COMPANY OVERVIEW (Per 2017 10-K; August 2017 Investor Day Presentation):
Del Taco was purchased by Levy Acquisition Corporation (“LAC”) and became a public company on June 30, 2015. LAC was originally incorporated in Delaware on August 2, 2013, and went public (selling 15 million shares at $10.00) as a special purpose acquisition company for affecting a merger, capital stock exchange, asset acquisition, stock purchase, reorganization or other similar business combinations.
As of January 2, 2018, there were 564 Del Taco restaurants, 312 company operated and 252 franchised. The majority of these restaurants are in the western Pacific states (California, Oregon, Washington). Del Taco is considered the second largest Mexican American Quick Service chain.
Del Taco serves two distinct types of food – Mexican and American. The variety ranges from tacos and burritos to burgers and fries. The dual menu offers something for everyone which attracts a broader customer base than a typical QSR or Fast Casual concept. Del Taco serves its customers freshly prepared food typical of Fast Casual with the speed, value and convenience of QSR – a combination they call QSR Plus. They believe this provides them a unique spot in the marketplace; distinct from their competitors. Additionally, their menu features both premium items such as plated meals, as well as value priced items such as the “Buck and Under” menu. While the lower priced items are designed to appeal to the value-oriented customer, the “Buck and Under” menu has proven to increase the check average because of its variety which allows customers to supplement their order with the lower priced items. For the year ending January 2, 2018, approximately 20% of Company store sales consisted of “Buck and Under” menu items.
MENU SALES MIX DAY PART (2017 10-K):
Menu Strategy “Something for Everyone”:
As noted above, Del Taco has a well-defined menu strategy where the objectives are to shift more transactions to higher priced premium menu items. This is achieved by communicating value and underscoring the Brand’s fresh-made and healthy position and through menu board optimization; a process management implemented through extensive market studies, data analytics and scientific customer insight.
The new menu board has contributed to the success of their strategy. Key features:
- “Buck and Under” communications were simplified and visually de-emphasized.
- Menu clutter was reduced, with less than 40 items reduced from 70 previously. This speeds throughout and increases the ability to showcase high-margin premium items. Del Taco claims that the new menu has improved ease of ordering and elevated the “Quick Service Plus” branding initiatives.
- Higher priced “Dinner at Del” offerings are visually highlighted on the menu board “Hot Spot” where consumers tend to look first.
- High margin carbonated soft drinks are visibly shown, rather than text listed. This has increased purchases.
- Continue to evolve their menu to create platforms that convey the QSR Plus positioning and reinforce their “Start with Fresh and Serve with Value” brand position.
Balanced Day Parts:
The majority of Del Taco restaurants are opened 24-hours a day contributing to a well-balanced day part sales mix. Sales by day part breakdown:
- 5% Breakfast
- 1% Lunch
- 6% Snack (2-5PM)
- 3% Dinner
- 5% Late Snack (8PM-Midnight)
- 1% Graveyard (Midnight-5AM)
This menu strategy and the balanced day parts provide some unique opportunities for sales growth.
LONG-TERM GROWTH STRATEGY (2017 10-K)
Del Taco’s growth strategy is based on their differentiated position as a QSR Plus, a disciplined business model with strong unit economics. Their objectives, as described in the 2017 10K, are to:
- Expand store count, fill the “white space”
- Drive restaurant sales growth
- Optimize margins
Del Taco believes they are in the early stages of growth with 564 locations in 14 states and estimate the store potential at 2,000 locations. For 2017 they opened 12 new Company units and 8 new franchise units and in 2018 they expect to open a total of 25 to 28 new locations across Georgia, Florida, Michigan and Oklahoma). For core markets alone, Del Taco has identified opportunities for 300+ potential new store locations.
For growing sales, Del Taco has developed an integrated strategic approach that are geared to increase customer frequency, attract new customers and improve check average by enticing add-on spending, including the menu innovation as discussed above.
They utilize a highly coordinated marketing and advertising campaign using multiple marketing channels that include: TV, radio, outdoor and direct mail, social and digital, and in-store materials. Additionally, Del Taco’s Raving Fans E Club has an active membership of over 800,000 who are regularly engaged with the restaurants through regular notices and by the high frequency of E Club promotional redemption.
For store operations, Del Taco utilizes a balanced scorecard measurement system – T.E.A.M.S. (Tracking Experiences and Measuring Success). Elements that include: customer surveys, internal audits, staffing metrics, speed of service metrics, sales metrics, and key controllable costs. While this program is not unique to the restaurant industry, Del Taco’s operational assessment program has apparently generated strong buy-in from the franchise community.
SOURCES OF REVENUE (2017 10-K):
Del Taco’s source of revenue is divided by three parts in 2017.
Franchise Sublease Income: consists of rental income received from franchisees related to properties where Del Taco has subleased a leasehold interest to the franchisee but remain primarily liable to the landlord.
UNIT LEVEL ECONOMICS:
As of year-ending 2017, AUV’s for stores opened at least 12 months were $1,410,000. With a goal of $1,500,000 in 2018. The typical Del Taco is 2,000 to 2,600 square feet and utilizes a drive thru window.
In late 2017, management updated their current economic model for AUV to range from $1.35 million to $1.50 million with a 3-year cash on cash return ranging from 24% to 28%. The average investment is estimated at $950,000 and has been consistent the last 3 years. Projected restaurant level EBITDA margins is 17-18%. This is expected to be lower than in the past (20.6% in 2016 and 19.7% in 2017) because of higher rent expenses.
SHAREHOLDER RETURN (2017 10-K):
Del Taco has not declared or paid a dividend on their common stock since becoming a public company. The value of the stock has been affected by a significant number of outstanding warrants and holdings by the private equity firms that previously owned Del Taco. Approximately 17% of these warrants remain. While LAC went public at $10.00/share in 2014, the stock ran up to $16.00 as TACO was acquired in mid 2015, and has traded between $8.00 and $16.00 ever since. During the fourth quarter of 2017, the Company repurchased 249,210 shares and 23,253 warrants for an aggregate of $13.8 million.
RECENT DEVELOPMENTS (Per Q1 Release and Conference Call)
Results in terms of sales in Q1’18 were strong, relative to industry peers. Company stores had comps up 2.6% (the 23rd consecutive quarter of gains) and franchise comps were up 5.2%. Systemwide comps were up 3.7%, bringing the two year comp to 7.9%. The company restaurant EBITDA contribution was 18.4% of sales, down from 19.1% YTY. Adjusted corporate EBITDA was $13.9M, down from $14.6M in Q1’17. Income from operations was down 26.5% to $6.3M (5.6% of revenues). After a lower tax rate (27.1% vs 40.1% in ’17) and fewer shares outstanding, diluted EPS was down about 18%. Three company stores were opened and one franchised location closed in Q1. Management pointed out that the first five weeks of Q2 were up 1% and 3%, for company and franchised store respectively, on top of 8% a year ago, obviously very encouraging. The comparisons get a bit easier as Q2 evolves, as the second half of Q2’17 was up 6% for the company and 7% for franchisees, all of which is generating impressive two year comps. In terms of the stock repurchase program, $20.9M remains, with only 9,811 warrants repurchased at $3.37 in Q1.
Higher labor and occupancy expenses affected Q1 but will be offset later in the year by higher menu prices. Cost of goods was flat in Q1 but should be better as 2018 unfolds. Below the store operating line, G&A was up 50 bp to 9.3%, driven by legal and related expenses, stock based compensation, the expense side of franchise revenues, partially offset by management incentive compensation. D&A was up 50 bp to 5.3% of revenues, driven by new assets and the writeoff of a franchise “right” asset related to the closing. In terms of guidance for 2018 as a whole, the Company reiterated their expectation of systemwide comps of 2-4%, restaurant EBITDA margin of 19.3-19.8%, expansion of 25-28 stores systemwide, an effective tax rate of 26.5-27.5%, EPS of $0.59-$0.63.
Per the conference call, management elaborated on why franchisee comps outperformed company results. Franchisees have been slightly more aggressive with price increases, and the company’s California concentration was affected more by weather at the end of Q1. The barbell menu served the system well throughout Q1. Menu prices were up 2.5% YTY in Q1, will be up nearly 3% in Q2, nearly 3.5% in Q3 and up to 4% in Q4. At the same time, the Buck & Change menu will be expanded.
The conference call elaborated more on menu development by daypart, systemwide training efforts, the timing of advertising programs, efforts to control labor and commodity costs. All of this is naturally embedded in company guidance for the remainder of 2018. G&A expense, as a percentage of revenues is expected to decline after 2018, having absorbed the expenses of being public and investing to support future growth.