CARROLS CORP TAST1
October 18, 2011 - 9:57pm EST by
elke528
2011 2012
Price: 9.39 EPS $0.85 $1.19
Shares Out. (in M): 22 P/E 11.0x 7.9x
Market Cap (in $M): 208 P/FCF 10.7x 18.4x
Net Debt (in $M): 251 EBIT 47 57
TEV ($): 459 TEV/EBIT 9.8x 8.1x

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Description

Can I interest you in a mini-Chipotle trading at 6x EBITDA and 11x earnings?  Would you be interested in a spin-off situation that will result in the pure play of a restaurant chain with regional strength, improving menu and marketing execution, and strong appeal to the fast-growing Hispanic community?  Would it entice you more to know that insiders own 42% of the shares?
 
Carrols owns and operates three restaurant chains:  (i) the largest Burger King franchisee in North America with 303 restaurants in the Northeast, Midwest, and the Carolinas; (ii) Pollo Tropical ("PT"), a Caribbean-flavored chicken fast casual chain with 90 locations, of which 85 are in Florida (with an additional 30 franchised restaurants); and (iii) Taco Cabana ("TC"), a Mexican fast casual chain with 157 restaurants, almost all in Texas.  In February, Carrols announced that by the end of 2011 it would spin off PT and TC into a new company, to be called Fiesta Restaurant Group ("FRG").  The purpose of the spin would be to allow the FRG restaurants to pursue a growth plan, as both PT and TC are experiencing positive trends.  Meanwhile, the remaining Carrols will be able to pursue acquisitions in a highly fragmented Burger King franchise environment.

Why does this opportunity exist?

  • It is hardly obvious that a company called "Carrols" is so focused on Hispanic restaurants. The best example of this I saw was of a recent Bernstein strategy piece on companies focused on Hispanic consumers. On a chart estimating exposure and appeal to Hispanics, Carrols was not even on the chart (and there were some other small-cap restaurants on the chart).
  • The three brands combined with its small market cap make it too time consuming and unappealing for sell-side analysts. That's the only explanation I have for why there are 7 analysts for small-cap restaurant companies like Einstein Noah and 11 for Red Robin Gourmet Burgers while only 2 for Carrols.
  • There are relatively few people who even have familiarity with the regional brands, since they are so geographically separate. Furthermore, the operational improvements and strategic moves that PT and TC have made are still relatively new.
Investment Thesis:

1) PT and TC are strong regional restaurant chains with great name recognition in the sweet spot of key restaurant industry trends today and in the near future.

Pollo Tropical is a 90-location, Caribbean-flavored grilled chicken chain with menu items such as black beans, yucca, and fried plantains. 70% of the company-owned restaurants are located in their "core market" of Miami-Dade, Broward, and Palm Beach counties, with about one-third alone in Miami-Dade. Carrols acquired PT in 1998 when the chain had just 36 restaurants.

In 2007, management decided to venture outside of Florida for the first time, and headed to heavily Puerto Rican and Cuban areas of New Jersey, and later Connecticut and Brooklyn.  Their strategy at the time was to "plant the flag" in each area and then increase the restaurant density to leverage marketing and supply chain costs.  With the onset of the recession in late 2007, they found that the lower socio-economic demographics in these new markets were unable to support the restaurants, and it didn't make sense to backfill with additional ones.  In 2009, PT retrenched, reduced restaurant growth and capex, and focused on paying down debt.  New restaurant capex in 2009 was 27% of 2008's amount.

Meanwhile, PT started experimenting in 2009 with a new store format to appeal to a broader, "more Anglo" market.  Starting with a store in Tampa, they (a) improved the look and feel of the restaurant (more dark wood, less palm motif), (b) Anglicized the menu with items like mac & cheese, brown rice, and mashed potatoes, and (c) improved the service by adding table runners who bring the food to the table on real plates with real silverware.  Seeing an immediate impact on same-store sales, even in the existing Hispanic neighborhoods, PT recognized the potential and rolled it out to the rest of their non-core markets, including Tampa/St. Pete, Orlando, and the few remaining restaurants in the Northeast.  At the same time, PT introduced new menu items in all restaurants and heavily marketed a new $5 lunch combo deal - the latest promo is a chipotle chicken sandwich with split pea soup and a drink for $5.  The results (in combination with significant improvements in their core markets) are quite strong.

  Q109 Q209 Q309 Q409 Q110 Q210 Q310 Q410 Q111 Q211
PT Comps -3.0% -3.1% -0.1% 0.3% 3.7% 6.3% 8.8% 10.7% 13.5% 10.7%
PT Avg Sales/Restaurant ($000) $484 $486 $481 $459 $497 $515 $526 $517 $580 $585
PT EBITDA Margin (a) 14.6% 15.2% 14.3% 14.9% 14.8% 17.4% 15.7% 16.7% 19.3% 18.2%
 
Despite the improvements in the menu and service, PT still couldn't do anything about the existing store locations. Their first opportunity to prove the new concept outside existing markets and with a new site location model came in Jacksonville in November 2010. The "system" is simple: put stores in higher-income areas. Even after being open nearly a year, this restaurant is still running weekly sales that are ~40% higher than the system average. In July, PT opened its first location outside Atlanta and a few weeks ago, they opened their second Jacksonville location. I believe that both locations are doing even better than the first Jacksonville location.
For those of you who are unfamiliar with Florida: Jacksonville is in the state, but it's really in the South - unlike South Florida, which is a strange mix of the Northeast and Latin America. So for a chain with a name like Pollo Tropical to be doing well in Jacksonville really means something about the widespread acceptance of foreign-sounding names - although I guess something about the name Chipotle coming out of Denver might convince me as well.

Taco Cabana is a Mexican chain well-known in Texas for its 24-hour operations, freshly-made tortillas, decent beer selection and frozen margaritas, and cheap tacos a step above Taco Bell. TC was founded in 1978 in San Antonio, and its tall pink signs are ubiquitous around the state, with 40 locations in Houston, 38 in the DFW metroplex, 32 in San Antonio, and 21 in Austin. Carrols acquired the brand in 2000, and has been consistently growing its store count since 2002 from 115 to 157. However, they had not done much with the brand image, which continued to be oriented around reliable late night, cheap food.

In late 2009, however, TC began to focus on enhancing their brand image by focusing on the "authentic flavors of Mexico" and started to update their menu and brought in a rotation of Mexico-inspired dishes like Street Tacos and Fajitas Puebla. At the same time, they began to renovate their DFW stores with an elevated service model like PT did outside their core markets (in conjunction with a slight price increase to pay for the increased labor cost). Once the renovations were largely complete, the DFW stores has same store sales comps about 400 bps higher than the rest of the TC system.

In addition, TC has started some innovative and brand-enhancing marketing through the use of social media. They hired Anjelah Johnson, a comedienne from MadTV who had a decent Facebook following, to do some funny ads (my favorite: goo.gl/TET5C). They also benefited by being a sponsor of the Dallas Mavericks during their NBA championship run last year. As a result, their Facebook fans now total over 80,000. For reference, Qdoba, which has over 3x the stores, has only about 102,000 fans.

  Q109 Q209 Q309 Q409 Q110 Q210 Q310 Q410 Q111 Q211
TC Comps -1.6% -3.8% -4.3% -4.5% -2.0% -0.1% 1.0% 2.3% 2.0% 4.5%
TC Avg Sales/Restaurant ($000) $408 $414 $406 $388 $397 $412 $409 $397 $406 $437
TC EBITDA Margin (a) 13.1% 12.6% 10.6% 12.5% 10.9% 10.7% 10.2% 11.8% 10.2% 10.2%

With the success in DFW, TC has taken their remodeling plan to Austin this year and to San Antonio and Houston in 2012-13.  Many locations in San Antonio and Houston have not been renovated in over 10 years (unlike DFW, which was a newer market for them), so they should see a double bump from both an improving image as well as improving service.

PT and TC are well-positioned in these difficult days for the restaurant industry. These are difficult times for restaurants in general. Commodity prices are volatile and the consumer is stretched. In such an environment, fast casual chains win over both the casual dining segment (i.e.: Applebees, TGI Fridays, Chili's) and independent operators. Fast casual will win over casual dining because of an inherent price advantage not only from labor but also because of the lack of tipping (incidentally, there is a small sign on the wall of the PT stores with the elevated service model that says "Please no tipping. We need the jar for sangria"). Chains in general will win over independents due to their ability to gain scale in purchasing and supply chain, leverage marketing costs, and most importantly in this environment, experiment with price increases. Furthermore, each brand's appeal to the Hispanic consumer is an asset as that demographic continues to grow faster than the rest of the population. Finally, PT's food is quite healthy (there's even a PT 21-day diet plan), which positions it well when nutrition information is required to be on menu boards. 

2) The spin off makes a lot of sense so each entity can focus on the right strategic approach. Despite the progress with PT and TC, Carrols still has more BK units than PT and TC combined, and the poor performance at BK has dragged the overall valuation down. BK has been weak as a result of poor marketing performance of the franchisor, as both McDonald's and Wendy's have improved operations and menu and taken share. As can be seen below, while Carrols' performance has been weak, they've actually done better than the whole Burger King system in 7 out of the past 10 quarters.

  Q109 Q209 Q309 Q409 Q110 Q210 Q310 Q410 Q111 Q211
BK (TAST) Comps 5.1% -4.7% -6.1% -3.0% -6.4% -1.4% -3.2% -6.1% -5.0% -3.6%
BK System Comps 1.6% -4.9% -4.6% -3.3% -6.1% -1.5% -4.2% -5.8% -6.0% -5.3%
BK (TAST) Avg Sales/Restaurant ($000) $300 $305 $302 $310 $282 $302 $295 $282 $268 $292
BK (TAST) EBITDA Margin (a) 7.4% 9.5% 9.4% 7.9% 4.3% 5.9% 7.1% 4.7% 1.4% 5.8%

The post-spin strategy for BK will be to pursue acquisitions of other BK franchisees (if it's not acquired before then).  Interestingly, private equity has been active in BK.  The two largest examples are Cerberus, which owns Strategic Restaurants Acquisition Company (~275 units) and GSO Capital Partners, a Blackrock subsidiary, which owns Heartland Food Corp (~223 units).  Both have made acquisitions in 2011. 
 
The BK franchise system remains highly fragmented: Carrols is the largest franchisor, but only has about 5% of the restaurants.  Given overall BK performance in the past year and commodity cost inflation, it's probably a good time to find value in BK franchises.
 
The post-spin strategy for PT and TC is to open new restaurants and for TC to continue with their remodels.  As of August, management expects to open 12-15 new FRG restaurants in 2012. 

The recent debt refinancing created a lot of value, even though the market didn't recognize it. In July, Carrols refinanced its credit facility by getting some bank debt for Carrols (RemainCo) and floating some bonds for the soon-to-be Fiesta Restaurant Group. More than just one more thing on the pre-spin to-do list, this was extremely important because it separated the collateral for the deal. Now, even if the spin doesn't happen and BK can go BK (sorry, had to get that in) without affecting FRG.

3) Strong management with significant insider alignment (42% insider ownership): Carrols as a whole is currently led by Alan Vituli, an industry veteran who helped take the company private in 1986 (when it was just a BK franchisee). Prior to getting into the restaurant business in the 1980s, Vituli was an investment banker and an accountant. Post-spin, Vituli will be chairman. 

Below is a table of the key members of management, their insider ownership percentages, tenure, and expected position post-spin.  In addition to the large ownership percentages, their longevity with the business clearly stands out.  This is a highly experienced group.

 

  Pre-Spin Position Ownership % Carrols since Current Position since Post-Spin Position
Alan Vituli CEO 7.3% 1986 1992 Chairman, Carrols and FRG
Dan Accordino COO 3.1% 1972 1993 CEO, Carrols
Paul Flanders CFO 0.4% 1997 1997 CFO, FRG? (TBA)
Joseph Zirkman General Counsel 0.4% 1993 1993 TBA
Jim Tunnesen President, PT 0.3% 1972 2003 President, PT
Mike Biviano President, TC 0.4% 1973 2002 President, TC
Others and Individual Directors   0.5%      
Subtotal, Management and Individual Directors   12.4%      

Going forward, FRG will be led by Tim Taft, another industry veteran who also has experience with growing regional fast food chains as well as public market experience.  During the 1990s and early 2000s, Tim was President and COO of Whataburger, a fast food chain with over 400 stores, mostly in Texas.  After that, he began the turnaround process at Pizza Inn, which is currently benefitting from his efforts.  I expect him to bring a greater focus on high quality service in order to differentiate the FRG brands from other Hispanic-oriented restaurants.

Finally, the single-largest shareholder is Jefferies, with 30% ownership and two seats on the board.  They got their position in 2008 by buying out the stakes of Madison Dearborn and Bahrain Investment Bank (which had bought control of Carrols from management in 1996 and then sold half their stake to Madison Dearborn in 1997).  So far, Jefferies seems to be helping make some sensible strategic and capital allocation decisions. 

4) Good unit economics leads to attractive growth plans for new stores - especially if other new stores are like Jacksonville. For a small-cap company with three distinct brands, Carrols provides an extraordinary amount of disclosure, so it's relatively easy to determine unit economics. When possible, Carrols secures their locations by acquiring land, building the restaurant, and then after a few months, doing a sale/leaseback transaction at a ~9% cap rate.

Based on current system averages and using some conservative assumptions, I calculate that PT's levered IRR (post sale/leaseback) is 25% (vs. 40% according to the CFO).  But if the Jacksonville store holds its volume, the IRR there will be closer to 70%! 

My calculations show TC's levered IRR to be 17% (vs. 25-30% according to the CFO), but newer stores with the elevated service model in the DFW market must be significantly higher.

For reference, I have incorporated a comparison chart for PT and TC against Chipotle using Chipotle's definitions in their investor presentations.  While PT and TC are certainly not on par with Chipotle, they do hold their own especially considering the maturity of their store base, and their margins should improve over time as they implement their individual strategies. 

  CMG PT TC
Average LTM Sales/Restaurant $1,885 $2,138 $1,624
Restaurant operating margin 26% 13% 7%
Restaurant EBIT $498 $285 $118
Investment cost (assumes lease) $795 $600 $525
ROI % 63% 47% 22%

5) Attractive valuation on an absolute and relative basis.

Currently, TAST trades at 6.0x LTM EBITDA, 11.1x P/E, and a 14% FCF yield (based on maintenance capex, which is clearly disclosed in the filings).  As can be seen, PT has outperformed even Chipotle and Panera in the past two quarters (actually vs. Panera, it's four quarters), and TC has done pretty well, but the valuation is lower than almost all comparable fast casual/fast food restaurant chains.  Looking at the company this way, it becomes more apparent how BK performance is dragging the rest of TAST down. 

  Market Cap EBITDA EBITDA Margin EV/ EBITDA P/E Net Debt/ EBITDA Avg Comps, Last 2 Qs Franchise %
Chipotle $10,140 $389 19% 25.1x              52.9        (1.0x) 11.2% 0%
Panera $3,289 $281 17% 10.9x              25.7        (0.8x) 3.6% 54%
JACK $1,041 $170 8% 8.7x              16.8          2.6x   65%
   Jack in the Box             1.7%  
   Qdoba             5.6%  
Sonic $453 $129 23% 7.6x              40.7          4.1x 2.6% 87%
BH (Steak & Shake) $438 $81 11% 5.8x              13.6          0.4x 4.6% 28%
AFCE $350 $45 30% 9.1x              15.1          1.3x 2.2% 98%
BAGL $214 $44 11% 6.4x              19.0          1.6x -0.3% 0%
TAST $206 $75 9% 6.1x              11.1          3.3x   5%
   Pollo Tropical             12.1%  
   Taco Cabana             3.3%  
   Burger King             -4.3%  

Post-spin, the market should assign more reasonable multiples for the individual companies.  Looking at it this way, there is ~25% downside on TAST with upside of 50-100%. 
 
Valuation Framework: 
  FRG BK Total
LTM EBITDA (a) $49 $25 $75
EV/EBITDA Multiple 10.0x 5.0x  
Enterprise Value $495 $127 $621
Debt $210 $65 $275
Cash $6 $2 $7
Equity Value $290 $63 $354
Shares Outstanding            22.2          22.2          22.2
Price/Share $13.10 $2.87 $15.97
Upside from Current Price     70%
  (a) Reallocates corporate overhead from BK to FRG and adds ~$2m of standalone costs to FRG. 

Range of potential outcomes (based on LTM EBITDA):

Price per Share FRG Multiple          
BK Multiple 7.0x 8.0x 9.0x 10.0x 11.0x 12.0x 13.0x
3.0x $6.98 $9.21 $11.45 $13.68 $15.91 $18.14 $20.37
4.0x $8.13 $10.36 $12.59 $14.82 $17.05 $19.29 $21.52
5.0x $9.27 $11.50 $13.73 $15.97 $18.20 $20.43 $22.66
6.0x $10.41 $12.65 $14.88 $17.11 $19.34 $21.57 $23.81
7.0x $11.56 $13.79 $16.02 $18.25 $20.49 $22.72 $24.95
               
Δ from Current Price FRG Multiple          
BK Multiple 7.0x 8.0x 9.0x 10.0x 11.0x 12.0x 13.0x
3.0x -26% -2% 22% 46% 69% 93% 117%
4.0x -13% 10% 34% 58% 82% 105% 129%
5.0x -1% 22% 46% 70% 94% 118% 141%
6.0x 11% 35% 58% 82% 106% 130% 154%
7.0x 23% 47% 71% 94% 118% 142% 166%



Risks:
  • Poor execution: All the glowing commentary above about the experienced management team and the post-2009 initiatives like the elevated service model, improved menu at TC, and new site selection system at PT begs the question: why didn't these great operators figure this all out earlier? Unfortunately, I don't have a great answer for that, but if you look at these brands over a longer timeframe (not just since 2006, which is when Carrols went public in its current form), the management team has actually grown PT and TC significantly and showed some discipline by not buying more BK franchises when those prices got bid up in the late 1990s.
  • Significant recession: The low end of the valuation table above should reflect a recession scenario. Keep in mind, however, that the worst quarter at PT in 2008-09 was -3.6% in Q408, which is not too bad considering that the South Florida housing market was in free-fall.
  • A really bad hurricane: As mentioned above, 70% of PT, their most profitable brand, is located in South Florida. While hurricanes typically don't devastate such a wide area (Miami-Dade to Palm Beach Countiescovers about 100 miles), anything's possible.
  • The spin doesn't take place or is significantly delayed.
  • Jefferies overhang: I presume that Jefferies expects to get out via a series of secondary offerings once the spin takes place and the market starts to more easily see the current execution of PT and TC and the potential in those brands. Since they got into this investment in 2008, it is still relatively young for them and they should be somewhat patient.

Catalyst

  • Successful spin process
  • Continued new store openings for PT and TC
  • Successful remodelings at TC
  • Stabilization at BK
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    Description

    Can I interest you in a mini-Chipotle trading at 6x EBITDA and 11x earnings?  Would you be interested in a spin-off situation that will result in the pure play of a restaurant chain with regional strength, improving menu and marketing execution, and strong appeal to the fast-growing Hispanic community?  Would it entice you more to know that insiders own 42% of the shares?
     
    Carrols owns and operates three restaurant chains:  (i) the largest Burger King franchisee in North America with 303 restaurants in the Northeast, Midwest, and the Carolinas; (ii) Pollo Tropical ("PT"), a Caribbean-flavored chicken fast casual chain with 90 locations, of which 85 are in Florida (with an additional 30 franchised restaurants); and (iii) Taco Cabana ("TC"), a Mexican fast casual chain with 157 restaurants, almost all in Texas.  In February, Carrols announced that by the end of 2011 it would spin off PT and TC into a new company, to be called Fiesta Restaurant Group ("FRG").  The purpose of the spin would be to allow the FRG restaurants to pursue a growth plan, as both PT and TC are experiencing positive trends.  Meanwhile, the remaining Carrols will be able to pursue acquisitions in a highly fragmented Burger King franchise environment.

    Why does this opportunity exist?

    Investment Thesis:

    1) PT and TC are strong regional restaurant chains with great name recognition in the sweet spot of key restaurant industry trends today and in the near future.

    Pollo Tropical is a 90-location, Caribbean-flavored grilled chicken chain with menu items such as black beans, yucca, and fried plantains. 70% of the company-owned restaurants are located in their "core market" of Miami-Dade, Broward, and Palm Beach counties, with about one-third alone in Miami-Dade. Carrols acquired PT in 1998 when the chain had just 36 restaurants.

    In 2007, management decided to venture outside of Florida for the first time, and headed to heavily Puerto Rican and Cuban areas of New Jersey, and later Connecticut and Brooklyn.  Their strategy at the time was to "plant the flag" in each area and then increase the restaurant density to leverage marketing and supply chain costs.  With the onset of the recession in late 2007, they found that the lower socio-economic demographics in these new markets were unable to support the restaurants, and it didn't make sense to backfill with additional ones.  In 2009, PT retrenched, reduced restaurant growth and capex, and focused on paying down debt.  New restaurant capex in 2009 was 27% of 2008's amount.

    Meanwhile, PT started experimenting in 2009 with a new store format to appeal to a broader, "more Anglo" market.  Starting with a store in Tampa, they (a) improved the look and feel of the restaurant (more dark wood, less palm motif), (b) Anglicized the menu with items like mac & cheese, brown rice, and mashed potatoes, and (c) improved the service by adding table runners who bring the food to the table on real plates with real silverware.  Seeing an immediate impact on same-store sales, even in the existing Hispanic neighborhoods, PT recognized the potential and rolled it out to the rest of their non-core markets, including Tampa/St. Pete, Orlando, and the few remaining restaurants in the Northeast.  At the same time, PT introduced new menu items in all restaurants and heavily marketed a new $5 lunch combo deal - the latest promo is a chipotle chicken sandwich with split pea soup and a drink for $5.  The results (in combination with significant improvements in their core markets) are quite strong.

      Q109 Q209 Q309 Q409 Q110 Q210 Q310 Q410 Q111 Q211
    PT Comps -3.0% -3.1% -0.1% 0.3% 3.7% 6.3% 8.8% 10.7% 13.5% 10.7%
    PT Avg Sales/Restaurant ($000) $484 $486 $481 $459 $497 $515 $526 $517 $580 $585
    PT EBITDA Margin (a) 14.6% 15.2% 14.3% 14.9% 14.8% 17.4% 15.7% 16.7% 19.3% 18.2%
     
    Despite the improvements in the menu and service, PT still couldn't do anything about the existing store locations. Their first opportunity to prove the new concept outside existing markets and with a new site location model came in Jacksonville in November 2010. The "system" is simple: put stores in higher-income areas. Even after being open nearly a year, this restaurant is still running weekly sales that are ~40% higher than the system average. In July, PT opened its first location outside Atlanta and a few weeks ago, they opened their second Jacksonville location. I believe that both locations are doing even better than the first Jacksonville location.
    For those of you who are unfamiliar with Florida: Jacksonville is in the state, but it's really in the South - unlike South Florida, which is a strange mix of the Northeast and Latin America. So for a chain with a name like Pollo Tropical to be doing well in Jacksonville really means something about the widespread acceptance of foreign-sounding names - although I guess something about the name Chipotle coming out of Denver might convince me as well.

    Taco Cabana is a Mexican chain well-known in Texas for its 24-hour operations, freshly-made tortillas, decent beer selection and frozen margaritas, and cheap tacos a step above Taco Bell. TC was founded in 1978 in San Antonio, and its tall pink signs are ubiquitous around the state, with 40 locations in Houston, 38 in the DFW metroplex, 32 in San Antonio, and 21 in Austin. Carrols acquired the brand in 2000, and has been consistently growing its store count since 2002 from 115 to 157. However, they had not done much with the brand image, which continued to be oriented around reliable late night, cheap food.

    In late 2009, however, TC began to focus on enhancing their brand image by focusing on the "authentic flavors of Mexico" and started to update their menu and brought in a rotation of Mexico-inspired dishes like Street Tacos and Fajitas Puebla. At the same time, they began to renovate their DFW stores with an elevated service model like PT did outside their core markets (in conjunction with a slight price increase to pay for the increased labor cost). Once the renovations were largely complete, the DFW stores has same store sales comps about 400 bps higher than the rest of the TC system.

    In addition, TC has started some innovative and brand-enhancing marketing through the use of social media. They hired Anjelah Johnson, a comedienne from MadTV who had a decent Facebook following, to do some funny ads (my favorite: goo.gl/TET5C). They also benefited by being a sponsor of the Dallas Mavericks during their NBA championship run last year. As a result, their Facebook fans now total over 80,000. For reference, Qdoba, which has over 3x the stores, has only about 102,000 fans.

      Q109 Q209 Q309 Q409 Q110 Q210 Q310 Q410 Q111 Q211
    TC Comps -1.6% -3.8% -4.3% -4.5% -2.0% -0.1% 1.0% 2.3% 2.0% 4.5%
    TC Avg Sales/Restaurant ($000) $408 $414 $406 $388 $397 $412 $409 $397 $406 $437
    TC EBITDA Margin (a) 13.1% 12.6% 10.6% 12.5% 10.9% 10.7% 10.2% 11.8% 10.2% 10.2%

    With the success in DFW, TC has taken their remodeling plan to Austin this year and to San Antonio and Houston in 2012-13.  Many locations in San Antonio and Houston have not been renovated in over 10 years (unlike DFW, which was a newer market for them), so they should see a double bump from both an improving image as well as improving service.

    PT and TC are well-positioned in these difficult days for the restaurant industry. These are difficult times for restaurants in general. Commodity prices are volatile and the consumer is stretched. In such an environment, fast casual chains win over both the casual dining segment (i.e.: Applebees, TGI Fridays, Chili's) and independent operators. Fast casual will win over casual dining because of an inherent price advantage not only from labor but also because of the lack of tipping (incidentally, there is a small sign on the wall of the PT stores with the elevated service model that says "Please no tipping. We need the jar for sangria"). Chains in general will win over independents due to their ability to gain scale in purchasing and supply chain, leverage marketing costs, and most importantly in this environment, experiment with price increases. Furthermore, each brand's appeal to the Hispanic consumer is an asset as that demographic continues to grow faster than the rest of the population. Finally, PT's food is quite healthy (there's even a PT 21-day diet plan), which positions it well when nutrition information is required to be on menu boards. 

    2) The spin off makes a lot of sense so each entity can focus on the right strategic approach. Despite the progress with PT and TC, Carrols still has more BK units than PT and TC combined, and the poor performance at BK has dragged the overall valuation down. BK has been weak as a result of poor marketing performance of the franchisor, as both McDonald's and Wendy's have improved operations and menu and taken share. As can be seen below, while Carrols' performance has been weak, they've actually done better than the whole Burger King system in 7 out of the past 10 quarters.

      Q109 Q209 Q309 Q409 Q110 Q210 Q310 Q410 Q111 Q211
    BK (TAST) Comps 5.1% -4.7% -6.1% -3.0% -6.4% -1.4% -3.2% -6.1% -5.0% -3.6%
    BK System Comps 1.6% -4.9% -4.6% -3.3% -6.1% -1.5% -4.2% -5.8% -6.0% -5.3%
    BK (TAST) Avg Sales/Restaurant ($000) $300 $305 $302 $310 $282 $302 $295 $282 $268 $292
    BK (TAST) EBITDA Margin (a) 7.4% 9.5% 9.4% 7.9% 4.3% 5.9% 7.1% 4.7% 1.4% 5.8%

    The post-spin strategy for BK will be to pursue acquisitions of other BK franchisees (if it's not acquired before then).  Interestingly, private equity has been active in BK.  The two largest examples are Cerberus, which owns Strategic Restaurants Acquisition Company (~275 units) and GSO Capital Partners, a Blackrock subsidiary, which owns Heartland Food Corp (~223 units).  Both have made acquisitions in 2011. 
     
    The BK franchise system remains highly fragmented: Carrols is the largest franchisor, but only has about 5% of the restaurants.  Given overall BK performance in the past year and commodity cost inflation, it's probably a good time to find value in BK franchises.
     
    The post-spin strategy for PT and TC is to open new restaurants and for TC to continue with their remodels.  As of August, management expects to open 12-15 new FRG restaurants in 2012. 

    The recent debt refinancing created a lot of value, even though the market didn't recognize it. In July, Carrols refinanced its credit facility by getting some bank debt for Carrols (RemainCo) and floating some bonds for the soon-to-be Fiesta Restaurant Group. More than just one more thing on the pre-spin to-do list, this was extremely important because it separated the collateral for the deal. Now, even if the spin doesn't happen and BK can go BK (sorry, had to get that in) without affecting FRG.

    3) Strong management with significant insider alignment (42% insider ownership): Carrols as a whole is currently led by Alan Vituli, an industry veteran who helped take the company private in 1986 (when it was just a BK franchisee). Prior to getting into the restaurant business in the 1980s, Vituli was an investment banker and an accountant. Post-spin, Vituli will be chairman. 

    Below is a table of the key members of management, their insider ownership percentages, tenure, and expected position post-spin.  In addition to the large ownership percentages, their longevity with the business clearly stands out.  This is a highly experienced group.

     

      Pre-Spin Position Ownership % Carrols since Current Position since Post-Spin Position
    Alan Vituli CEO 7.3% 1986 1992 Chairman, Carrols and FRG
    Dan Accordino COO 3.1% 1972 1993 CEO, Carrols
    Paul Flanders CFO 0.4% 1997 1997 CFO, FRG? (TBA)
    Joseph Zirkman General Counsel 0.4% 1993 1993 TBA
    Jim Tunnesen President, PT 0.3% 1972 2003 President, PT
    Mike Biviano President, TC 0.4% 1973 2002 President, TC
    Others and Individual Directors   0.5%      
    Subtotal, Management and Individual Directors   12.4%      

    Going forward, FRG will be led by Tim Taft, another industry veteran who also has experience with growing regional fast food chains as well as public market experience.  During the 1990s and early 2000s, Tim was President and COO of Whataburger, a fast food chain with over 400 stores, mostly in Texas.  After that, he began the turnaround process at Pizza Inn, which is currently benefitting from his efforts.  I expect him to bring a greater focus on high quality service in order to differentiate the FRG brands from other Hispanic-oriented restaurants.

    Finally, the single-largest shareholder is Jefferies, with 30% ownership and two seats on the board.  They got their position in 2008 by buying out the stakes of Madison Dearborn and Bahrain Investment Bank (which had bought control of Carrols from management in 1996 and then sold half their stake to Madison Dearborn in 1997).  So far, Jefferies seems to be helping make some sensible strategic and capital allocation decisions. 

    4) Good unit economics leads to attractive growth plans for new stores - especially if other new stores are like Jacksonville. For a small-cap company with three distinct brands, Carrols provides an extraordinary amount of disclosure, so it's relatively easy to determine unit economics. When possible, Carrols secures their locations by acquiring land, building the restaurant, and then after a few months, doing a sale/leaseback transaction at a ~9% cap rate.

    Based on current system averages and using some conservative assumptions, I calculate that PT's levered IRR (post sale/leaseback) is 25% (vs. 40% according to the CFO).  But if the Jacksonville store holds its volume, the IRR there will be closer to 70%! 

    My calculations show TC's levered IRR to be 17% (vs. 25-30% according to the CFO), but newer stores with the elevated service model in the DFW market must be significantly higher.

    For reference, I have incorporated a comparison chart for PT and TC against Chipotle using Chipotle's definitions in their investor presentations.  While PT and TC are certainly not on par with Chipotle, they do hold their own especially considering the maturity of their store base, and their margins should improve over time as they implement their individual strategies. 

      CMG PT TC
    Average LTM Sales/Restaurant $1,885 $2,138 $1,624
    Restaurant operating margin 26% 13% 7%
    Restaurant EBIT $498 $285 $118
    Investment cost (assumes lease) $795 $600 $525
    ROI % 63% 47% 22%

    5) Attractive valuation on an absolute and relative basis.

    Currently, TAST trades at 6.0x LTM EBITDA, 11.1x P/E, and a 14% FCF yield (based on maintenance capex, which is clearly disclosed in the filings).  As can be seen, PT has outperformed even Chipotle and Panera in the past two quarters (actually vs. Panera, it's four quarters), and TC has done pretty well, but the valuation is lower than almost all comparable fast casual/fast food restaurant chains.  Looking at the company this way, it becomes more apparent how BK performance is dragging the rest of TAST down. 

      Market Cap EBITDA EBITDA Margin EV/ EBITDA P/E Net Debt/ EBITDA Avg Comps, Last 2 Qs Franchise %
    Chipotle $10,140 $389 19% 25.1x              52.9        (1.0x) 11.2% 0%
    Panera $3,289 $281 17% 10.9x              25.7        (0.8x) 3.6% 54%
    JACK $1,041 $170 8% 8.7x              16.8          2.6x   65%
       Jack in the Box             1.7%  
       Qdoba             5.6%  
    Sonic $453 $129 23% 7.6x              40.7          4.1x 2.6% 87%
    BH (Steak & Shake) $438 $81 11% 5.8x              13.6          0.4x 4.6% 28%
    AFCE $350 $45 30% 9.1x              15.1          1.3x 2.2% 98%
    BAGL $214 $44 11% 6.4x              19.0          1.6x -0.3% 0%
    TAST $206 $75 9% 6.1x              11.1          3.3x   5%
       Pollo Tropical             12.1%  
       Taco Cabana             3.3%  
       Burger King             -4.3%  

    Post-spin, the market should assign more reasonable multiples for the individual companies.  Looking at it this way, there is ~25% downside on TAST with upside of 50-100%. 
     
    Valuation Framework: 
      FRG BK Total
    LTM EBITDA (a) $49 $25 $75
    EV/EBITDA Multiple 10.0x 5.0x  
    Enterprise Value $495 $127 $621
    Debt $210 $65 $275
    Cash $6 $2 $7
    Equity Value $290 $63 $354
    Shares Outstanding            22.2          22.2          22.2
    Price/Share $13.10 $2.87 $15.97
    Upside from Current Price     70%
      (a) Reallocates corporate overhead from BK to FRG and adds ~$2m of standalone costs to FRG. 

    Range of potential outcomes (based on LTM EBITDA):

    Price per Share FRG Multiple          
    BK Multiple 7.0x 8.0x 9.0x 10.0x 11.0x 12.0x 13.0x
    3.0x $6.98 $9.21 $11.45 $13.68 $15.91 $18.14 $20.37
    4.0x $8.13 $10.36 $12.59 $14.82 $17.05 $19.29 $21.52
    5.0x $9.27 $11.50 $13.73 $15.97 $18.20 $20.43 $22.66
    6.0x $10.41 $12.65 $14.88 $17.11 $19.34 $21.57 $23.81
    7.0x $11.56 $13.79 $16.02 $18.25 $20.49 $22.72 $24.95
                   
    Δ from Current Price FRG Multiple          
    BK Multiple 7.0x 8.0x 9.0x 10.0x 11.0x 12.0x 13.0x
    3.0x -26% -2% 22% 46% 69% 93% 117%
    4.0x -13% 10% 34% 58% 82% 105% 129%
    5.0x -1% 22% 46% 70% 94% 118% 141%
    6.0x 11% 35% 58% 82% 106% 130% 154%
    7.0x 23% 47% 71% 94% 118% 142% 166%



    Risks:

    Catalyst

    Messages


    SubjectCMG versus TAST
    Entry10/20/2011 06:23 PM
    Membertyler939

    Why are Chipotle's operating margins so much higher than Carroll's?  I know there's not much they can do to change the BK franchise operations, but could they change their operating model in the other stores to be more like Chipotle's to get their margins up?

    I didn't tweet about it, but I think Pollo Tropical is great.

    SubjectFRGI
    Entry01/18/2013 12:42 PM
    Memberstraw1023
    elke or anyone else,
     
    Anyone still follow FRGI?
     
    You have any thoughts on FRGI valuation at these levels ($18.63 at present --> EV = $625mm)? Looking at 6% store growth (actually, less than 6% as unprofitable locations closed at almost same rate) and 4% SSS growth for 2013. $60mm EBITDA; steady-state (no new stores) unlevered FCF about $35-40mm (let's say $37mm). EBITDA probably a bit low due to store openings and D&A certainly greater than maintenance capex.
     
    So, now trades at 10.4x EBITDA and 17x unlevered FCF. The SSS growth is respectable, but this strikes me as fully valued at this point. Anyone have thoughts as to why stock rallying so hard recently?
     
     
     
     
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