750k of debt interest per week through the complete closure.  They indicated that the 26 stores that had been opened for four weeks as of 5/26/20  contributed about $1.3M of cash to reduce that burn rate. The most recently opened stores are gaining volume more quickly than the first, which makes sense in that the public is presumably becoming more relaxed about the situation.  Overall, management seemed to state that stores should be breaking even, in terms of EBITDA, at about 50% of old volumes, the corporation at 60%, but it would be higher in the current ramp up year. Reference was made to “rent deferrals and abatements on 80% of the stores, payments to begin in Jan’21” but it is unclear what manner of adjustment is typical, and how that is built into the break even points referenced above.

Interested readers should access the full call and monitor the anticipated reopening program. Suffice to say, however, that it is a long way back and “re-invention” applies to all aspects of the operations. Openings are being put on hold, food offerings are being revamped, Amusements are being re-evaluated in view of new cleanliness and social distancing requirements. You don’t need us to tell you that the Dave & Buster’s concept is more challenged than most to cope with all the new operating requirements.

Which brings us to the current Enterprise Value. After the recent equity offerings and increase of debt, as the table above shows: the current Enterprise Value is north of $1.2B. The EV/EBITDA multiple in the best of times was 7-8x. We can only wonder how long it will be until PLAY generates an EBITDA north  of $150-200M to justify the current situation, let alone a higher valuation.

Roger Lipton

 

NOBLE ROMANS, INC. (NROM) – REPORTS MARCH QUARTER – UPDATED WRITEUP

NOBLE ROMANS, INC. (NROM) – REPORTS MARCH QUARTER – UPDATED WRITEUP

Indianapolis based Noble Roman’s, Inc. (NROM)  reported their first quarter, ending 3/31, as described below. Our previous writeups relative to NROM are available through the SEARCH function on our Home Page:

CONCLUSION:

Noble Roman’s (NROM) is one of the smallest publicly held restaurant companies, but  seems to enjoy a good reputation in the markets, especially Indiana and surrounding areas, where they have operated for decades. The recently improved balance sheet,  the continued profitability  of existing company operated Noble Roman’s Craft Pizza and Pub (NRCPP) locations (including the mid-pandemic exceptional opening in Brownsburg),  the maintenance of company wide operating profit through the pandemic, the ongoing prospect for successful franchising of both NRCPP units and the non-traditional venue should allow for a new growth period for the brand. The number of fully diluted shares is about 25M (down about 10% as a result of the new financing) so the enterprise value (including $8.5M of debt) is comfortably under $20M. A large portion of the $3M EBITDA the last several years has been used to service debt, but a much higher percentage should be available to support growth in the future. As we like to say, we are all living in a new world, and Noble Roman’s is no exception.

MARCH QUARTER RESULTS

Results, as with all companies, were influenced by the pandemic in the three months ending March. Total revenues were $2.719M compared to $2.922M in 2019. Operating profit before interest and taxes was $589k compared to $754k a year earlier. Heavy interest charges this year ($926k, of which $718k was non-cash), partially offset by a tax benefit of $82k,  provided a GAAP loss of $255k (vs. a GAAP profit of $476 in 2019). The weighted average shares outstanding was reduced to 22.853M vs. 25.585M, due to fewer fully diluted shares after a constructive balance sheet restructuring.

The highlights of the quarter, as outlined in the corporate release, were:  a new $8M debt package, plus obtaining a $715k loan from the PPP which is expected to be forgiven, the highly successful opening of the 5th company operated NRCPP,  the $321k Adjusted Net Income, after adding back the $658k writeoff of non-cash interest of unamortized previous debt costs.

The franchising division (royalties and fees from non-traditional locations, NRCPPs franchising, grocery store royalties and fees) provided revenues of $1.467M vs $1.593M. Royalties and fees were virtually the same for the non-traditional venue at $1.278M vs $1.287M and the decline was in the grocery segment ($189k vs $305k) as labor became an issue in the deli departments of grocery stores when the pandemic hit. The margin contribution was $.977M vs. $1.098M, a still impressive 66.6% of revenues, vs. 69.0% in 2019.

The company operated Noble Roman’s Craft Pizza and Pub division, including the latest location that opened in Brownsburg, IN on 3/25, generated $1.092M vs. $1.143M. The store level EBITDA margin (after about 1.0% of non-cash rent expense) was $121k (11.1%) vs $132k (11.5%). Revenue was increased by the Brownsburg opening on 3/25 but the State of Indiana closed all dining rooms on 3/14. We estimate that sales for the four locations  (prior to Brownsburg) were slightly positive in January and February before pandemic concerns affected sales starting in early March. Cost of sales was 21.6% vs. 20.8%. Labor expense was 29.1% vs 32.0%. Facility cost was 18.6% vs. 17.6%. Packaging cost was 2.8% vs 3.6% Delivery Fees was 3.2% vs. 1.3%. Other operating expenses was 13.6% vs. 13.2%. Total store level expenses were 88.9% vs 88.5%.

There is a third operating division, relatively immaterial, in which the company operates one non-traditional location. That location generated $154k in revenues and $2.4k in EBITDA  margin, vs. $170k and $16.8k. This division is not expected to grow.

NROM had previously announced that the Brownsburg location, opened at the peak of the pandemic on 3/25, without the normal inside dining, generated over $50k of weekly sales in its first week. The Company has since indicated  that Brownsburg is still generating weekly volume in the mid-thirties, the highest of the five existing locations, obviously very encouraging.

The new $8M five year debt package was closed, fortunately, in early February, providing liquidity to ride out the pandemic storm as well as provide growth capital once the health crisis abates. The Company has described that the interest rate is high at LIBOR plus 7.75% plus 3% of annual PIK interest, added to the loan principal, plus warrants, but there is no principal due for several years and previously issued warrants have been eliminated. The result is $33,333 of debt service on the $8M, plust $60k per year on the remaining convertible debenture for the next several years (less than half the previous debt service), reduction of about 2.5M fully diluted shares, and $1.6M of additional funds that will come in from the new warrants. The proceeds paid off all previous bank debt and the convertible debt that had not been extended and provided capital for approximately four new locations, including Brownsburg.

Per the Conference Call:

Relative to the most important growth segment, the NRCPP locations, Scott Mobley, CEO, described how dining rooms were closed on 3/14. Prior to the pandemic, off-premise sales were about 20% of the total. He had indicated previously that sales bottomed at  a relatively modest  30% decline from pre-Covid levels, as a result of the success of the year old Pizza Valet curbside pickup  service. Several weeks ago, the Governor of Indiana allowed dining rooms to open at 50% of capacity. Since then, sales have increased steadily so are most recently running down 20-25%. On-premise sales are about 30% of the total and the increase is a combination of fresh on-premise revenues, while cannibalizing a portion of the previous off-premise increase. Mobley informed listeners that it had just been announced that dining rooms can operate at 75% of capacity this coming Friday. Mobley volunteered that staffing is always a concern, but less so for NROM than many others since store level staff was largely maintained through the pandemic.

Scott Mobley also pointed out that some of the non-traditional franchisees, hospitals, c-stores, etc. were challenged by staffing over the last several months. Some, like entertainment centers and bowling alleys are completely closed. Hospitals have generally not allowed visitors. Sales within this venue are expected to recover and grow over time, but he cautioned that the rate of recovery is uncertain and could be slower than desired.

Paul Mobley, CFO, pointed out that the increase in A/R was largely the result of a $77k A/R from the landlord in Brownsburg, which was collected in April, and a $50,000 increase in A/R from manufacturers, which is now current. The Company currently has a cash balance of $1.4M so should be able to comfortably fund the addition of 3 more stores over the next nine months. In response to a question, he indicated that the Company should be cash flow positive in Q2 and the balance of the year, obviously assuming that there is no major macro-economic and/or health related disruptions. He also indicated that both existing franchisees of the NRCPP are interested in building new locations. The franchisee in Lafayette is already developing a unit in Kokomo, IN, targeted to open later this summer, and the Evansville franchisee is evaluating possible new locations, yet to be selected and financed. Mobley also indicated that he is having serious discussions with a potential new franchisee, but that is yet to be finalized.

CONCLUSION: Provided at the beginning of this article

Roger Lipton

THREE FINE RESTAURANT COMPANIES: CAKE, CBRL, & CHUY PROVIDE UPDATES, WHAT CAN WE LEARN?

THREE FINE RESTAURANT COMPANIES: CAKE, CBRL, & CHUY PROVIDE UPDATES, WHAT CAN WE LEARN?

CHEESECAKE FACTORY (CAKE)

There are 294 total company operated restaurants in US and Canada, @ 12/31/19,  including 206 Cheesecake Factories CAKE, 23 under the North Italia brand, 50 within Fox Restaurant concepts, 13 under Grand Luxe Café, 1 under RockSugar Southeast, and 1 under the Social Monk Asian Kitchen brand. The Fox Concepts and North Italia comprise 28.3% of 12/19 assets and 3.7% of consolidated revenues (or only about $90M, as North Italia and the remainder of Fox were completed on 10/2/19). There are also 26 CAKE restaurants operating internationally under licenses, as well as the bakery subsidiary.  Comps for Cheesecake Factory restaurants, for the two months ending 5/31, were down 63%, including 87 full or partial closures. Stores that are opened without dining rooms are doing about $4M annualized.

It is worth noting that off-premise activity represented 22% of Q1 sales, more than at most of their full service casual dining competitors, a solid base on which to build. In April CAKE amended their credit line with covenant relief, reduced operating costs, suspended the dividend and stock repurchases, and raised $200M from a convertible preferred equity raise. The cash balance was $260M as of 4/30.

As of  6/2, CAKE has reopened about 25% of all 294 (that would be about 73 locations), of which 34 are Cheesecake Factories  (out of 206), restaurants under COVID-19 capacity restrictions. They hope to have 65% of dining rooms opened, with limited capacity, by mid-June. They began reopening dining rooms the second week of May. The (17% of) Cheesecake Factories that have so far opened their dining rooms  have recaptured about 75% of last year sales average. Stores that are opened without dining rooms are doing about $4M annualized.

We suspect that the 17% (34 of 206) Cheesecake Factories that have opened are those most easily accessed by today’s stay at home customers. Time will tell how successfully average sales will build as the system openings proceed. Recovery of profit margins will be inhibited by delivery expenses and increased packaging costs, like everybody else, and also by fewer high-margin drink sales.

Also, while Cheesecake Factory is clearly the dominant brand within the portfolio, other than pointing out that North Italia has a lot of growth potential and Fox is an incubator of new brands, there has been no update on how they are doing. They do, after all, represent 28% of corporate assets and hundreds of millions of dollars of annualized sales (as of Y/E ’19).

CRACKER BARREL (CBRL)

CBRL reported its financial results for the third quarter ending May 1, 2020 and provided an update relative to COVID-19.  For the third quarter of fiscal 2020, through April, all 664 Cracker Barrel stores remained open, comp restaurant sales declined 41.7% and comparable store retail sales declined 45.5%. However, all stores were operating in an off-premise-only model with no dine-in service from late March through late April, with incremental dine-in openings initiating thereafter. It is noteworthy that off-premise sales only represented 9% of the mix prior to COVID-19.  A relatively old customer base, with breakfast representing 25% of sales, are relevant factors in the rebuilding process.

Since the end of Q2, the table above shows the weekly progress over the last four weeks for all comparable stores. The Company points out In the week ending May 29, 2020, when compared to the comparable period in 2019, comparable store restaurant sales for stores with limited dine-in service For the full week (434 out of roughly 664, about 2/3 of the system) decreased approximately 32% compared to approximately 76% for stores that were limited to an off-premise-only business model.  The Company points out that, as of 5/29, 505 stores had limited dine-in service, and the Company expects that substantially all stores will have limited dine-in service by the end of June. It can be expected that the system restaurant comps will move closer to the negative 32%, and hopefully improve from there over time.  Retail comps have been steadily improving and will presumably move higher as restaurant activity brings more customers inside.

CBRL had a strong balance sheet ahead of the pandemic, has not raised equity capital but drew down its full revolving credit line in Mid-March and net debt to trailing twelve month EBITDA rose to 2x as of 4/30/20, vs. 1x three months earlier.

Once again, however, a negative 32% or 22% or even a negative 12% doesn’t bring profitability back to previous levels.  Labor is higher, protein is costing more (at least temporarily) and sanitizing efforts provide an additional expense line.

CHUYS HOLDING – (CHUY)

Prior to their June 1 release, the Company had provided a Q1 (3/31) updates, with subsequent events as well. They indicated that off-premise revenues had tripled from 14-15% of sales to 45-50% of (old) sales, roughly 20 percent of that from delivery.  Online ordering was 45% of off-premise activity, compared to 18% before the pandemic. The weekly burn rate was $200,000 by end of May, compared to $500k/wk in April. They had cancelled non-essential capex, temporarily suspended rent payments, continued to work with landlords. As of 5/17, they had $27M of cash on hand and they announced on 6/1 their intention to sell $50M of common stock.  Amid the pandemic, they furloughed 80 pc of hourly employees, 40% of store management, 40% of corporate and administrative staff. Non-furloughed workers had salaries reduced by 25-50 pc, senior mgt. took pay cuts of 50-75% and Board of Director compensation was suspended. They continued paying health premiums for eligible furloughed employees.

As reported on June 1st, for the second quarter (two months) through May 24, 2020 comparable restaurant sales decreased approximately 49.8% from the same period last year. The following table shows selected weekly comparable restaurant sales and average sales, for the 92, out of 101 system-wide locations that are open.

The Company commented that: “during the eight-week period ended May 24, 2020, we remained current with all of our vendors but deferred a majority of our lease obligations and as allowed under the Coronavirus Aid, Relief, and Economic Security Act deferred the payment of our employer social security taxes. Had we fully paid these expenses during such period, we estimate that we would have had approximately $27 million of cash and cash equivalents as of May 24, 2020 (down from actual current $32M).

“In response to the business disruption caused by the COVID-19 pandemic, during the eight-week period ended May 24, 2020, we transitioned our restaurants to a more limited menu and a primarily off-premise operating model with reduced labor, operating expenses, marketing and corporate overhead expenses, along with the cancellation or postponement of all non-essential planned capital expenditures. At the end of the eight-week period ended May 24, 2020, we were operating 18 restaurants in to-go only format, 74 with limited dine-in seating and nine were temporarily closed.  Based on our operations over this eight-week period, we estimate we achieve positive EBITDA (1) with average weekly sales above approximately $43,000 after taking into account all restaurant operating costs, including rent, and G&A expenses.   As we expand our operations by increasing our dine-in capacity and reducing the off-premise operating model for our restaurants, we expect to incur additional restaurant operating expenses and G&A expenses. With the increased expenses resulting from such expanded operations, we estimate we achieve positive EBITDA (1) with average weekly sales above approximately $54,000.”

Management actions, to get through these challenging times, have been commendable. We accept the fact that the cash burn has been reduced, and that the cash flow breakeven point has been lowered, for the time being. However: the new fully loaded (with corporate G&A) EBITDA breakeven point as described may be optimistic. $54,000/week annualizes to $2.8M per store, or about $290M system-wide. In calendar 2019, CHUY reported $426M of revenues, with income from operations of $3.4M. Adding back $20.7M of D&A, $14.2M of Impairment and closing costs, $0.6M of legal settlement, and $2.9M of pre-opening costs, provides Adjusted EBITDA of $41.8M. That means that ($426-290M) $136M of sales above “break even” last year generated only $41.8M of Adjusted EBITDA, or a 30.7% “flow-through”. That’s not much “leverage” from the higher sales. We believe cash generation from the incremental sales should be 40-50%. (Cost of sales, 26%, is variable, Labor, 35.4% is perhaps half variable, Operating Expenses, 15%, is perhaps half variable, Occupancy, 7.5% is mostly fixed, G&A, 5.6% can’t by leveraged by more than a point, so 26 + 17 + 8 + 1 = 52% variable, ballpark).  That leaves 48% theoretical flow through. Especially since there is no expense line that is expected to help, our conclusion is that the average weekly sales need to be $60-65k/wk. to generate positive corporate EBITDA. It’s interesting that $60-65k/week is 74%-80% of the previous sales that we suggested in our recent Darden (DRI) analysis as the approximate EBITDA breakeven range for full service casual dining restaurant chains.  Let’s watch 🙂

CONCLUSION

CAKE, CBRL, and CHUY are all well run restaurant chains, strongly positioned competitively, supported by strong balance sheets, with admirable operating histories. The reports described above show definite sequential progress over the last two months. There is, however, a lot of “wood to chop” before profit margins recover and an attractive return on capital can be earned. We stand by our prior reasoning that year to year sales comparisons have to recover to a negative 20-25% to provide a breakeven corporate EBITDA. While companies in all industries like to report “Adjusted EBITDA”, for old school analysts and investors that consider GAAP earnings relevant: GAAP breakeven (depreciation is not “free cash flow”, and interest expense will be higher than before) will require 10-15 points more of revenues. That means that GAAP breakeven will require sales to be down only 5-15% YTY, 10% as the midpoint. Above this GAAP pretax breakeven point, the last 10 points of revenues will generate perhaps 4 points of pretax profits, 3% after tax.

It is a new world, on many levels.

Roger Lipton

SEMI-MONTHLY FISCAL/MONETARY UPDATE – THE CORONAVIRUS, EVEN SOCIAL UNREST, WILL PASS, ECONOMIC RAMIFICATIONS WILL BE FAR LONGER LASTING

SEMI-MONTHLY FISCAL/MONETARY UPDATE – THE CORONAVIRUS, AND EVEN THE SOCIAL REST, WILL PASS, BUT THE ECONOMIC RAMIFICATIONS WILL BE FAR LONGER LASTING

PROLOGUE

We wrote most of this update a couple of weeks ago, before the horrific situation in Minneapolis triggered protests, often with accompanying riots, in major cities all over America. There is no doubt that the growing wealth and opportunity gap in America, in and of itself,  is adequate justification for protest and rebellion. The stage was set, on top of that, by the social and economic tension from several months of restricted activity due to the coronavirus pandemic. While we cannot claim to be an authority regarding social trends, the recent developments, unfortunately, magnify  and accelerate even further the trends we discuss below.

THE MONTH OF MAY

While the general equity markets were strong all month, as investors seem to assume that the Coronavirus pandemic is in the rear view window, gold bullion strengthened a bit as well, up 2.6% for the month. The gold mining stocks continued their strong relative performance of April, up by low double digits in May and now comfortably positive for the year. As we have suggested, the gold miners should move at a multiple of the gold price because of their operating leverage and that is happening. Most impressively, since March31st, the low point, gold bullion is up about 9.9% and our gold mining stocks are up over 5 times that, measured by an average of GDX and GDXJ, the two major gold mining ETFs.

We continue to point out that the miners are down a lot more from their highs of 2011-2012 than gold bullion. Bullion, at $1730/oz. is down about 10% from the high and the gold mining stocks are still down well over 50%. Theoretically, then, if gold bullion moves up by 10%, the miners could double. That might be a “reach”, but the seven times move over the last two months could be indicative of what is ahead. Let’s hope so.

The following update is longer than we like to provide. However, since there is so much misinformation about the role of gold and the prospects for the gold miners, we want our readers to  be as well informed as possible.

THE STIMULUS IS MIND BOGGLING –THERE IS NO END IN SIGHT, AND IT IS A WORLDWIDE PHENOMENON

The coronavirus will pass, but the economic ramifications will be far longer lasting.  You don’t get out of a fiscal/monetary hole by continuing to dig. The current health crisis has brought forward, accelerated, and magnified the economic trends that were already in place. The monstrous buildup in debt is important because economic history has clearly shown that the higher the debt burden the bigger the drag on productive growth. This is why the longest (and falsely promoted as “the strongest”) economic expansion in US history only provided 2.3-2.4% annual real GDP growth from ’10 through ’19. You heard it here first: there is no chance in hell that future growth (after the “dead cat bounce” from current levels) will be higher than 2% or so, likely to be materially lower, with the new debt burden that the world will be carrying. 

We all know that the Fed balance sheet is exploding, as it finances the monstrous government spending. It is instructive to look at the pattern of growth over the last dozen years, as the supposedly apolitical Fed ignores the conservative side of the Keynes economic equation. John Maynard Keynes suggested, in the late 1920s and early 1930s,  that the Fed should provide stimulus in hard times and pull it back in better times, presumably muting potential booms and busts. Unfortunately, economic conditions never seem to get good enough to remove the previous accommodation.

Recapping the last dozen years: The Fed Balance sheet was under $1T in early ’08. It grew to about $2.2T by late’08, stayed around that level until mid ’09 when it started moving to about $3T by late ’11. From late ’12 to late ’14 it moved to $4.5T where it stayed until early ’18. The economy apparently never got quite good enough to pull back between ’10 and late ’17. In early ’18 the Fed announced a program of “automatic” reduction, with the implied objective to get back to perhaps $2.5-3.0T. It got back (only) to $3.7T by the end of ’19, but with the economy softening and distortions in the short term “repo” bond market, the Fed backed off and built its asset base to $4.2T, clearly on the way to a new high by mid’20.

Which brings us to the current “new world”. Since March 4, 2020, the Fed has taken its balance sheet from $4.2T to $7.0T, and Chairman, Jay Powell, has indicated that he will do “whatever it takes”. We expect it to be $10T or more in a matter of months. Folks,, this does not provide organic, productive, sustainable economic growth. This only provides an addictive high (not so high, in this case), supportive by always increasing doses of fiscal/monetary drugs.

The money printing, as the Central Banks finance their respective deficits, is not limited to the United States. Just this week, the European Common Bank announced a $2T stimulus package and The Japanese Central Bank weighed in with $1T. While the European economy, in total, is larger than the US, the Japanese economy is only 1/6 our size, so these are huge numbers in any context.

The debt and deficits that require the Fed’s intervention are likewise exploding. The US debt, excluding unfunded entitlements like Social Security, is now approaching $26T, up from $22.7 at 9/30/19. The operating deficit which was supposed to be about $1.2T for the full year ending 9/30/20 is now expected to be at least $4.0T. The deficit in April alone was $738B. At this junction, after trillions of dollars have already been provided, it is clear that there is much more fiscal/monetary stimulus to come and nobody knows the ultimate magnitude or duration. Most importantly: virtually everyone, fiscal hawks and doves alike, bipartisan in nature, agree that the support must be provided, and we can all worry about the ramifications later.

 THE PRICE OBJECTIVE FOR GOLD BULLION

The price of gold has shown a strong long term correlation with the federal US debt. The buildup of the Federal Reserve balance sheet over the last fifteen years has also strongly correlated with the gold price. The above discussion therefore supports a materially  higher price of gold related securities.

We believe that gold has proven itself for thousands of years as a store of value, is the ultimate currency, and this is the single most important reason that it is worth owning. It competes with paper currencies as the supply and demand of one currency (gold) must relate to the supply and demand of unbacked colored paper. 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. A chart looks similar on a worldwide basis. 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.

The chart above indicates that 7% could be 35%, or five times the current price. This  ballpark calculations indicate what we consider to be a rational value of 5-6x the current $1730/oz, or $8600 to $10,300/oz. This ballpark price range objective is at the current time. The monetary base is now rising at about 20% per year with all the money printing to support the economy in the current crisis. Though gold is now moving steadily higher, the monetary base is also rising so the price objective within just the next few years could be well over $10,000/oz.

THE TIMING – FOR GOLD BULLION PRICES

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, which peaked at $16-17T in mid ’19 and is now in the low teens. Even in Germany, the strongest European country, the entire yield curve has been negative or close to it. We believe that the amount of negative yielding debt will continue its upward march and could even include some of the US debt, especially based on President Trumps implied blessing just two weeks ago. 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.

There are other charts we could provide that show a long term correlation of the price of gold to the level of US debt. Over the last fifteen years the same sort of correlation has taken place between gold and the buildup of the Federal Reserve balance sheet.

THE GOLD MINING STOCKS

The chart just below shows the gold mining index, XAU, relative to the price of gold bullion. Since 2008, the relative valuation of gold equities to gold bullion has fallen 75% from the prior 25-year average. The ratio of the XAU Index to spot gold averaged 0.25x for a quarter century through 2008. As of 3/31/2020, the ratio was 0.05x.

We believe that the substantial divergence in performance is due to mostly outdated opinions.  Managements have been improved, balance sheets have been strengthened, operations have been streamlined. Additionally, energy costs, which are 15% or operating expenses, are much lower today than the range of $80-120/bbl of ten years ago.  Higher gold prices and lower expenses have produced impressive recent results from established miners and should become even more so.

SUMMARY

The healthcare crisis, now exacerbated even further by the social unrest,  has accelerated, magnified, and brought forward in time many of the long term fiscal/monetary trends that we have been expecting for some time. We continue to feel that gold mining companies are the single best asset class in terms of reward versus risk.

We’ve been joined lately in our conviction relative to gold by legendary investors and portfolio strategists such as David Rosenberg, Jeff Gundlach, Ray Dalio, Jim Roberts, Stanley Drukenmiller, David Einhorn, Stephanie Pomboy, Luke Gromen and others. Long term proponents of gold and gold miners such as John Hathaway Fred Hickey, Bill Fleckenstein and Peter Schiff are more convinced than ever. Though it’s nice to have some “smart money” in our camp, the investment world in general is just beginning to take small positions in this sector.

Gold bullion is up about 14% this year at this moment (a safe haven, after all). The miners, which were down for the year a month ago, are now in positive territory and catching up with bullion. In the last two months, gold mining stocks, as measured by an average of  GDX and GDXJ, the two largest gold mining ETFs,  have moved over 5x the price change of bullion (Our Investment Partnership, RHL Associates, LP, has done even better).  We believe we are still in the first inning of the resumption of the long term bull market for gold related securities.

Roger Lipton

 

 

FEEDBACK FROM BLOOMIN’ BRANDS (BLMN) – REGARDING OFF PREMISE SUCCESS AND  CORPORATE BREAK EVEN POINT

FEEDBACK FROM BLOOMIN’ BRANDS (BLMN) – REGARDING OFF PREMISE SUCCESS AND CORPORATE  BREAK EVEN POINT

We continue to look for new data points that will help us understand which restaurant chains have the best chance to survive, then prosper, and when.

We’ve previously asked the question as to how much of the new off-premise business will be retained as the dining room activity rebuilds, and that jury is still out. We’ve suggested that store level margins will suffer as dining rooms are only 25-50% open and operating expenses (especially labor and new sanitizing requirements) burden the bottom line. Our article in mid-May, describing developments at Darden (Olive Garden and Longhorn Steakhouse) suggested that YTY same store sales have to get back to something like down 25% to approximate corporate cash flow break even. All of that is confirmed by commentary from Bloomin’ Brands on May 5th, as well as highly qualified Michael Halen, at Bloomberg Intelligence, just this morning, 5/29.

From Management Conference Call, May 5th:

      “Have to get back to down 20-25% to be cash flow breakeven…. For our brands, we talked a lot about Outback and things and Carrabba’s on off-premises. But Bonefish and Fleming’s have taken it from virtually nothing. Bonefish had some, Fleming’s had hardly anything…..So I think at Bonefish, we’ve seen it. We’ll see what happens at Fleming’s…As of  May 5th: 2/3 takeout, 1/3 delivery (half and half third party/in house).”

As described below by Michael Halen, off-premise revenues at Outback and Carabba’s had tripled, from an average of 18%, so we figure overall sales were running down YTY an average of approximately 46%. Management also confirmed, above, that sales have to recover to roughly a negative  20-25% to approximate corporate cash flow breakeven.

Per: Michael Halen at Bloomberg Intelligence, on 5/29/20

“Bloomin’s same-store sales may drop double digits in 2020 as dining-room closings and high unemployment hurt sales, yet a strong off-premise business at Outback will mitigate losses. We see Outback’s in-house delivery service as a competitive advantage as it has wider margins, control of service and access to customer data.

“Off-Premise Sales as % of Total Before Coronavirus

(Bloomin’ Brands)Outback Steakhouse 15% & Carraba’s 21%, Cheesecake Factory 17%, Cracker Barrel 9%,Applebee’s 13%, IHOP 10%,Olive Garden 17%, Brinker (Chili’s&Maggiano’s 17% Texas Roadhouse 7%

Bloomin’s decision to prioritize direct delivery over third-party aggregators created a competitive advantage over casual-dining peers, as we see it. This includes wider margins, access to customer data — which allows for personalized marketing — and significantly faster delivery times (35 minutes). According to management, 74% of customers prefer self-delivery for the superior service and safety it provides. “Delivery is profitable, with more than 630 units offering the service. Bloomin’s recent partnership with DoorDash complements the existing self-delivery platform and expands the company’s reach to new customers.

“Delivery sales are now split evenly between in-house and third-party providers. Off-premise sales almost tripled from the beginning of March into the end of April. (05/29/20)”

OUR COMMENTARY

Aside from the typical description of off-premise sales building rapidly through April and early May, and the confirmation of corporate breakeven for full service casual diners around a negative 20-25%, we think the movement to self-delivery may prove to be an important new development. We are all aware of the extra expense, management challenge and corporate liability of self-delivery. However, control of “the last mile”, more complete customer interaction and the elimination of delivery charge from third parties could make self-delivery an increasingly attractive option. The 74% surveyed preference of customers toward self-delivery could prove to  be “anecdotal” but might also be an important indicator. Self delivery might especially appeal to regional chains, as opposed to multi-national giants, for whom The Brand is an important competitive advantage.

CONCLUSIONS

  • Off-Premise is here to stay
  • Overall margins will be hindered until restaurants get well over a negative 20%, back to at least full capacity, 
  • Cash breakeven for full service casual dining operators is approximately down 20-25% YTY
  • Self-Delivery is at least worth considering

Roger Lipton

NOBLE ROMANS, INC. (NROM) – UPDATED WRITEUP

NOBLE ROMANS, INC. (NROM) – UPDATED WRITEUP

CONCLUSION

It’s a fresh start in our new world for Noble Romans, Inc. (NROM), a fifty year old well established Midwest brand. Their flagship Noble Romans Craft Pizza and Pubs survived the pandemic relatively well and an $8M financing in early February significantly improved their balance sheet. Though NROM is one of the smallest publicly held restaurant companies, with an enterprise value of under $20 million, we continue to follow their progress because the stock seems to represent good value statistically and there continues to be substantial potential for growth.

THE COMPANY

2019 RESULTS Noble Romans, Inc. (NROM) reported calendar 2019 results last week. We have written a number of articles describing NROM, which can be accessed through SEARCH and under Corporate Descriptions. In order of current importance: Indianapolis based NROM Romans operates five Noble Roman’s Craft Pizza & Pubs (NRCPP) in their home market, is actively looking for several additional locations, franchises two NRCPP units in Indiana with a third under development, franchise/licenses about 640 non-traditional locations (c-stores, entertainment centers, hospitals, etc.) all over the US and have licensed 2,402 grocery stores to sell Noble Roman’s products made fresh in their deli departments.

The largest source of revenues, $6.2M in 2019, comes from royalties and fees, including $1.136M from the grocery store venue. The least important segment currently is the grocery venue, declining in recent years ($1.423M in ’18) as a strong economy limited labor availability to assemble pizzas in the deli departments. Though that could improve in the post-pandemic  world,  Noble Roman’s has focused  on franchising, both the NRCPPs and non-traditional  venues. The four NRCPPs generated $4.8M in 2019. Details of these operations, as well as the 50 year history of the brand are described in our previous reports. As shown in the table below, there were a number of fourth quarter non-cash adjustments, so the full year operating results, combined with the balance sheet improvement, from ’19 to February’20, are most relevant to the prospects.

The table above is excerpted from the ’19 10-K. The Franchising division generated revenues of $6.2M in ’19, down from $6.4M, as grocery fees declined, partially offset by an increase in non-traditional and NRCPPs fees.  The margin contribution was $4.071M vs. $3.794M, up 7.3% YTY, and the margin improved sharply to 66.0% from 59.0%, as operating expenses were reduced. The 4 NRCPPs that were operating in ’19 generated $4.8M of revenues, exactly flat with ’18. Food and Packaging Cost was 24.1% vs 24.6%. Labor was 30.0% vs. 31.4%. Though those Prime Costs were well controlled, Facility Costs (including common area charges, and a $134,544 non-cash accounting required rent adjustment, ASU 2016-02 accounting for leases) jumped to 17.2% from 13.6% and Other Operating Expenses (including marketing, delivery charges, and insurance, the latter two of which are expected to be lower in ‘20) jumped to 16.7% from 11.6%. Store level margin contribution therefore declined to 12.0% from 18.8%. Adding back the $134,544 non-cash rent charge, the margin contribution was a more respectable 14.8%. The Company also operates one non-traditional location, down from three a year earlier. That small venue generated $48k of operating cash flow, up from $12k in ’18. General & Administrative Expenses were $1.74M in ’19, up 4.2% from $1.67M in ’18, preparing for growth which was delayed until the new financing  took place in February,  2020.

BALANCE SHEET

The 12/31/19 balance sheet, although important, and improving through ’19, was dramatically restructured in early February 2020. Immediately after the restructuring in early February, the company had current assets of approximately $4.4M and current liabilities of $1.1M, or net working capital of $3.3M, for a current ratio of 4-to-1. At 12/31/18 and 12/31/19, the company reported net A/R from franchisees of $4.4M and $4.0M, respectively, each of which were net of valuation allowances of $4.3M and $5.6M, respectively. These A/R adjustments  in large part go back to 2014-2015, arising from contract breaches of approximately 80 non-traditional franchisees. The receivables include NROM legal costs, as spelled out in the franchise agreements.

Immediately after the balance sheet restructuring in early February, the company had two pieces of long-term debt. The largest is an $8M note due in 2025 which has no required principal payments due until 2/28/23 at which time monthly principal payments begin in the amount of $33,333 and continue until maturity. The new note bears interest of LIBOR plus 7.75%, plus 3% payment in kind to be added to the principal. There are also principal payments due based on consolidated excess cash flow as defined. As management said on the conference call: “We know full well that this is expensive financing. However, it was the best we had available…we made the decision in early 2020..to start growing and carry out our business plan….we closed just in time…so fortunately we had the liquidity to both withstand the Covid-19 changes and continue growing our business at the same time.” Also, while warrants were attached to the new financing, retirement of warrants attached to the previously outstanding convertible notes result in a net reduction of about 2.9M shares, from about 28M to 25M. Cash provided by the exercise of the new warrants would also generate an incremental $1.6M from the new warrants, which could be used for additional growth.

The other long-term debt is $625k of subordinated convertible (at $0.50/share) unsecured notes which mature 1/31/23. With no required principal payments on either piece of debt until 2023, the annual amount of cash to service its debt is approximately $800k, versus about $1.5M previously.

Additionally, on April 25th, the Company borrowed $715k under the PPP, which the Company anticipates will be forgiven in accordance with provisions of the CARES Act.”

THE NEW WORLD FOR NOBLE ROMAN’S, ALONG WITH EVERYBODY ELSE

Management was working on the new financing package prior to the pandemic, as well as constructing their fifth NRCPP location. The first of the two successful NRCPP franchisees was also moving forward with an additional location, in Kokomo , IN, which is currently under development. The result of the above described financing is that previous debt is repaid and the Company has the funds to open four new NRCPPs in the near future, one of which has already opened. While the financing is expensive, as management says, the lack of principal payments, which the Company was making with the previous financing, provides substantial additional free cash flow for the next several years.

The pandemic has obviously produced major adjustments. Since sales at the NRCPPs were not disastrous, store level managers were maintained at full salary and most crew members were retained. The NRCPP units were previously doing about 20% of their sales off-premise. The Company had fortunately introduced a “Pizza Valet” curbside pickup approach about a year ago, as well as working with, though not promoting, third party delivery services. That emphasis served them well and sales, according the conference call, have been running down YTY a relatively modest 30%. Other changes made in the last year included a modified dough formula that travels better and a new carry out box that holds temperature more effectively. Dining rooms have reopened at 50% of capacity as of 5/11, two weeks ago today and  it is anybody’s guess how fast and how far dining room activity rebuilds.

The fifth Company operated NRCPP opened on March 25th in Brownsburg, IND,  a small city just outside of Indianapolis , and did an extraordinary $50000+ in its first week.  It goes without saying that the reception of the Brownsburg community, in the heart of the Coronavirus pandemic, speaks volumes about the value, and the potential for growth, of the Noble Romans brand. As President, Scott Mobley, described it on the conference call: “in my thirty years of industry experience I have never seen anything like it….during the first two days of opening, the entire lot, maybe 200 parking spaces were occupied at one time, with a line of cars 20 deep along the street to enter the parking lot….. we ended up having to make numerous system adjustments on the fly as well as instituting controls on the order rate”. He indicated later in the call that Brownsburg is still doing an impressive $36,000/week.

Relative to non-traditional locations, specifics were not given about sales levels, other than indicating that they vary widely between convenience stores, entertainment facilities, hospitals, etc. Scott Mobley did indicate that a new product extension is planned for the non-traditional venue that will target existing franchisees as well as new ones. It is an entirely new sales opportunity, has been tested, and several franchisees have already shown interest. Scott Mobley indicated that this development could be significant, indicating his comment was just a teaser in terms of potential benefits.

Another significant development is the creation of new somewhat  smaller version of the NRCPP, 3,600 sq.ft., down from about 4,200 sq.ft. This new version incorporates what has been learned about off-premise service, improving the carry out option for both the Company and the customer, at the same time maintaining the seating capacity and ambience of the full service experience.

CONCLUSION: Provided at the beginning of this article