All posts by Roger Lipton


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Accounting Adjustments aside, the prospects are dependent on store level economics, the probability that margin improvement can be achieved within the existing store base, which could fuel a long term expansion program for company and franchised locations. Management is candid about the continuing emphasis on improving store level margins, before considering aggressive unit expansion, new franchising, or franchising of existing company locations. The store level margin at Taco Cabana is not productive enough to attract franchisees, and the revenues per store have now been in the $1.8M range for the last five years. While the store level margins at Pollo Tropical are attractive, success outside of the original Florida core market has been problematic, so that brand is a work in progress as well. Store level revenues and margins at PT were higher six or seven years ago, came down as stores were built outside of Florida, are going up again as the chain has consolidated once again within Florida. Considering the unforgiving industry wide environment, we have our doubts that dramatic operating progress can be made at Taco Cabana in the near to intermediate term. On the Pollo Tropical side of things, margins could edge up somewhat, after unproductive stores have been closed and/or impaired, but the success outside of Florida continues to be a wild card. Notwithstanding the fact that Jefferies/Leucadia owns 14% of FRGI and they are very smart people, last I looked they don’t have a magic wand. If they want to own the rest of it, I wish them luck, seriously.  Overall, we consider FRGI “fairly priced” at the current time.


Fiesta Restaurant Group operates and franchises two distinct restaurant brands: Pollo Tropical and Taco Cabana.

Pollo Tropical was founded in 1988 in Miami, FL. From the outset the concept’s strategy was to grill the marinated chicken (signature product created from Latin American influences) in full view of the customers. There was to be no prepackaged, precooked menu items and no microwaves in the kitchen. This standard is still maintained today. Menu favorites include MOJO Roasted Pork and Tropi Chops – a Create Your Own Bowl of Fire-Grilled Chicken Breasts or Crispy Pollo Bites, Roasted Pork or Grilled Vegetables served over Rice.

Pollo Tropical restaurants are designed to create an inviting dining experience with a tropical, festive atmosphere. As of December 2018, there was a total of 169 Pollo Tropical restaurants; 139 of which are Company owned, all located in Florida. There are 30 franchised locations: 24 located in Puerto Rico, Panama, the Bahamas and Guyana. There are 5 non-traditional locations on college campuses and 1 located in a hospital in Florida. In 1998 Pollo Tropical was sold to Carrol’s Restaurant Group which is the largest Burger King franchise.

Taco Cabana was founded in 1978 in San Antonio, TX and is a Fast Casual restaurant specializing in Mexican cuisine. Taco Cabana is known for its pink stores and sunny enclosed patio dining areas. The enclosed patio along with the pink décor provide a vibrant, contemporary ambiance and relaxing atmosphere. The menu’s primary features are: Tacos, Flame Grilled Fajitas, Quesadillas and Burritos. Most locations offer live music at different times during the week. Most menu items are hand-made daily on site in an open display cooking area. The open air design is to create a patio café effect. As of December 2018, there were a total of 170 Taco Cabana restaurants; 162 of these are Company operated and all are located in Texas. The 8 remaining locations are franchised and located in New Mexico.   In 2001 Carrol’s Restaurant Group acquired Taco Cabana and made it a part of their restaurant portfolio.

In May, 2012, Carrol’s divested itself of Pollo Tropical and Taco Cabana in a spinoff to the public, the combination named Fiesta Restaurant Group.

Store Closures:  Based on their strategic renewal plan (launched in February 2017), Fiesta Restaurant Group has closed a number of their restaurants from both concepts. Since that date a total of 77 restaurants were closed (60 Pollo Tropicals and 17 Taco Cabanas); all locations were considered under-performing.


Strategic Renewal Plan:

On February 27, 2017 Fiesta Restaurant Group announced the appointment of Richard Stockinger as CEO and President of the Company. Shortly thereafter, Fiesta launched the “Plan” designed to significantly improve their core business model and drive long-term shareholder value. The “Plan” consisted of the following:

  1. Revitalizing restaurant performance in core markets,
  2. Managing capital and financial disciplines,
  3. Establishing platforms for long-term growth, and
  4. Optimizing each brand’s restaurant portfolio.

Strategies for Growth:

Fiesta’s long-term growth strategy is focused on profitably building their base business, growing new distribution channels including catering, delivery, licensed and franchised locations, and developing new restaurant locations.

These growth strategies primarily include:

  • Focus on consistency of operations and food quality – to date they have improved system processes and equipment, added incremental labor, implemented tighter managers’ span of control and enhanced field leadership. Additionally, Fiesta has implemented food preparation processes to insure high quality freshness and consistency.
  • New product innovation.

o   As part of both brands DNA, their menus are centered on freshly prepared, quality food offerings that have broad appeal and provide everyday value. Both brands have their own product development team that enables them to continually reaffirm current offerings and develop new products.

  • Focus on effective advertising to highlight everyday value proposition.

Fiesta utilizes an integrated, multi-level marketing approach that includes periodic system-wide promotions, outdoor marketing, in-store promotions, local trade area marketing, social media, digital and web based marketing, and other strategies which include the use of radio and TV, limited time offerings, emails and app based loyalty programs. This broad media approach reinforces the key attributes of each brand. Pollo Tropical and Taco Cabana’s advertising expenditures in 2018 were 3.5% and 3.4%, respectively.

  • Grow off-premise sales.

o   Fiesta’s inclusion of portable menu items such as wraps, sandwiches, bowls, and salads as well as home replacement meals, and increased focus on catering and delivery continues to be a key focus for both brands. Thus far Fiesta has invested in catering resources utilizing leadership and enhanced digital capabilities, enhanced online ordering and smartphone apps. Additionally, in late 2018, Pollo Tropical began utilizing portable point of sale tablets which accept payment to improve speed of service.

  • Continue reimage program.

o   Fiesta continues to implement enhancement initiatives, updating interior and exterior elements to the current standard to be more relevant with their guests.

  1. Growth of non-traditional licenses and international franchise development.
  • Currently, Fiesta is updating their FDD to support franchise growth in the future.
  1. Improve profitability and optimize infrastructure.
  • Focus on operational efficiencies while prudently growing their restaurant base, with profit enhancement initiatives focused on food and labor costs.
  1. Develop new restaurants.
  • Opportunities to develop both brands in Florida and Texas; as well as potential future expansion opportunities in other regions of the U.S.


In 2018, total revenues were $688,597,000. 99.6% of revenues were derived from sales of Company operated restaurants with the remainder from franchise royalties and fees.

  • Selected Financial Data – The following table sets forth summarized consolidated data for each of the years ended December 30, 2018 and December 31, 2017, each 52 weeks long.
  • Pollo Tropical:
    The average net sales for a Company operated Pollo Tropical were $2,521,000 with average food costs of 32.9%, restaurant wages and related expenses of 23.2%, and occupancy and other expenses of 18.5%; leaving a 25.4% restaurant level EBITDA (before advertising of 3.5%).
  • The average Pollo Tropical ranges in size from 2,800 to 3,700 square feet with interior seating for approximately 70-90 guests. Per the ’18 10K, the “historical” costs of constructing a store have been $0.5 to $0.7M for Interior costs and signage plus $0.9 to $1.8M for Exterior costs. Since these costs vary, depending on new construction vs. conversion, and owning vs. leasing land and/or building, it is difficult to generalize as to typical “cost” of a new unit.The average check in 2018 was $11.63. Meal period breakdown: dinner representing 52.9% and lunch 47.1%.
  • Taco Cabana:
    The average Taco Cabana net sales for a Company operated unit were $1,846,000 with average food costs of 30.8%, restaurant wages and related expenses of 32.5%, and occupancy and other expenses of 21.8%; leaving a 14.9% restaurant level EBITDA (before advertising of 3.4%).The average Taco Cabana is approximately 3,500 square feet with indoor seating for 80 guests and additional outside patio seating for 50 guests. Similarly, as in the Pollo Tropical discussion above, the “historical cost” of opening a Taco Cabana location have been $0.4 to $0.6M for Interior costs and signage and $0.4 to $1.2M for Exterior costs, but it is difficult to generalize.The average check was $10.47 in 2018. Meal period breakdown averages were: dinner 24.9%, lunch 22.3%, and breakfast 23.4%.SHAREHOLDER RETURN (2018 10-K):

    •On February 26, 2018, the Company announced that its board of directors approved a share repurchase program for up to 1,500,000 shares of the Company’s common stock. The Company repurchased 112,358 shares of its common stock under the program in open market transactions during the twelve months ended December 30, 2018 for $2.8 million.

  • RECENT DEVELOPMENTS  (per Q4 and 12 mos.’18 report)Comp sales in Q4 were down 1.9% at Pollo Tropical and up 5.1% at Taco Cabana. For the full year, comp sales were up 2.2% at PT and up 4.5% at TC. Restaurant level Adjusted EBITDA in Q4 was 21.0% of sales at PT, up from 17.7%. At TC, restaurant level Adjusted EBITDA was 11.8% of sales at TC, up from 7.0% a year earlier. Consolidated Adjusted Corporate EBITDA was $15.8M, up 77% from $8.9M in ’17.In Q4, PT’s 1.9% comp decrease was the result of 4.4% increase in average check and a 6.3% decrease in transactions. Cannibalization cost about 60 basis points and menu price increase was about 4.3%. The improvement in store level Adjusted EBITDA was the result of lower advertising and repairs and maintenance, lower cost of sales and labor, partially offset by higher real estate taxes.In Q4, TC’s 5.1% comp increase was the result of a 9.6% increase in average check and a 4.5% decrease in transactions. Menu price increase was 6.2%, the remainder of the average check increase from higher priced promotions and brand repositioning. The improvement in store level Adjusted EBITDA was the result of lower advertising and repairs and maintenance, lower labor (medical benefits), lower cost of goods, partially offset by higher incentive bonuses and higher real estate taxes.

    Below the store level, G&A was $13.5M, up from $12.9M, 8.1% of revenues vs. 7.9% in ’17, due to “board and shareholder matter costs”, severance costs, investment in resources to build off premise business, partially offset by lower incentive based compensation. There were impairment charges of $10.1M at PT and $4.5M at TC in Q4, primarily related to 14 PTs and 9 TCs closed, as well as 4 underperforming PT and TC restaurants that are still operated. Adjusted EBITDA for the Taco Cabana division increased to $3.4M in Q4, up from a loss of $0.7M in ’17. Adjusted EBITDA for the PT division was $12.4M in Q4, up from $9.7M in ’17.

    On the conference call, management indicated that during Q1’19, through 2/17, PT comp sales were running down 3.7%, with cannibalization costing about 90 bp.Taco Cabana comps were running up 1.8% through 2/17. Doordash has been employed as a delivery partner during Q 1’19. Management talked, at both brands, about new products, an expanded loyalty program, the increased use of kiosks and ordering tablets, the potential benefit from Doordash, remodeling of 10-13 locations at each brand, and expanded emphasis on catering.

    Conclusion: Provided at the beginning of this article

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John Maynard Keynes had some good ideas back in the 1920s: the Federal Reserve Bank had been formed in 1913, and would manage the economy, control inflation, reduce the frequency and severity of booms and busts, stimulate the economy in hard times, and pull back the accommodation in good times.

Keynes articulated this very well, in 1923: “Markets cannot work properly if the money, which they assume as a stable measuring-rod, is undependable. Unemployment, the precarious life of the worker, the disappointment of expectations, the sudden loss of savings, the excessive windfalls to individuals, the speculator, the profiteer–all proceed in large measure, from the instability of the standard of value”.

Harry Browne, the brilliant economist, and writer, who wrote “You Can Profit from the Coming Devaluation” in 1970 (which I republished in 2012), anticipating the devaluation of the US Dollar when Nixon closed in the gold window in 1971, put it another way. He said that “you can’t have a sound economy without a sound currency”.

Starting with the longer term view, under the management of our Federal Reserve, the 1913 Dollar (when the Fed was formed) has become worth about $.03. (In contrast, an ounce of gold still has roughly the same purchasing power.) More recently, over the last ten years, our Fed (with imitation by the ECB, Japan, and China) has given us several “QE’s”, during which short term interest rates have gone to zero, there is still something like TEN TRILLION of sovereign debt with rates at ZERO or less, and the Fed balance sheet went from $900B to $4.5 TRILLION .

After several Quantitative Easings over the last ten years, a little over eighteen months ago the Fed announced that they would raise interest rates to “normalized” levels (presumably upwards of 3% for short rates and above 4% for  thirty year paper) and, on an automatic programmed basis, reduce the balance sheet to a more tolerable $2.5 trillion (still almost a triple from where it started in 2008). We predicted that this program wouldn’t go far, because the economy couldn’t tolerate it, and interest rates on (now) $22 Trillion of debt would wreck the US budget. Sure enough: it is now clear that the interest rates will not rise further, and the Fed balance sheet will only shrink perhaps another $200B this year, down to about $3.7 trillion. This latest objective apparently provides comfort that the economy will not be choked off from the “steady” growth: one year, in 2018, at 3.0% (with lower tax rates, repatriation of $800B of dollars overseas, and reduced governmental regulation), projected from this point to be back to the 2.3% range of the Obama administration.

Back to John Maynard Keynes and Harry Browne:

Keynes: “Markets cannot work properly if the money, which they assume as a stable measuring-rod, is undependable. Unemployment, the precarious life of the worker, the disappointment of expectations, the sudden loss of savings, the excessive windfalls to individuals, the speculator, the profiteer–all proceed in large measure, from the instability of the standard of value”.

Browne “you can’t have a sound economy without a sound currency”.

Does any of this sound familiar? These days it’s called a “wealth gap”, and politicians are calling for rich people to “pay their fair share”. Savings haven’t been “lost”, but they are earning next to nothing unless large risk is undertaken.

Where do we go from here? Quantitative Easing again, BUT MUCH LARGER. When an addict is hooked, each hit has to be bigger than the last, to maintain the high. The Fed balance sheet went from $900B to $4.5T, a quintuple, and will only have come down by about 18% to about $3.7T. Never before in the history of the planet has ongoing monetary accommodation (including $1 trillion current deficits) been necessary in the middle of a (relatively) strong economy.  In addition to the modest reduction in the Fed balance sheet, short term interest rates, after going slightly negative, have only risen to 2.7% before the Fed said “basta” as the economy threatens to roll over. We can only imagine how much capital will need to be injected by the Fed, and how low or negative interest rates will be taken to counter the next recession.

In conclusion: Don’t believe the economic fiction that we need not fear inflation, from accommodation of the past or from further stimulation, that deficits don’t matter, that the new Modern Monetary Theory will keep things under control. All kinds of assets have already been inflated in price, and that wealth effect has clearly been enunciated as a goal of the Fed. Unfortunately, the benefit has not been spread equally among citizens, and this is a worldwide problem. The saddest part is that the politicians of today, just as in the past, show no inclination to correct the fiscal/monetary policy in a constructive way. The longer  this financial party continues, the worse will be the hangover.

Roger Lipton

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Back on 11/27/18, our conclusion, in part: “we think it is, at the very least, a possibility that corporate cash flow improvements will not take place as projected. Store expansion plans would need to be adjusted….overall, we think DFRG from this price could work out well if operations improve as projected. Also, there are still hundreds of billions of dollars out there looking for a home….even with the apparent risks…the debt burden could become critical if the operational improvement is delayed, and successful integration of newly acquired concepts has been a flawed assumption many times in the past.  For our money, we hesitate to be short DFRG, especially because of the takeover possibility, but the downside risk is too substantial for us to be comfortable on the long side.”

We stand by the above conclusion. Readers, for more background,  can refer back to our previous writeup.


We most recently wrote about DFRG back in December. As a result of their company changing acquisition of Barteca, with the two dynamic concepts, Bartaco and Barcelona Wine Bar, Del Frisco’s had taken on about $300M of high interest (over 9%) debt. They were, naturally, optimistic about the outlook. Setting aside the expectations at that point for calendar ’18, which was largely concluded, management was looking out further to 2021.

The guidance for 2021 was annual revenues of $700M, at least $100M of adjusted corporate EBITDA (This is not “free cash flow” when you are carrying $300M of 9% debt). However,  Net debt would be reduced to 2.50-3.0x, which would not require much paydown, no more than $50M, but would be a lot more tolerable than the 8x based on trailing adjusted EBITDA of 35M for the TTM of 12/31/18. So it all depends on building the EBITDA return to the $100M level, from $35M in ’18. (Adjusted EBITDA was down 9.8% in Q4 and 3.2% for all of ’18.) They were going to get there by 2021 with 10-12% revenue growth, comp increases of 0-2%, maintaining strong store level margins, G&A cost leverage, adjusted EBITDA growth of 15% annually.  They were planning capex of $50-60M in ’19, which would obviously require an immediate improvement, unless further debt were somehow added.

Activists investors have been attracted to this situation, Engaged Capital in particular has placed a representative on the Board of Directors as chairman of the transaction committee which is reviewing strategic options. It has been reported that some investors believe the company is worth more as two separate entities. With an enterprise value of approximately $550M, or 15.7x trailing twelve months EBITDA, investors are obviously betting on the potential of EBITDA increasing to something like the $100 M projectionfor 2021. The current enterprise value of $550M would obviously be 5.5x, but it would be three years from now that the $100M would be in the rear view mirror.  Should that happen, an enterprise value of a reasonable 10x, or $1B, less $300M of debt which could still be in place, would put the stock at almost three times the current value. That’s called the power of leverage, and tells you why activists are interested.

However, it gets back to execution at the store level. In Q4 and in calendar ’18, store level Adjusted EBITDA was down at Del Frisco’s Double Eagle, Del Frisco’s Grille, and Corporate. Bartaco and Barcelona’s Q4 and YTY comparisons were not shown. In Q4 and calendar ’18, traffic and sales were lackluster at Double Eagle and the Grille, generally flat sales with traffic down a little, improving a touch in Q1’19 but not enough to improve margins (as we see it).  Bartaco had store level EBITDA of 20.4% in Q4 and 24.6% for the year, Barcelona had Q4 EBITDA of 21.9% inQ4 and 22.4% for the year.  We don’t know whether Q4 is a relatively strong quarter for these two concepts, but Q4 was obviously weaker than the first nine months in terms of EBITDA. These two concepts are running positive comps in the low to mid single digits, but that is not enough to build margins a lot. Even Bartaco and Barcelona are not immune to higher labor and occupancy expenses. One specific change of plans: capex for ’19 was reduced to $25-35M, down about 50% from the previous plan of $50-60M, which we predicted. Adjusted Ebitda for ’19 i s now projected at $58-66M, which, after $28M of debt service , without taxes, would only leave $25-35 for capex unless debt were added.

Focusing on the longer term, management explained the relatively lackluster Q4, had a number of reasonable rationalizations and indications of pending improvement, and maintained their previous optimism. The previous guidance has been largely maintained. Q4 delivered an Adjusted EBITDA ( we always feel that quotation marks should be put around Adjusted, but we’ll just capitalize it) pretty much in line though toward the lower end of expectations. In addition to the guidance for 2021, management has added expectations: “by the end of 2023, we are targeting generation on annual basis of at least $800M in consolidated revenues and $130M in Adjusted EBITDA. To achieve these long term targets, we need to satisfy the following key annual goals:” and they reiterated the YTY growth parameters previously indicated. If they meet 2021 objectives, 2023 will look pretty reasonable.

An important element of this equation is the progress at Bartaco and Barcelona Wine Bar. Since YTY comparative numbers are not provided, and will not be for at least the next two quarters, there is limited transparency in this regard.

Conclusion: Provided at the beginning of this article

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Almost everybody has noticed that their is an increasing strain between franchisees and their franchisors.  It is no accident that new franchisee associations are being formed and existing organizations are getting more militant. There are many intangible reasons, as too many franchisors do not treat their “z’s” as partners. We have written many times that the “asset light”, “free cash flow” model is not reflecting the necessary investments in the system to keep franchisees as profitable as possible. Many franchisees are especially bothered by the fact that their franchisors are spending hundreds of millions, sometimes billions, of dollars buying back stock and making acquisitions, while leaving the franchised operators without the necessary new product development, technology upgrades, marketing initiatives, etc.etc.

With all of that in mind, the bottom line is the bottom line. Too many franchisees are suffering financially, under more pressure than ever. The typical franchise royalty is 5%, give or take a point, plus 2%, as an advertising contribution. There are often additional charges, not all that material in and of themselves, but adding to an already large burden. Let’s say the franchisee is fortunate enough to be making 17-18% store level EBITDA (and Depreciation is not free cash in the long run).  Rebating 7 points out of 17 or 18 points starts to feel like a pretty big load, and there is still local G&A to be carried. Even if store level EBITDA, before royalties, is in the low  twenties, 7 points gets to be a bother.  Additionally: many franchisees, Dunkin’ Donuts and Burger King and Jack in the Box are just a few examples of mature systems where decent money is still being made at the store level because the store leases were signed ten or fifteen years ago, so occupancy expenses are lower than today’s economics would allow. That’s, of course, why so few new units are being built by many mature franchised systems, especially in the USA. Today’s economics do not allow it.

When Ray Kroc started franchising McDonald’s restaurants over 60 years ago, the royalty was 1.9%. By the 1960s, franchisors had started charging 2-3%, by the 1970s 3-4%, by the eighties 4-5%, and 5% seems to be the standard today, plus advertising and other fees.

At the same time, there are no material expenses that are lower, as a percentage of sales, certainly not occupancy expenses or labor, and food costs are unpredictable commodities. The biggest single negative trend, that nobody would debate, is the immense competition that has become commonplace. Even in today’s over-stored situation, there are more new stores being built, within chains, than closing.  This competitive pressure has also created the need for far more support from the franchisor, if the increasingly critical public is to be satisfied and the franchisee partner is to succeed.  Over the last fifty years, as the franchisor should be providing more support and burdening the franchisee less, the trend has been just the reverse.

The answer: lower fees, especially ongoing royalties. 

This specific suggestion will not be adopted by existing large chains, because it would be such an obvious reduction of the current royalty stream. However, well established franchisors could, and should, absorb more of the additional systemwide needs, such as technology upgrades. “Mid-stage” franchising companies could put some part of the following suggestions in place.

If I were running an early stage franchising company, I would put in place a sliding scale royalty system, charging 2.5-3.0% at a modest sales level, higher if the franchisee does better. Give them a little room to make money if the store doesn’t do quite as well as everybody hopes. If the store clicks, everybody is happy and 4-5% on the higher sales won’t seem like such a burden. For my multi-unit franchisees,  I would charge lower up front fees for development of 2nd, 3rd and additional stores, and this is sometimes already being done (whether admitting it to Wall Street or not). This is logical and appropriate, because less franchisor support is required as a franchisee builds local infrastructure.

It seems likely that a young franchising company adopting this strategy would have a huge competitive edge and the total royalty stream is likely to build more rapidly using this progressive approach.  Profitable franchisees, and a more appropriate sharing of store level profits in today’s economic reality, make for a successful system in the long run.

Roger Lipton



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I’ve listened to a lot of conference calls lately describing Q4’18 and describing prospects for calendar ’19. It’s clear to all of us that restaurant operating costs are rising, labor being the most conspicuous line item. Higher expenses, sooner or later require price adjustments, in the hope of maintaining operating margins. The problem is that there continues to be intensive competition that precludes the necessary menu price adjustments. The results over the last couple of years have demonstrated that traffic decreases have predictably offset price increases and resultant revenues (same store sales) have mostly been flat. The following capsules, relating to company operated chains, provide a picture of current pricing, the resultant effect on profit margins, and what we can expect going forward. Our commentary, unless otherwise noted, is relative to the most recently reported quarter.

BJ’s Restaurants: Perhaps the most notable exception to the trends described below. Their menu has been revamped and upgraded, Prices are up 4.4% while maintaining traffic and store level operating margins. Wage expense will still be a challenge, up 5% in ’19, but ’19 is expected to be more of the same in terms of strong results on an absolute and a relative basis.

Brinker International: Managing Chili’s and Maggiano’s, prices were down 0.1% and up 0.5%, respectively. There have been major menu changes, especially at Chili’s with a strong focus on value, so transactions have been maintained. Unfortunately, there has been margin erosion at the restaurant level. It remains to be seen whether the aggressive value orientation will pay off over time, in terms of rebuilding margins. Menu pricing is expected to be up about 1.5% going forward.

Cheesecake Factory: Has been running about 3% price, which they expect to be the ongoing case. Resultant traffic has been roughly flat. Unfortunately, restaurant margins have been damaged, for the quarter and the year. Wages are expected to be up 6% going forward, especially in California, where pricing is also higher. There is no reason to expect restaurant margins to improve.

Cracker Barrel: Has been running about 3.7% price, traffic close to flat. Menu prices were increased 10% at Thanksgiving and Christmas. Pretax operating earnings were flat for the qtr and six months. Wages are expected to be up 3.3% plus higher training expense. Again, no reason to think that restaurant margins will expand.

Chipotle: Prices are running up 4.1%, with traffic up by about a point, menu prices to increase about 1.7% going forward. Wages are going up by 4-5% in ’19. A great number of moving parts here, still trying to bounce back from the health incidents over three years ago. Traffic is hardly better than it was then and margins have a long way to go.

Pollo Tropical: Owned by Fiesta Restaurant Group, had a price increase of 4.4%, as the brand is repositioned. Transactions were down 6.3%. Appears that adjusted EPS and EBITDA are stabilizing but a lot of moving parts here. Time will tell.

Taco Cabana: Owned by Fiesta Restaurant Group, had a price increase of a massive 9.6%, as the brand is repositioned. Transactions were down 4%. Once again, lots of moving parts and it will take time to see how this re-invention plays out.

Shake Shack: Pricing was up 2.6%, expected to move up another 1.5% in calendar ’19. Transactions were down over 1%, for a couple of years now. Store margins are coming down, not just from higher expenses but because lower volume stores are opening. Wages are expected to rise by about 5% in ’19, continuing the trend that has seen a 43% increase in minimum wage in NY since 2016, 20-30% in other key markets.

McDonald’s: While highly franchised, McDonald’s has thousands of company operated stores. US stores had a 4.7% price increase in ’18 and traffic was flat. Company operated US stores had a store level EBITDA of 17.5% in ’18, down 70 bp, so the price increase did not offset the higher expenses.

Red Robin: Still trying to re-invent themselves, with a heavy emphasis on value, menu prices were down 0.1% (Price was up 1%, discounting took it down), expected to be up 2%+ in ’19. Too many challenges here to use this one as a generalized indicator.

Starbucks: Pricing up 4%, traffic flat. Should look the same in ’19, though higher traffic is the hope. US operating margin was only up 3% on a  8% revenue increase, so came down materially on a  percentage basis. No reason to expect an increase in store level profits unless traffic increases materially.


With the exception of BJ’s, which is firing on virtually all the relevant cylinders, just about everybody else is “margin challenged”. Relative to menu pricing, the largest companies in QSR, represented here by McDonald’s and Starbucks, are raising prices about 4% annually. Cheesecake and Cracker Barrel, among the largest casual diners, are increasing prices in the 3-4% range annually, and their margins are down and flat respectively. Chains that are either sharply below, or sharply above these ranges, such as Chili’s and Red Robin, or Taco Cabana and Pollo Tropical, are going through their respective repositioning, and time will tell how they do.

In any event, one of our conclusions is that a 3-4% menu price increase is not enough, in the absence of higher traffic as well, to rebuild EBITDA “profit” margin at the store level, not when wages are going up by 5% which alone costs about 150 bp on the income statement. At the same time advertising, insurance, rents, and most of the rest of the 15 points of “other operating expenses” are trending up as well.  This is all you need to know as to why franchisees of major systems, McDonald’s, Jack in the Box, Tim Horton’s to name just a few that so far have gone public with their dissatisfaction, are asking for a larger voice.

Another conclusion is that every chain must be prepared to invent (if they are young) and reinvent (if mature) themselves in terms of the employee culture, the customer experience, the hospitality quotient, in essence: you must differentiate your commodity. Absent that, customers will feel no need to dine with you (Domino’s still delivers), or call Doordash (with a lower margin for you), or grab and go at no shortage of prepared meal purveyors.

Roger Lipton

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The general equity market continued strong in February, while the precious metals complex consolidated the strong gains of December and January, with hardly any change. Gold bullion was down 0.6%, the gold miner ETFs (GDX and GDXJ) were down an average of 1.8%, the three mutual funds that we track (Tocqueville, Oppenheimer and Van Eck) were up an average of 0.6%. Our gold mining oriented investment partnership is performing in line with those ETF and mutual fund benchmarks, for the month and the year to date.

While we have a lull in marketplace volatility, it seems worthwhile to reflect on at least part of the essence of our conviction, why gold is the “real money”, proven to be so over literally thousands of years, currently representing probably the most undervalued asset class of all. It is true that there are other asset classes that have protected purchasing power as well or better than gold over chosen periods of time, such as: stocks of well run companies, well situated real estate, art created by legendary artists, to name just a few. Gold, however, the same gold that was produced in the days of King Tut (1341-1323 B.C.E.) has protected purchasing power without the uncertainty of stock picking, location analysis, or artist selection. An ounce of gold reflects roughly the same number of hours worked, and value of goods and services as it did 3,000 years ago, 200 years ago, 100 years ago, 50 years ago, and 20 years ago. (Not 6 years ago, to be sure, but give it time!)

Everyone talks about how inflation is “non-existent”, in spite of the monetary “accommodation”, which means money printing, unbacked paper currency creation with no limitation, debt levels worldwide still increasing. Even our Federal Reserve PHD’s are scratching their collective heads as to why inflation has not resulted from the trillions of paper dollars injected into the monetary system by the Central Banks. The new theory, dubbed Modern Monetary Theory, is postulating that the paper unbacked currency creation doesn’t matter. Remember the last “new paradigm”, the dotcom bubble of 1999-2000?

Let’s keep it simple. Put a few people in a small city, perhaps on an island, with a fixed amount of goods and services, and a fixed amount of money in circulation. If suddenly the money supply doubled, and there was no change in the goods and services available, what do you think would happen to prices? Of course everyone would have more “money” to spend, and they would compete for the “stuff” and prices (the quoted required paper exchange value) would of course rise. By the way: it’s the currency creation that’s the inflation, the cause, which we’ve already experienced.  The price rise is the effect of the inflation (insertion of more currency), and is coming.

So why hasn’t the price rise, following the “inflation” happened in the last ten years? The answer is, IT HAS! The Central Banks created trillions, which governments used to buy bonds and stocks around the world, keeping interest rates low in the bond markets, forcing fixed income buyers to reach for yield in the bond market and sometimes buy stocks in desperation while governments (Switzerland and Japan & others) bought stocks as well. This “misallocation of resources”, this “financial promiscuity”, this unprecedented monetary “experiment” has created not only artificially high stock and bond markets but private market valuations approaching $100 billion for unprofitable companies such as Uber and WeWork. Why do you think $100M (and higher) transactions in residential real estate are becoming commonplace and $200M was spent for a Van Gogh. People of substantial means are trying to get at least some of their resources out of “cash”, which they know is being diluted all the time. They don’t know what their Central Park West apartment or Van Gogh will sell for fifty years from now, but they are certain that the colored paper in their pocket will buy a very small fraction of today’s purchasing power. Grocery prices, certain Chinese or Mexican produced apparel, or increasingly powerful consumer electronics may not be quoted higher in price, but almost every important asset class other than gold has appreciated substantially, especially over the last ten years.

One last point for this installment:

While the hue and cry for a higher minimum wage has been a constant feature of our political and economic dialogue, let’s think for a moment about the way the economic world really works, and always has. Workers get a raise, $15 minimum hourly wage now in 20 states, and feel good for a little while, because they immediately have more discretionary income. However, the higher wage comes from their employer who produces goods and services and that production has to generate a return on investment. Since that employer’s profit margin has just been materially reduced, in probably a matter of months they will raise the price of whatever they are selling. So the employee who received higher pay fairly quickly finds that he or she is paying more for the stuff they are buying. This is why, it’s the middle class that really gets screwed by the inflationary process. The wealthy have their stocks, bonds, homes, art, stock options, etc. The impoverished have their various government benefits, food stamps, and emergency care at the hospital if they really need it. It’s the middle class, playing by all the rules, that can’t seem to get ahead. They are making more “money”, but don’t ever seem to get ahead.

Wrapping this up, the “Inequality of Wealth, the “Wealth Divide”, as the rich get richer and the poor left behind, that everyone talks about has been a feature of the last 47 or 48 years. Various charts clearly show that prior to the 1970s the purchasing power of the rich and poor was increasing at just about the same rate. The divergence in discretionary purchasing power clearly began in the late 1970s.

I don’t believe it is coincidental that Richard Nixon “closed the gold window” in August of 1971, eliminating convertibility of the dollar into gold. This predictably allowed for unfettered money creation, kicking off the double digit inflation of the 1970s, a fed funds rate that was 18% when Ronald Reagan took office, and the move in gold from $35 to $850/oz. The 1971 Dollar is worth about $0.15 today in purchasing power, and that seems to me like just yesterday. This is why it’s been said that “inflation is the cruelest tax”.

It just so happens that the gold owned by the US Treasury as well as the major trading countries collectively, relative to the unbacked (fiat) paper currency that is circulating, is almost the same very low percentage (6-7%) that it was in 1971, before gold went from $35 to $850/oz. in eight years. Most economists, even non “goldbugs” would agree that gold represents an alternative currency. This particular currency, gold, is mined, with great investment and risk, at the rate of about $140 billion per year. The colored paper that we all carry around in our pocket is being created worldwide, with the tap of a computer key, at the rate of trillions of dollars annually. Which currency would you suspect will maintain its purchasing power better over time?


Roger Lipton

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Management has done a reasonable job, over the years, in managing the Jack in the Box brand within a difficult environment. Activists have periodically looked at this situation, so a transaction is always a possibility.

However, we feel that most of the obvious levers have been pulled in terms of building shareholder value. Qdoba has been sold, most of the refranchising has been done, and JACK is already levered to almost 4x the current EBITDA run rate. The capex requirement for this mature system is substantial and the franchisor will likely have to play a financial role to aid franchisees, so the free cash flow might not be quite so “free”. An activist would have to pay 13-15 times the current run rate of EBITDA, which we don’t view as a great bargain. Store level economics, at today’s real estate costs, don’t support rapid unit growth, at least domestically, and international growth takes time with its own set of challenges.

Remaining publicly held, the Board could take the leverage up by $4-500M, and that could retire perhaps 15% of the equity (at a premium to the current price). You would then have a mature franchisor selling at 10x the EBITDA run rate, not so attractive with the challenges stated above.

While not privy to all the details of the franchisee discomfort, management at JACK are stakeholders as well and they haven’t been consciously trying to bury the brand. It isn’t the first time that a franchisor hasn’t been sufficiently sensitive to the needs of their franchise partners (at JACK), especially when incubating a second, more rapidly growing brand (Qdoba). Even the McDonald’s system is going through a similar “therapeutic” process, nowhere as intensely as at JACK.   It is in everyone’s interest to settle this matter amicably,  so that will happen in time but it could be costly in various ways to the franchisor. Relative to strategic alternatives, and the value of The Brand, this sure doesn’t help.

Putting it all together, we’ll pass on this one.


Jack in the Box was founded in 1951 in San Diego, CA and has since become one of the nation’s largest hamburger chains. Jack in the Box is the second largest QSR burger chain in 9 of the major markets and number 1 in another. These 10 markets comprise 70% of JACK’s total store count. As of September 30, 2018, there is a total restaurant count of 2,237 in 21 states and Guam, of which 137 are Company-operated and 2,100 are franchise-operated. The Company also formally operated the Qdoba Mexican Grill chain until December 2017 when Apollo Global Management bought the concept. As discussed below under “Unit Level Economics”, it is difficult to open economically attractive locations, with today’s real estate costs, especially for franchisees that are paying royalties, as evidenced by the fact that total systemwide units has been virtually flat over the last five years. In Fiscal 2018, only one company operated store was opened (with five closed), and franchisees opened just eleven (with twenty one closed), resulting in a net contraction, systemwide, of fourteen units. As a result, as discussed below, virtually all the company initiatives in recent years have related to improving productivity at existing locations and refranchising the existing company units. From fiscal 2014 to fiscal 2018 the number of company operated locations was reduced from 431 to 137.

Although JACK is best known for its hamburgers, their most popular menu item is the tacos. The restaurants sell approximately 554 million tacos a year. Other unique items found on JACK’s menu are Eggrolls and Teriyaki Bowls. In recent years, JACK has realized that a significant number of their core customers are heavy late night users and therefore introduced “Munchie Meals” specifically for this crowd. (Munchie Meals consist of a sandwich, 2 tacos, fries and a drink for a special price).

Another unique feature of the Jack in the Box brand is its iconic spokesperson. A fictitious character with a ping pong ball-like head of a clown cap and 2 blue eyes and dressed in a business suit. JACK has been the brand’s identity and spokesperson since the 1980’s, much like Ronald McDonald for McDonald’s. The character is so popular that during Christmas holidays the restaurants would sell an antenna topper for $1 that featured JACK in different attire. These antenna toppers were so popular that the restaurants typically sold out days before the promotion ended. JACK has won several industry advertising awards.

Jack in the Box is also known for its many other product innovations for a burger chain. Products such as Sirloin Burger, originally launched in 2007 and brought back on occasion, a Club Sandwich, Bacon Shake, Sourdough Buns, Ribeye Burger, Bonus Jack – burger using Ciabatta Buns, the Buttery Jack Burger platform, All-Day Breakfast (years before McDonald’s), the Food Truck Sandwich series, and recently the Pannidos (originally introduced in 2004). The significance of all this array of product innovation is that through the years this has become a part of JACK’s DNA and its core customers have grown to expect these additions as integral components of what Jack in the Box is all about.

The Qdoba Mexican Eats era – In 2003 Jack in the Box purchased Qdoba Mexican Eats, a fast casual restaurant chain from ACI Capital. In 2017, JACK sold Qdoba to Apollo Global Management.


Jack in the Box’s primary long-term strategies are focused on meeting evolving customer needs, with emphasis on improving operations consistencies and targeting investments designed to maximize return. The key initiatives include:

  • Simplifying Restaurant Operations – through the following:

o   Back of the House simplifications including equipment, technology that can drive higher throughput, improve overall quality, and reduce labor costs.

o   Reduce redundancy in food stock units; simplification of all operating procedures.

o   Upgrade kitchen equipment.

  • Leverage Technology – Implement new technology such as Mobile applications to meet this growing need of consumers and technology to improve in-store efficiencies.
  • Differentiating through Innovation – JACK continues to focus on what makes them different by balancing premium and value innovation and leveraging the brands unique personality to differentiate creatively and focus mostly on their customers – menu and marketing focus; optimizing delivery and Mobile app.
  • Elevating the Brand Image – focusing on targeted investments designed to maximize returns.

o   Drive-Thru Enhancements – remodeling the Drive-Thru only. 70% of JACK’s customers use the Drive-Thru.

o   Restaurant Remodels – plans are for up to 600 mature restaurants to receive either a full remodel or Drive-Thru enhancements over the next 3 years.

o   Exploring a range of strategic and financial alternatives to maximize shareholder value. Potential alternatives to include a sale of the Company or executing on the Company’s previously announced plans to increase its leverage. As of February 18, 2019, JACK’s Quarterly Press Release – The Company’s Board has not set a timetable for the conclusion of this process nor has it made a decision related to any strategic or financial alternatives at this time. The Company has had discussions with potential buyers; however, there can be no assurance that the exploration will result in a transaction.


In 2018, total revenues were $869,690,000 with 51% derived from Company-operated restaurants, 30% from franchise rental fees and from franchise royalty and other fees. Total revenue for 2018 represents a 21% drop from 2017 revenues. This was caused mainly by the refranchising of 135 Company-operated Jack in the Box locations during the year.  Revenue is derived from retail sales at Jack in the Box Company-operated restaurants and rental revenue, royalties (based upon a percent of sales), and franchise fees from franchise restaurants. In addition, they recognize gains or losses from the sale of Company-operated restaurants to franchisees, which are included as a line item within operating costs and expenses, net, in the accompanying consolidated statements of earnings.

The following summarizes the most significant events occurring in fiscal 2018, and certain trends compared to the prior year.

  • Same-Store and System Sales – System same-store sales increased 0.1% and system sales decreased $3.1 million, or 0.1%, compared with a year ago. A decrease in traffic at both Company-operated and franchise-operated restaurants was offset by menu price increases.
  • Company Restaurant Operations – Company restaurant costs as a percentage of Company restaurant sales improved to 73.5% from 75.8% in the prior year primarily due to the benefit of refranchising units that had lower AUVs than the average for all Company restaurants.
  • Franchise Operations – Franchise costs as a percent of franchise revenues increased to 40.3% from 39.2% in the prior year, primarily driven by incremental costs incurred in 2018 related to the implementation of a mystery guest program, and an increase in costs associated with franchisee restaurant remodels, partially offset by an increase in franchise restaurant AUVs.
  • Jack in the Box Franchising Program – Jack in the Box franchisees opened a total of 11 restaurants. As part of JACK’S refranchising strategy, they sold 135 Company-operated restaurants to franchisees in several different markets during 2018 and generated proceeds from the sale of restaurants of $96.9 million. The Jack in the Box system was 94% franchised at the end of fiscal 2018 as they completed their refranchising program.UNIT LEVEL ECONOMICS (2018 10-K)
  • The average net revenues for Company-operated stores is $2,193,000, the average food costs and packaging is 28.8%, payroll and employee benefits is 28.8% and occupancy and other is 16.0%. Total restaurant level costs of 73.6% leave an EBITDA of 26.4%. The high level of EBITDA is a function of efficient store level operations, good control of cost of goods as well as payroll, and relatively low “Occupancy and Other” as a result of locations opened many years ago with occupancy expenses that are low by current standards.The average investment in a Jack in the Box franchise is $1,481,500 – $3,336,000. The difference mainly being in land and building costs, combined with owning vs. leasing of same.
  •  SHAREHOLDER RETURN (2018 10-K):


    • Return of Cash to Shareholders – JACK returned cash to shareholders in the form of share repurchases and quarterly cash dividends. They repurchased 3.9 million shares of their common stock at an average price of $86.86 per share, totaling $340.0 million, including the cost of brokerage fees. JACK also declared dividends of $1.60 per share totaling $45.7 million.
    • Dividends – In fiscal 2018 and 2017, the Board of Directors declared four cash dividends of $0.40 per share each, and in fiscal 2016, declared four cash dividends of $0.30 per share each.
    • Stock Repurchases – In May 2018, the Board of Directors approved a stock buyback program, which provided a repurchase authorization for up to $200.0 million in shares of their common stock, expiring November 2019. In the fourth quarter of 2018 they repurchased 1.6 million shares of their common stock at an aggregate cost of $140.0 million. During fiscal 2018, JACK repurchased 3.9 million shares of their common stock at an aggregate cost of $340.0 million. As of September 30, 2018, there was approximately $41.0 million remaining under the Board-authorized stock-buyback program, which expires in November 2019.



    On December 4, 2018, Jack in the Box’s National Franchise Association (NFA) which represents 2,000 of the Company’s total 2,237 restaurants, filed a lawsuit against the Parent Company. The suit is over access to marketing financials and franchisees’ costs when restaurants are remodeled.

    The Association has filed a Breach of Contract and implied Covenant of Good Faith and Fair Dealing in the suit. The dispute details the Parent Company’s “failure to perform its contractual obligations resulting in a negative impact on its franchisees’ financial business model as it pertains to the rights assured to franchisees under the current franchise agreement” according to the NFA.

    It is the third time the NFA has brought grievances with JACK’s management to light. The first was in July where the Association had a majority vote of no confidence in the current management team, and secondly in November the NFA filed a complaint with the California Department of Business Oversight regarding JACK’s new financial restructuring strategy.

    The NFA claims they have the right to review marketing income and expenditures as part of the 1999 agreement. In addition, the Association claims JACK is violating franchise terms by assigning some its costs of new roofs and the structural upgrades to franchisees when stores are remodeled.

    Franchisees are also seeking a seat on the Company’s Board of Directors.

    Recent discussions with several franchisees stated the legal action has grown out of frustration as management has ignored all previous attempts to discuss the franchisees’ concerns. The franchisees stated that on many occasions they have expressed their willingness to work with management to correct these issues, but management has disregarded their complaints as frivolous and unfounded.

    RECENT DEVELOPMENTS: Per First Fiscal Quarter, ending 1/20/19

    Systemwide same store sales were down 0.1%. Company locations were up 0.5%, including average check growth of 3.8% and traffic decline of 3.5%. GAAP Earnings from continuing operations were $1.19 per share in the quarter, after deducting losses from discontinued operations of $0.16 per share. Earnings from operations were $58.3M, down from $73.4M, but there were a number of non-comparable items, such as $5.4M additional Impairments in ’18, more than offset by $8.7M lower loss on the refranchising sale of company operated locations. There were some other less material differences resulting from new required Revenue Recognition standards relating to franchise advertising fees and other services. Adjusted EBITDA was reported to be $83.0M inQ1, compared to $85.4M a year earlier.

    In terms of line items for company operated stores, cost of goods was flat at 28.8%, Payroll expense was up 60 bp to 29.4%, Occupancy and Other was down 80bp to 15.6%, resulting in store level EBITDA of 26.2%, up by 20 bp.

    The commentary in the formal earnings release talked about the (modest) improvement of same store sales driven by a more value-oriented approach, while still avoiding deep discounting. While continuing the effort to improve store level productivity, the Company continues to be “focused on balancing the interests of all our stakeholders, including our franchisees, customers, employees and shareholders…..continue to explore a range of strategic and financial alternatives to maximize shareholder value. Potential alternatives could include….sale of the company or….increasing its leverage…the company remains committed to implementing a new capital structure as soon as practicable.” No further discussion of this aspect of corporate strategy was allowed on the conference call.

    Guidance was provided for the balance of ’19, virtually all of which was consistent with the line items from Q1. One item that caught our eye was the expectation that 25 to 35 new restaurants would open systemwide, which, while still modest and likely to be offset by at least a few closings, would be an increase from only 12 in ’18. This could be a function of new development requirements tied to the refranchising process. The guidance of $260-270M of adjusted EBITDA for ’19 is less than four times the $83M in Q1, but Q1’s sixteen weeks accounts for that.

    On the conference call, management talked about progress with the value driven product strategy, balanced with premium products such as the 100% Ribeye Burger. Delivery, now available through 85% of the system, using Doordash, Uber Eats (and others?), is helping, with a higher average check, two thirds of the orders at dinner and later, and the sales are considered largely incremental. A new mobile app is also helping, launched in Q1, and Apple Pay is functionable for the 100,000 unique users that have already placed at least one order. More than 50 restaurants have been remodeled in the last twelve months and there are 17 new franchised locations under construction. A major overhaul of the drive-thru experience will start to be rolled out later this year, to reach 85% of the system by the end of ’21.

    There were no shares repurchased in the first quarter. Nine new franchised restaurants opened, so full year guidance of 25-35 locations is on track. Second quarter sales were running “flat”, as of 2/21, despite record snowfall in the Northwest and trends improved over the prior two weeks with the introduction of the $4.99 Sourdough Patty Melt Combo and the $4 Fish Sandwich. Full year ’19 guidance continues to be 0-2% same store sales, so improvement is obviously expected. There was, predictably, quite a bit of discussion about other product initiatives, and also reference to the publicly disclosed “strains” with their franchisees. Management responded, also predictably, that they are bending every effort to support the franchise system in the quest for improved profitability.

    CONCLUSION: Provided at beginning of this article

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Shake Shack reported their fourth quarter and year. It was very much as management had predicted, reflecting modest same store sales gains, cost pressures at the store level as well as  continued high administrative expense level to support very rapid expansion. New locations, heavily weighted in Q4, opened at strong levels, which held the year’s AUV of domestic company operated locations at $4.39M, down from $4.598M, about 100k higher than the guide. We should interject here that this “beat” might have been at least partially the result of heavy openings (17 out of 34 for the year) in Q4, including the honeymoon effect of 17 out of 120 total stores in the year’s AUV.

Rather than dwell on Q4, which followed the trends of the individual quarters, the full year’s result is probably most informative. 34 domestic company stores were opened against a base of 90. Same shack sales were up 1.0% and traffic was down about a percent. Shack level profit (EBITDA) was 25.3% of sales, down 130 basis points YTY.  AUVs were down 4.6% to a still impressive $4.39M. For the year, Cost of Goods was down 10 bp to 28.3%. Labor was up 110 bp to 27.4%. Other Operating Expenses were up 130 bp to 11.6% partially offset by Occupancy Expenses which were down 80 bp to 7.3%. G&A expense was up 60 bp (not “leveraging” yet), and depreciation expense was up a noteworthy 30 bp to 6.3%. Pre-opening expense was constant at 2.7%, averaging about 360k per store. Pretax Operating Income was down, $31.7M (6.9% of revenues) vs. $33.8M (9.4% of revenues). Diluted EPS was $0.52 per share, not comparable to last year (with its adjustments).

Following the above numbers, management presented “adjustments”, which brought the “adjusted pro forma net income” to $0.71 per share.

Rather than itemize the adjustments, we think it is more productive to focus on the store level operating metrics. New stores, as predicted, are opening at levels closer to $3M than the current $4.4M domestic company AUV. Store level EBITDA of new stores is closer to 20% than the 25.3% of ’18. Accordingly, management is guiding, for ’19, to AUVS of 4.0-4.1M, with store level EBITDA of 23.0-24.0%. This guidance could prove to be conservative, but realistic expectations is lower relative to past years. This is a result of guidance, including total revenues up 28-29%, SSS of 0-1%, including 1.5% price. There will be a continued aggressive opening pace (36-40 new company openings plus 16-18 licensed), G&A of 66.4-68.2M, up 26-29% (leveraging slightly against the revenue gain), depreciation expense up 40% or more (higher investment per store?), pre-opening expense of $13-$14 M(a constant 350-360k/store).

Relative to Q4’18 and ’18 as a whole, and implications for ’19 and ’20, our bottom line is that, based on cost expectations at the store level,  corresponding lower store level margin, combined with ongoing corporate spending to support the aggressive growth plan, it will be hard for SHAK to show improvement in net income per share. Of course, we are of the old school, unable to lose (we almost wrote “shake”) our attachment to Generally Accepted Accounting Principles.


Our contribution to the dialogue is that, while the revenues per store have been, as management predicted, coming down, the investment per store is going UP.  The following three short paragraphs are copied from the ’16, ’17 and ’18 10k filings.

 Construction: per the ’16 10K

“A typical Shack takes between 14 and 16 weeks to build. In fiscal 2016 the cost to build a new Shack ranged from approximately $1.2 million to $3.4 million, with an average near-term build cost of approximately $1.8 million, excluding pre-opening costs. We use a number of general contractors on a regional basis and employ a mixed approach of bidding and strategic negotiation in order to ensure the best value and highest quality construction.”

 Construction: per the ’17 10K

“A typical Shack takes between 14 and 20 weeks to build. In fiscal 2017 the cost to build a new Shack ranged from approximately $1.1 million to $3.3 million, with an average near-term build cost of approximately $1.7 million, excluding pre-opening costs. The total investment cost of a new Shack in fiscal 2017, which includes costs related to items such as furniture, fixtures and equipment, ranged from approximately $1.6 million to $3.7 million, with an average investment cost of approximately $2.2 million. We use a number of general contractors on a regional basis and employ a mixed approach of bidding and strategic negotiation in order to ensure the best value and highest quality construction.”

Construction: per the ’18 10K

“A typical Shack takes between 14 and 20 weeks to build. In fiscal 2018, the total investment cost of a new Shack, which includes costs related to items such as furniture, fixtures and equipment, ranged from approximately $1.4 million to $4.0 million, with an average investment cost of approximately $2.2 million. We use a number of general contractors on a regional basis and employ a mixed approach of bidding and strategic negotiation in order to ensure the best value and highest quality construction.”

Editor’s comment: With depreciation guided to increase by more than 40% in ’19, it’s possible that the investment per store is moving higher still.


You can see that, while there have been some changes in wordings (your interpretation is as good as mine), the $1.8M investment, as described in the ’16K is a lot lower than the $2.2M investment of ’18. AUV  in ’16 was $4.981M, virtually flat with ’15. The pre-opening expense seems to have been about constant at 350k/location. Back in ’16, the store level EBITDA was  28.2% (down from 29.1% in ’15).

So: the store level EBITDA cash on cash return in ’16 (adding the $350k of pre-opening to the $1.8M cost of construction) was 28.2% of $4.981M which implies $1.4M, an awesome 65% of the total $2.15M investment. (No wonder the new issue went to $90/share.) Today, however, the 23% expected EBITDA margin (at most) on new stores doing $3.3M (at most) would be a 29.7% cash on cash return. People…..this is a big difference, and this could be the best case. 

We have copied below our conclusions after recent quarterly reports, which we stand by. More importantly, the latest information, as disclosed in the ’18 10K and management’s guidance going forward, provide investors with more food for thought (no pun intended). We saw that one analyst referred to SHAK as the next Krispy Kreme, which it’s not, but SHAK isn’t what it used to be.

Roger Lipton

CONCLUSION – from 8/7/18 after SHAK had run down 11% following Q2 report

SHAK ($56) has come down (11%) 23because it has been priced beyond “perfection” and never should have run up after Q1. The concept, as good as it is, can be expected to do an AUV somewhere between $3-3.5M per unit as the system is built out. Store level EBITDA will end up in the 20-23% range. A 23% EBITDA generation on $3.25M of sales would be $747K of EBITDA, or a 37% store level cash on cash return on the $2M investment , an admirable operating model.  If we look down the road a few years to when SHAK has a couple of hundred units, growing not quite so fast, and growing after tax earnings and EBITDA at perhaps 25% annually, the stock might have a 40x multiple on expected after tax earnings. The problem is that the P/E on ’19 EPS estimates (that could be a reach) is twice that. It will therefore take SHAK several years beyond ’19, until 2022, for the fundamentals to catch up with today’s stock valuation of $2B.  Of course, it’s possible that the P/E on next twelve month earnings could be even higher than it is currently, but the P/E range that the stock sells at will likely be contracting as time goes on. This expectation is under the optimistic assumption that there are no major mistakes along the way, in which case there would obviously be an immediate major adjustment downward.  This discussion may be one reason why there has been almost continuous liquidation of common shares by insiders and private equity owners, to the tune of hundreds of millions of dollars ever since SHAK came public early in 2015.

CONCLUSION – From 5/10/18, after SHAK had run up 23% following Q1 report

As you no doubt suspect, while we have the utmost respect for this management team, our conclusion is that SHAK ($58) is priced beyond “perfection” at approximately 100x ’18 projected EPS and perhaps 70x what we consider an optimistic view of ’19. If you like EBITDA as a measure, based on “Adjusted Corporate EBITDA” of $65B  in calendar ’17, the $2.2B market capitalization represents 33x TTM EBITDA. Especially considering that store level economics, while still more attractive than many other restaurant companies, are not as alluring as back in the day when Manhattan locations were annualizing at $7.4M and paying for themselves at the store level (before depreciation) in fifteen months. Management here is as good as it gets, but they are not magicians. This is still a people business, serving burgers, not providing a proprietary cancer cure.


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It is not a coincidence that QSR stock was uncharacteristically weak, in a strong market, on Friday, as Kraft Heinz (KHC) was “taken out and shot”, down 25% on the day.

Both KHC and QSR are heavily owned by 3G, a Brazilian based holding company. It should be noted that Warren Buffet’s Berkshire Hathaway owns 22% of KHC, with a much smaller (3.3%) holding of QSR. Berkshire cashed out $3 billion of preferred stock in QSR a little over a year ago.

An extensive article in the weekend edition of the Wall Street Journal described how 3G “became the standard bearer for zero-base budgeting (ZBB), the accounting practice invented in the 1960s that 3G perfected and popularized, first with its acquisitions of Brazilian beer companies, and then globally. It requires justifying every expense each year, no matter how small, rather than using the prior year’s budget as a starting point”.

Quoting 3G co-founder, Jorge Paulo Lemann, the WSJ reported: “I’m a terrified dinosaur. I’ve been living in this cozy world of old brands and big volumes. You could just focus on being very efficient and you’d be OK.  All of a sudden we are being disrupted in all ways. We bought brands and we thought they would last forever. Now, we have to totally adjust to new demands from clients”.

The WSJ followed Lemann’s comments by saying: “The results are exposing the limits of 3G’s hyperfocus on a financial strategy to manage the companies, while not putting enough toward marketing, research and development.”

Relative to Restaurant Brands:

Later in the same article: “3G shook up the restaurant industry with the purchase of Burger King in 2010, followed by acquisitions of Tim Hortons and Popeyes. Cost cuts led to higher margins, and RBI stock price soared. Restaurant Brands wasn’t keeping up with change to the industry and consumer tastes, said Jeremy Scott, an analyst with Mizuho Securities, USA. Competitors such as McDonald’s, Starbucks, and Panera moved to remodel their restaurants, adopt technologies including self-service kiosks and emphasize fresh ingredients. The firm was forced to pour money last year into restaurant remodeling, introducing new espresso drinks (at Tim Horton’s) and simplifying menus. It is also modernizing Popeye’s cash registers to more easily track what customers are buying.”

Duncan Fulton, chief corporate officer for RBI (QSR) said the company is not only focused on cost-cutting but has invested to grow the number of restaurants at its chains.”

WSJ continued: “It’s preferred measure of profitability, adjusted earnings before interest, taxes, D&A, grew 2.6% in the fourth quarter of 2018, the slowest growth the company has reported since BK’s merger with TH. Mizuho’s Mr. Scott said he expects the high spending to continue for another two years as RBI races to catch up, putting pressure on profits.”


We have written extensively over the last year or so (you can use the “Search” function on our Home Page) about the slowdown in earnings and EBITDA growth at QSR. The largest contributor to overall corporate EBITDA growth, from 2015-2017, was the improvement at Tim Horton’s. This was not only the result of ZBB inspired cost cutting, but price increases of supplies sold to the TH system, which has resulted in major lawsuits from the franchise community. We have predicted that the lawsuits will be settled, but the tactics are history not to be repeated.  The cost cutting referred to above no doubt also took place at Burger King, Tim Horton’s in turn, and have already been implemented at the most recently acquired Popeye’s. The unit growth is real, especially at Burger King and Popeye’s, less so at Tim Horton’s, but the “catchup” in systemwide support will absorb most of the increased royalties, and the “magic” at TH is no longer. We believe Mizuho’s Jeremy Scott is correct in his analysis.

Furthermore: as we have pointed out in the past, a great deal of QSR’s free cash flow (about $900M over the last two years) has been paid out to 41% owner, 3G, buying back stock at about 19x trailing “adjusted” EBITDA and over 20x forward earnings per share, hardly a bargain price. Obviously, the Board of Directors, with all but two members categorized as independent, thought a $550M stock buyback in ’18 was more important than reducing debt.  The debt, net of cash, of $11 billion was unchanged in the last twelve months, in spite of $2B of “adjusted EBITDA”.

One final, call it “cautionary”, note. Perhaps an analyst with more legal background than our own, familiar with governance standards in Canada (where QSR is domiciled), can explain why 3G’s ownership is in the form of “Partnership Exchangeable Units”. There must be an advantage for 3G, unlikely to help common shareholders, or this structure wouldn’t be in place. Whether this issue is material or not, full transparency is always a positive. As Ronald Reagan put it: “TBV”  😊

Roger Lipton

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