One Hour Analysis of Nathan’s Famous (NATH)
One Hour Analysis of Nathan’s Famous (NATH)
Mkt Cap :$240M
EV: $300M
S/O: 4.1M
Float: 1.6M
Yield: 3.2%
Along time ago (late 1990’s-mid 2000’s), I worked as an analyst for David Tice and the institutional investment research report, Behind the Numbers (BTN). We were one of the first firms to do what is now considered forensic accounting analysis and earnings quality analysis. Part of the analytical process was what we called a “One Hour Analysis”. It was the basic starting point and, honestly took more than an hour, but it was a catchy name. The idea was to spend some time reviewing Wall Street reports, SEC filings, news databases, financial databases, and other sources to produce a general understanding of the investment premise on the company and its business model. Generally speaking, within a couple of hours an experienced analyst could determine if there were enough red or yellow flags to pursue the analysis in much more detail. The notes on the company were kept and could be referenced by other analysts in the future to see if anything had changed since the last analysis. This allowed BTN to review hundreds of companies a year.
As part of this blog, I am going to post some of my One Hour Analysis on companies I have looked at. These will not be highly detailed posts but will give the reader a basic understanding of the company to help in their research process.
This post will cover Nathan’s Famous, Inc. (NATH)
I typically do not do many financial screens, but with every restaurant stock going down and fears of consumer demand rampant, I decided to look at the universe of publicly traded restaurant stocks to see if there were any that had a high percentage of cash to equity value. I ignored lease obligations (I know, I know), but did want to see how much debt a company was carrying. I have covered Ark Restaurants numerous times on this blog (including this update here), and ARKR has over 33% of its market capitalization in cash and is almost in a new zero debt position. But NATH showed up with $86M in cash and a $194M market cap (44%) and $151M in debt. I could not resist looking at NATH to see how the company was doing.
Quick Findings:
· Product Licensing (98%+ operating margins) drives profitability
· High Insider Ownership: (31% + Gabelli at 14%)
· Shareholder Friendly Return of Capital ($14M stock buyback +$30 in special dividends + 140% increase in dividend since 2017)
Business Model
“We are a leading branded licensor, wholesaler and retailer of products marketed under our Nathan’s Famous brand, including our popular Nathan’s World-Famous Beef Hot Dogs. Our products are currently marketed for sale in approximately 79,000 locations, including supermarkets, mass merchandisers and club stores, selected foodservice locations and our Company-owned and franchised restaurants throughout the United States and in seventeen foreign countries. The Company considers itself to be in the foodservice industry and has pursued co-branding initiatives within other foodservice environments.”
· Licensing Program (28% of revenue)
o From 10K: Our licensing program contracts with certain third parties to manufacture, distribute, market and sell a broad variety of Nathan’s Famous branded products including our hot dogs, sausage and corned beef products, frozen crinkle-cut French fries and additional products through retail grocery channels and club stores throughout the United States. As of March 27, 2022, packaged Nathan’s World Famous Beef Hot Dogs continued to be sold in supermarkets, mass merchandisers and club stores including Walmart, Kroger, Ahold, Publix, Albertsons, Safeway, ShopRite, Target, Sam’s Club, Costco and BJ’s Wholesale Club located in all 50 states. We earn revenue through royalties on products sold by our licensees.
o In 2013-14 NATH had popped up on many microcap blogs because the company had a new royalty agreement with Smithfield Foods/John Morrell that increased its royalty rate on March 2, 2014, from 3%-5% to 10.8%. The new agreement runs through 2032.
· Branded Product Program (57% of revenue)
o From 10K: The Branded Product Program (“BPP”) provides foodservice operators in a variety of venues the opportunity to capitalize on our Nathan’s Famous brand by marketing and selling certain Nathan’s Famous hot dog products. We believe that the program has broad appeal to foodservice operators due to its flexibility to deliver our products to a wide variety of distribution channels. In conjunction with the program, operators are granted a limited use of the Nathan’s Famous trademark, as well as Nathan’s point of purchase materials. Unlike our licensing and franchise programs, we do not generate revenue from royalties, but rather by selling our hot dog products either directly to foodservice operators or to various foodservice distributors who resell the products to foodservice operators.
· Operates quick-service restaurants and sells franchises (15% of revenue)
o From 10K: Operating quick-service restaurants featuring Nathan’s World Famous Beef Hot Dogs, crinkle-cut French fries, and a variety of other menu offerings, which operate under the name “Nathan’s Famous,” the name first used at our original Coney Island restaurant which opened in 1916.
o Our franchised restaurant operations are comprised predominately of our Nathan’s Famous concept, which features a menu consisting of Nathan’s World Famous Beef Hot Dogs, crinkle-cut French fries and beverages as well as other items. In fiscal 2021, we opened our first virtual kitchens (existing kitchens with no Nathan’s Famous branded store front presence, used to fill online orders). We earn royalties on sales at these franchise locations and virtual kitchens. In addition to our traditional franchised restaurants and virtual kitchens, we enable approved foodservice operators to offer a Nathan’s Famous menu of Nathan’s World Famous Beef Hot Dogs, crinkle-cut French fries, proprietary toppings and a limited menu of other Nathan’s products through our Branded Menu Program (“BMP”). We earn royalties on Nathan’s products purchased by our BMP franchise operators.
o 239 franchised, 287 virtual kitchens and 4 company-owned
§ Franchise Fee: 5.5% of revenue + 2% advertising fund
Licensing Program
On March 2, 2014, NATH signed a new royalty agreement with Smithfield Foods (John Morrell) that increased the royalty rate the company received on 20 SKUs from 3-5% to 10.8%. The new agreement runs through 2032. As a result of the agreement license royalties more than doubled in FY15. Since then, John Morrell license revenue has grown at a 7.8% CAGR. The company’s products are currently being distributed in over 65,000 supermarket/grocery channels in the US. This number has been relatively flat over the last few years. NATH is already deeply penetrated in Walmart, Kroger, Albertson’s and Costco. Growth in this segment should come from new store growth of the major supermarket chains, some unit growth (NATH already sells over 700 million hot dogs a year), price increases and perhaps some product innovation. The operating margin in this segment is nearly 100%, so incremental growth in revenue drops to the bottom line. This is clearly the most important segment.
Drivers of revenue growth:
· The increase is due to a 0.3% increase in retail volume during the fiscal 2022 period, as well as a 1.1% increase in average net selling price as compared to the fiscal 2021 period.
· The increase is due to a 12% increase in retail volume during the fiscal 2021 period, as well as a 12% increase in average net selling price as compared to the fiscal 2020 period.
· The increase at retail is primarily due to higher retail volume of 11.0% and a 2.0% increased average net selling price as compared to the fiscal 2019 period.
· The increase is due to a 2.2% increase in volume during the fiscal 2019 period as compared to the fiscal 2018 period, which was partly offset by a decline in average selling price of 1.3%. Beginning in fiscal 2019, we agreed to reduce the royalty rate earned on the foodservice business with John Morrell & Co., substantially on sales of hot dogs to Sam’s Club, in an attempt to secure additional business with WalMart.
· Total royalties earned on sales of hot dogs from our license agreement with John Morrell & Co. at retail and foodservice, substantially from sales of hot dogs to Sam’s Club, increased to $20,833,000 for the fiscal 2018 period as compared to $18,424,000 for the fiscal 2017 period. The increase is due to a 9.3% increase in volume during the fiscal 2018 period as compared to the fiscal 2017 period. Average selling prices, on which our royalties are calculated, increased by 4.5% due to pricing increases during the fourth quarter
· The increase is due to a 9.3% increase in volume during the fiscal 2018 period as compared to the fiscal 2017 period. Average selling prices, on which our royalties are calculated, increased by 4.5% due to pricing increases during the fourth quarter.
Branded Products Program
The Branded Products Program is the company’s foodservice sales program which is a bulk sales program distributed through major foodservice distributors like SYSCO, US Foodservice, PFG and McLane, as well as many smaller regional distributors. Products are sold in over 14,000 locations (down from 15,000 5 years ago), including national and regional restaurant chains, casinos, ballparks, arenas, schools, and colleges.
There are two components to YOY changes in revenue. First is the total number of pounds the company sells, which is driven by location expansion and hot dog sales growth. The other component to revenue growth is the change in the average selling price of the hot dog, which is partially correlated to the beef market.
Revenue has generally been range bound in the $56M-$62M, with FY22 reaching a new high at $66M. However, due to the pricing scheme relative to the input costs of the beef, operating margins have been much more volatile. Operating margins have ranged from 8%-18% since FY2015. Operating income has been below $10M in four of the last five years. We do not think that there will be much change in the operating income range over the next few years. There is speculation that, due to a four-year decline in beef cow inventories, prices could remain elevated or increase for the next four years. (Source)
Drivers of revenue growth and Cost of Sales:
· During the fiscal 2022 period, the total pounds of hot dogs sold in the Branded Product Program increased by approximately 78% as compared to the fiscal 2021 period. Our average selling prices, which are partially correlated to the beef markets, increased by approximately 10% as compared to the fiscal 2021 period.
· Cost of sales in the Branded Product Program increased primarily due to the 78% increase in the volume of product sold as discussed above, as well as a 19% increase in the average cost per pound of our hot dogs.
· During the fiscal 2021 period, the volume of business decreased by approximately 41% as compared to the fiscal 2020 period. Our average selling prices increased by approximately 0.4% as compared to the fiscal 2020 period.
· Cost of sales in the Branded Product Program decreased primarily due to the 0.8% decrease in the average cost per pound of our hot dogs, as well as the 41% decrease in the volume of product sold due to the COVID-19 pandemic as discussed above.
· During the 52-week fiscal 2020 period, the volume of business decreased by approximately 2.1% and our average selling prices increased by approximately 0.8% as compared to the 53-week fiscal 2019 period.
· Cost of sales in the Branded Product Program increased primarily due to the 6.7% increase in the average cost per pound of our hot dogs.
· During the fiscal 2019 period, the volume of business decreased by approximately 3.8%.
· Cost of sales in the Branded Product Program decreased primarily due to the 7.7% decrease in the average cost per pound of our hot dogs and the 3.8% decrease in the volume of product sold discussed above.
Concentration of Revenue:
One Branded Products customer accounted for 16% and 9% of total revenue for the fiscal years ended March 27, 2022 and March 28, 2021, respectively. One retail licensee accounted for 26% and 39% of the total revenue for the fiscal years ended March 27, 2022 and March 28, 2021, respectively.
A small number of our BPP customers account for a significant portion of our BPP revenues. Sales to our five largest BPP customers were 77.6% and 70.4% of our BPP revenues in fiscal 2022 and fiscal 2021, respectively.
Restaurants and Franchisees
While many investors are probably familiar with the iconic Nathan’s Famous restaurant on Coney Island that was founded in 1916, the company actually owns four restaurants and has over 238 franchised restaurants (71 international, 96 in NY/NJ). The number of franchised restaurants has been declining for over 7 years, with a small uptick in FY22. Revenue and operating income have declined substantially as well. We do not view this segment as a major contributor to growth or profitability in the future.
History of Shareholder Friendly Uses of Cash/Cash Flow
NATH has a long history of returning cash back to shareholders. As the company CEO noted in the 2019 shareholder letter, “In all, between stock buybacks and cash dividends, a total of approximately $220M has been returned to shareholders over the last 18 years—not bad for a company that had a market capitalization of less than $30M at the beginning of those 18 years!”
Recent Examples:
In March of 2015, the company completed an offering of $135M, 10% coupon, senior secured notes due 2020. The company used $116M of the offering to pay a special $25 per share dividend.
In 2016 the company bought back over $19M worth of stock. Since 2001, the company has retired over 5.2M shares at a cost of $84.8M. ($16.30 per share) Since 2007, the company has repurchased 3.36M shares at a cost of $77.6M ($23.00 per share), reducing the number of then-outstanding shares by 55.9%.
Just one year later, in November of 2017, the company issued $150M, 6.625% coupon, senior secure notes due 2025 to pay off the 2020 notes. The company used $21M of the proceeds to pay a $5 per share dividend.
In January of 2022, the company redeemed $40M of the $150M 6.625% 2025 notes. This reduced annual cash interest expense by $2.65M. The company recently raised its dividend by 29% or $0.10 per share to $0.45 per quarter. The total increase in the dividend is about $1.65M or about 62% of the savings. Since switching from an emphasis of stock buybacks and special dividends, the company has paid out 40-50% of CFO. We would expect that ratio to continue.
After paying down $40M worth of debt, the company still has $50M in cash and $110M in debt. The $110M 6.625% 2025 Notes can be called at 101.656% through November of 2022 and then at par until maturity in November of 2025. There is no scheduled principal amortization prior to final maturity.
Using somewhat conservative assumptions of $8-$11M in FCF after payments of $7M-$8M in dividends, the company could have approximately $80M-$90M in cash by the time the Notes are due. NATH has plenty of flexibility in terms of potential uses of the cash over the next several years. We believe the company will continue to look for opportunities to raise the dividend over time and refinance or retire the debt if possible (The company was debt free in FY14).
Ownership
Two-thirds of the stock is owned by insiders and institutions that typically buy and hold.
Insiders 31%
Gabelli 14%
Renaissance 5.8%
Zilkha 6%
Dimensional Funds 4.9%
BlackRock 3%
Vanguard 3%
Summary:
Nathan’s is a $240M market cap company that pays a 3.25% dividend that will probably grow modestly over time. While there are three reporting segments, the licensing segment drives 100% of the profitability of the company. The new licensing agreement that was signed in FY14 doubled the revenue in this high margin business. Long-term growth in revenue seems to be sub 8% unless there is a significant change in the number of locations the Branded Products segment.
NATH is a quality small/microcap company with a 3% yield and management that continuously looks for ways to return capital to shareholders. Perhaps the company is taken private at some point in the future, but there does not seem to be much that investors are currently missing with the company’s investment merits. The annual shareholder letters are informative.