CARROLS RESTAURANT GROUP INC TAST
March 11, 2016 - 7:49pm EST by
ringo962
2016 2017
Price: 13.95 EPS 0 0
Shares Out. (in M): 45 P/E 0 0
Market Cap (in M): 633 P/FCF 0 0
Net Debt (in M): 206 EBIT 0 0
TEV: 839 TEV/EBIT 0 0

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Description

Carrols Restaurant Group (TAST)

 

Carrols Restaurant Group, with 717 locations, is the largest operator of Burger King locations in the world. The company has a unique, mutually reinforcing culture that couples strong operating discipline with outstanding capital allocation. The operating discipline manifests itself in system-leading operating margins and same store sales comps. The capital allocation skills are evident in the company’s history of M&A, unit growth, a successful spinoff, and the ongoing relationship with Burger King that features a unique right of first refusal to purchase hundreds of Burger King locations on the East Coast.

 

Taken together, the operating skill and the capital allocation opportunity create a long runway for profitable growth that is still early, and still underappreciated by investors. The stock, currently trading at $14, should appreciate above $20 within a year with reasonable assumptions. Further growth above $20 will only be a matter of continued execution of a well-established plan.

 

Company History

 

Carrols was founded in the 1960s and operated a chain of burger restaurants under its own brand until the 1970s, when it converted to Burger King. The company added units through the late 1990s when Burger King became a built-out concept in the United States. Then, the company bought the Taco Cabana Mexican chain in Texas and Oklahoma, and the Pollo Tropical Caribbean chain in Florida. Both chains were small and represented an opportunity for Carrols to deploy its free cash flow from Burger King operations into unit growth for its newer chains. In 2012, Carrols spun these concepts out into Fiesta Restaurant Group (FRGI), a company that reached nearly $2 billion in market cap in early 2015 before falling along with other small cap stocks in the second half of the year. While the stock has been choppy recently, FRGI continues to put up impressive performance.

 

The spinoff of FRGI came shortly after 3G Capital took control of Burger King. The change in strategy at QSR presented a new growth opportunity for Carrols: consolidation of the fragmented Burger King store base. In the past, Burger King enforced a cap on the number of locations any one company could control. While this rule has long since been eliminated, it left the store base highly fragmented, with the median franchisee owning fewer than 10 units. 3G, whose plans called for strong operations and rapid store renovations, needed bigger, stronger owners. Carrols was their solution.

 

In 2012, 3G bought a stake in Carrols and transferred to the company ownership of 278 units. The company still operates 246 of those units; the rest were structurally unprofitable and have been closed as the leases and franchise agreements expired.

 

Subsequently, Carrols raised further capital through a stock sale and increases in the company’s bond capacity and line of credit. They have been deploying this capital by purchasing additional locations and by remodeling restaurants. Both uses of capital are attractive: remodels deliver low double digit IRRs, and acquisitions are often done at 5X EBITDA. Post close, Carrols can often increase EBITDA margins by hundreds of bps, bringing their purchase multiple lower by one to two turns.

 

Key Metrics

 

Store Count: Currently 717. Pre-authorized by Burger King to grow to 1,000 units. The company acquired 123 locations in 2014, 55 locations in 2015, and 12 YTD in 2016. The company has increased its line of credit in 2016 with a stated goal of further unit acquisition, so there’s basis to believe the pace of M&A will increase in 2016 over 2015.

 

Store remodeling: 430 locations have been upgraded to the current 20/20 format. An additional 85 to 95 will be remodeled in 2016, which will fulfill the company’s commitment to remodel at least 450 units by December 31, 2016. After 2016, the pace of remodels will slow, and the company will swing to free cash flow positive. The company anticipates using much of this cash flow for further store acquisitions.

 

EBITDA margins: The company reports EBITDA margins by store cohort. Stores owned before 2012 are referred to as legacy units. The legacy units have been managed well and are the company’s highest margin units. They have averaged 14% four-wall EBITDA margins over the last few years, though in 2015 they set a new recent high at 16.7% in the fourth quarter.

 

The 2012 cohort, purchased from Burger King corporate, were very low margin units and the company has spent the last few years improving their performance. EBITDA margin at these stores was just 3.0% in 2013. Now, that figure is at 13.5%, putting them within range of the average at Carrols legacy stores. The experienced regional managers (average experience: 27 years!) who led this effort can now be redeployed to new stores as they are acquired.

 

The 2014 and 2015 cohorts, purchased from other franchisees, were better performing units that required less improvement.

 

EBITDA margins are heavily influenced by beef costs. Beef spiked to multi-year highs in 2014 and 2015, before peaking in the middle of last year. As beef costs continue to decline, the company will have very easy margin comps through the balance of 2016.

 

Average unit volume

 

As the company has put up solid SSS, remodeled restaurants, and benefited from new menu items and promotions from Burger King, Carrols has put up impressive SSS performance. The all-units AUV number has been dragged down by acquired restaurants, which do less volume that Carrols units, but looking at the figures on a cohort basis shows ongoing improvement throughout the store base.

 

 

2013

2014

2015

All units

1,176,806

1,190,505

1,274,372

Legacy units

1,263,104

1,276,737

1,376,600

2012 cohort

1,084,442

1,102,482

1,214,315

2014 and 2015 cohorts

 

1,136,522

1,170,472

 

Valuation

 

The future valuation of Carrols will depend most heavily on the pace of store acquisition. If the company can buy approximately 100 units per year at the prices they have achieved in recent years, they will generate considerable value for shareholders. Presented below is a simple model of equity value at different store counts. A few notes on assumptions:

 

  • The company is already at 9% EBITDA margins on a 2015 store base that averaged fewer than 700 units and with high beef costs early in the year. So we believe the 9.00% figure presented in the 800 unit column to be conservative.

  • Through 1000 stores, we have assumed $50 million in additional debt per 100 stores. Beyond the 1000 store threshold, as EBITDA levels grow, we assume that increments of $50 million in additional debt will only be necessary per 200 stores. We believe both estimates are conservative, especially as store remodeling costs trail off in 2017.

  • We have used an EBITDA multiple of 9 to 11 in all scenarios, in line with the EBITDA multiples of many QSR and fast casual restaurant companies. We give no premium valuation for the company’s strong operational history and their lower risk store growth strategy, compared to restaurant concepts that must build new stores.

  • We treat the Burger King preferred stock on a fully converted basis.

  • The company is guiding to 2016 EBITDA of $80 to $90 million, but this guidance does not anticipate any new stores beyond the current 717. So our assumption of $94 million at 800 stores represents a lower per store estimate than the company’s.

 

 

 

Stores

800

900

1000

1200

AUV

$1,300,000

$1,400,000

$1,500,000

$1,550,000

Revenue

$1,040,000,000

$1,260,000,000

$1,500,000,000

$1,860,000,000

EBITDA Margin

9.00%

10.00%

11.00%

11.00%

EBITDA

$93,600,000

$126,000,000

$165,000,000

$204,600,000

multiple

9

11

11

11

EV

$842,400,000

$1,386,000,000

$1,815,000,000

$2,250,600,000

Debt

$206,000,000

$250,000,000

$300,000,000

$350,000,000

Equity value

$636,400,000

$1,136,000,000

$1,515,000,000

$1,900,600,000

FD Shares

45,421,000

45,421,000

45,421,000

45,421,000

Per share

$14

$25

$33

$42

 

Management and Alignment

 

QSR International, the 3G controlled owner of Burger King, owns 21% of the equity through their Series A Preferred stock convertible into 9.4 million common shares. The remaining executive officers and directors own 5.3.% of the shares. CEO Accordino has been with Carrols for 43 years, and the CFO Flanders is a comparative rookie with 19 years of experience with the company. Regional managers average 27 years of experience, and district managers average 19 years of experience.

 

Risks

 

  • The most important, and unquantifiable risk, the potential for a Chipotle-style pathogen scare that does irreparable harm to the brand. This hasn’t happened before to TAST but it is an ever-present risk for a QSR brand.

  • Labor costs could turn unfavorable. While this would hurt COGS and EBITDA margins, it could benefit TAST as smaller BK operators would be hurt more, creating the opportunity for accelerated store acquisitions. Additionally, if Burger King workers can demand more pay, so should most other low skill workers, and such workers have a high marginal propensity to spend. TAST would likely benefit from higher revenue comps on a lagging basis from any rise in labor costs, though this would be only a partial offset.




I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

Strong margin performance in 2016 due to falling beef costs. Ongoing store acquisitions.

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    Description

    Carrols Restaurant Group (TAST)

     

    Carrols Restaurant Group, with 717 locations, is the largest operator of Burger King locations in the world. The company has a unique, mutually reinforcing culture that couples strong operating discipline with outstanding capital allocation. The operating discipline manifests itself in system-leading operating margins and same store sales comps. The capital allocation skills are evident in the company’s history of M&A, unit growth, a successful spinoff, and the ongoing relationship with Burger King that features a unique right of first refusal to purchase hundreds of Burger King locations on the East Coast.

     

    Taken together, the operating skill and the capital allocation opportunity create a long runway for profitable growth that is still early, and still underappreciated by investors. The stock, currently trading at $14, should appreciate above $20 within a year with reasonable assumptions. Further growth above $20 will only be a matter of continued execution of a well-established plan.

     

    Company History

     

    Carrols was founded in the 1960s and operated a chain of burger restaurants under its own brand until the 1970s, when it converted to Burger King. The company added units through the late 1990s when Burger King became a built-out concept in the United States. Then, the company bought the Taco Cabana Mexican chain in Texas and Oklahoma, and the Pollo Tropical Caribbean chain in Florida. Both chains were small and represented an opportunity for Carrols to deploy its free cash flow from Burger King operations into unit growth for its newer chains. In 2012, Carrols spun these concepts out into Fiesta Restaurant Group (FRGI), a company that reached nearly $2 billion in market cap in early 2015 before falling along with other small cap stocks in the second half of the year. While the stock has been choppy recently, FRGI continues to put up impressive performance.

     

    The spinoff of FRGI came shortly after 3G Capital took control of Burger King. The change in strategy at QSR presented a new growth opportunity for Carrols: consolidation of the fragmented Burger King store base. In the past, Burger King enforced a cap on the number of locations any one company could control. While this rule has long since been eliminated, it left the store base highly fragmented, with the median franchisee owning fewer than 10 units. 3G, whose plans called for strong operations and rapid store renovations, needed bigger, stronger owners. Carrols was their solution.

     

    In 2012, 3G bought a stake in Carrols and transferred to the company ownership of 278 units. The company still operates 246 of those units; the rest were structurally unprofitable and have been closed as the leases and franchise agreements expired.

     

    Subsequently, Carrols raised further capital through a stock sale and increases in the company’s bond capacity and line of credit. They have been deploying this capital by purchasing additional locations and by remodeling restaurants. Both uses of capital are attractive: remodels deliver low double digit IRRs, and acquisitions are often done at 5X EBITDA. Post close, Carrols can often increase EBITDA margins by hundreds of bps, bringing their purchase multiple lower by one to two turns.

     

    Key Metrics

     

    Store Count: Currently 717. Pre-authorized by Burger King to grow to 1,000 units. The company acquired 123 locations in 2014, 55 locations in 2015, and 12 YTD in 2016. The company has increased its line of credit in 2016 with a stated goal of further unit acquisition, so there’s basis to believe the pace of M&A will increase in 2016 over 2015.

     

    Store remodeling: 430 locations have been upgraded to the current 20/20 format. An additional 85 to 95 will be remodeled in 2016, which will fulfill the company’s commitment to remodel at least 450 units by December 31, 2016. After 2016, the pace of remodels will slow, and the company will swing to free cash flow positive. The company anticipates using much of this cash flow for further store acquisitions.

     

    EBITDA margins: The company reports EBITDA margins by store cohort. Stores owned before 2012 are referred to as legacy units. The legacy units have been managed well and are the company’s highest margin units. They have averaged 14% four-wall EBITDA margins over the last few years, though in 2015 they set a new recent high at 16.7% in the fourth quarter.

     

    The 2012 cohort, purchased from Burger King corporate, were very low margin units and the company has spent the last few years improving their performance. EBITDA margin at these stores was just 3.0% in 2013. Now, that figure is at 13.5%, putting them within range of the average at Carrols legacy stores. The experienced regional managers (average experience: 27 years!) who led this effort can now be redeployed to new stores as they are acquired.

     

    The 2014 and 2015 cohorts, purchased from other franchisees, were better performing units that required less improvement.

     

    EBITDA margins are heavily influenced by beef costs. Beef spiked to multi-year highs in 2014 and 2015, before peaking in the middle of last year. As beef costs continue to decline, the company will have very easy margin comps through the balance of 2016.

     

    Average unit volume

     

    As the company has put up solid SSS, remodeled restaurants, and benefited from new menu items and promotions from Burger King, Carrols has put up impressive SSS performance. The all-units AUV number has been dragged down by acquired restaurants, which do less volume that Carrols units, but looking at the figures on a cohort basis shows ongoing improvement throughout the store base.

     

     

    2013

    2014

    2015

    All units

    1,176,806

    1,190,505

    1,274,372

    Legacy units

    1,263,104

    1,276,737

    1,376,600

    2012 cohort

    1,084,442

    1,102,482

    1,214,315

    2014 and 2015 cohorts

     

    1,136,522

    1,170,472

     

    Valuation

     

    The future valuation of Carrols will depend most heavily on the pace of store acquisition. If the company can buy approximately 100 units per year at the prices they have achieved in recent years, they will generate considerable value for shareholders. Presented below is a simple model of equity value at different store counts. A few notes on assumptions:

     

     

     

     

    Stores

    800

    900

    1000

    1200

    AUV

    $1,300,000

    $1,400,000

    $1,500,000

    $1,550,000

    Revenue

    $1,040,000,000

    $1,260,000,000

    $1,500,000,000

    $1,860,000,000

    EBITDA Margin

    9.00%

    10.00%

    11.00%

    11.00%

    EBITDA

    $93,600,000

    $126,000,000

    $165,000,000

    $204,600,000

    multiple

    9

    11

    11

    11

    EV

    $842,400,000

    $1,386,000,000

    $1,815,000,000

    $2,250,600,000

    Debt

    $206,000,000

    $250,000,000

    $300,000,000

    $350,000,000

    Equity value

    $636,400,000

    $1,136,000,000

    $1,515,000,000

    $1,900,600,000

    FD Shares

    45,421,000

    45,421,000

    45,421,000

    45,421,000

    Per share

    $14

    $25

    $33

    $42

     

    Management and Alignment

     

    QSR International, the 3G controlled owner of Burger King, owns 21% of the equity through their Series A Preferred stock convertible into 9.4 million common shares. The remaining executive officers and directors own 5.3.% of the shares. CEO Accordino has been with Carrols for 43 years, and the CFO Flanders is a comparative rookie with 19 years of experience with the company. Regional managers average 27 years of experience, and district managers average 19 years of experience.

     

    Risks

     




    I do not hold a position with the issuer such as employment, directorship, or consultancy.
    I and/or others I advise hold a material investment in the issuer's securities.

    Catalyst

    Strong margin performance in 2016 due to falling beef costs. Ongoing store acquisitions.

    Messages


    SubjectAUV
    Entry03/13/2016 05:31 PM
    Membershoobity

    Thank Ringo,

    We keep passing on this stock because it's been "too expensive" and that has done wonders. One thing we wanted to understand from your nice simple model is the AUV...why do you have this going up at you add more stores? Are they buying better stores or something?

    Thanks again


    SubjectRe: AUV
    Entry03/14/2016 10:47 AM
    Memberringo962

    Hi shoobity, thanks for the question. Historically they have a few drivers of increasing SSS:

     

    • Normal SSS increases. They comp above the QSR chain almost every quarter because of their strong operations. 
    • Restaurant remodels: As they remodel restaurants up to the QSR 20/20 standard, they get a one-time double digit lift at each restaurant that they remodel. Restaurant remodels also include a handful of unit relocations each year that can help a lot thanks to better locations. 
    • Lagging restaurant closures: This was more of a factor when they closed about 20 of the weak units they acquired from QSR a few years ago. But even in the small acquisitions they do from other franchisees, there are sometimes one or two units that come with the package that need to be closed.
    • Time: The higher unit counts in my write-up are clearly out-year numbers since it will take time to buy that many units. By the time that happens, the existing cohorts should have a few years of growth to get there. 

     


    SubjectRe: Why not just buy QSR?
    Entry03/14/2016 12:24 PM
    Memberringo962

    Yeah, that's most people's reaction when they think of this idea. However, I believe TAST to be so superior an investment idea to QSR that I actually sold my QSR shares in 2014 to purchase TAST. I continue to believe so. 

    First, TAST has superior growth prospects. There are 15,000 Burger King locations, approximately half in the United States. Last year, QSR franchisees opened 631 locations on a base of 14,300 or so Burger King locations. That's 4% growth. They will grow Tim Horton's faster but there's a limit to the number of locations that can be added to a combined store base approaching 20,000, and they are close to that limit.

    By contrast, TAST can put up low single digit growth from SSS alone. They also have the ability to acquire stores from the 7000 unit base in the United States, and to remodel stores. So they have a much longer runway to deploy capital within their business.

    Second, QSR has been run by 3G for years and is probably nearing the limits of 3Gs ability to cut costs. TAST has been run by the same management team for far longer than 3G has run QSR, but TAST had excess public company costs and operating personnel after they spun off FRGI a few years ago. As they acquire new stores, they are likely to benefit from favorable operating leverage for several more years. TAST has 14.5% restaurant-level EBITDA margins and 8.9% consolidated EBITDA margins after accounting for overhead. That spread has been between 5.1% and 5.6% for a few years, but it should begin to contract as the company scales.

    Third, the 2017E numbers you're looking at may or may not include assumptions for store acquisitions -- you'd need to look at each sell-side report individually. The few I've seen take a conservative approach and exclude M&A from their forecasts. That's despite the fact that store growth is the explicit, stated strategy of the company.

    Fundamentally, I believe that QSR was a better investment early in the ownership period of 3G, and that TAST will be a better investment in this later phase. TAST will benefit from QSR's stewardship of the Burger King brand, and TAST has its own levers to pull to generate value.

     

     

     

     

     

     

     

     


    Subject9-11x?
    Entry03/31/2016 09:05 AM
    MemberActII

    What makes you think 9-11x EBITDA is the right multiple for TAST when franchised QSR boxes are sold in the private market for 5x EBITDA (and TAST buys them for 2-4x fully synergized)??  Sell side keeps throwing those HSD-LDD EBITDA multiples out there and i just dont get it given where these types of businesses traded at in the '90s & early 2000s (like NPC)...

    For more context, TAST traded at an avg. of 6x EBITDA from '07-'13 when it owned Pollo (which has some of the best unit economics in industry). 

     

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