|Shares Out. (in M):||0||P/E|
|Market Cap (in $M):||34||P/FCF|
|Net Debt (in $M):||0||EBIT||0||0|
One might run away from a company that generated top-line CAGR of ~19% from 2002-2007 but concurrently witnessed EBITDA declining at over 20% CAGR for the same period. However, currently trading well-below its tangible book value of ~$51M (although likely to decline some today when results are released), an investment in Caribou Coffee provides substantial upside potential with limited near-term downside risk. Although I maintain a significant amount of concern regarding consumer discretionary businesses, I embrace CBOU as an attractive risk/reward long primarily based on the Company’s brand equity, owner-oriented management and Board (note $560K of insiders bought stock since August 11th with ~75% of such purchased by newly-hired CEO), and the likelihood that I ascribe to operating performance improving based on an effective turnaround implemented by recently hired management.
As a micro-cap, Caribou Coffee (“CBOU” or “the Company”) is an orphaned stock. A review of Q2’08 ownership evidences an absence of any notable institutional public ownership. However, and more importantly, there is owner-oriented alignment at the Board and management level. Arcapita Investment Management, which owns over 60% of CBOU’s stock, is tired of the Company’s recent underperformance and has engaged in several recent management changes that strongly position the Company to execute a successful turnaround. Arcapita is a Bahrain-based investment firm (
The attractiveness of CBOU as a long is premised on a successful operational turnaround. The turnaround is focused on four key areas:
In regards to framing a potential turnaround, it’s worth noting that it wasn’t long ago (in both 2005 and 2006) that CBOU generated EBITDA that exceeded $15M, but in 2007 the Company generated less than $5M of EBITDA. This year is a transition year but Q2 results did evidence recent improvements to operating performance that could be an inflection point of turnaround momentum (note that Q2’08 EBITDA grew by over 20% from prior period; when store closure expense is excluded, the growth yoy was ~65%).
Based on the Company’s current enterprise value of ~$30M, I am attracted to the high probability I assign to management being able to generate EBITDA of at least $10M, a figure the Company exceeded in 2002-2006 as noted below, and also the likely probability that management is able to drive EBITDA back above $15M. Assuming 6x EBITDA (~20% discount to SBUX’s current multiple), if EBITDA were at $15M, CBOU would trade at over $4.75 per share (more than 150% the current price and excluding NOL value at ~$.50 per share) but gaining comfort with again achieving $15M of EBITDA needs to be more than a leap-of-faith.
Historical EBITDA Summary
’02 ’03 ’04 ’05 ’06 ’07 1H’08
CBOU Revenue $108 $123 $160 $198 $236 $257 $125
CBOU Adjusted EBITDA ($M) $11.8 $11.6 $14.4 $15.9 $15.0 $3.8 $3.5 EBITDA Margin 10.9% 9.4% 9.0% 8.0% 6.4% 1.5% 2.8%
A key observation from the above is that CBOU’s margin has been on a steady decline. Furthermore, for context, Peet’s Coffee & Tea--the most comparable publicly-traded peer with almost 200 retail units (primarily in CA)—generated an LTM EBITDA margin at over 11% (note SBUX’s is over 13%). The average EBITDA margin at Peet’s over the past five years is 10.9% compared to 6.9% at Caribou. The main culprit for Caribou’s recent challenges has been the Company’s focus on top-line growth at the expense of optimizing the profitability of such growth and then only very recently reaping the benefits of a growing and profitable commercial segment. Based on CBOU achieving 8-11% EBITDA margin in the past on a lower revenue base, the strong profitable growth at CBOU’s commercial segment, and CBOU’s store unit profitability focus resulting in prudent store closures, I don’t think it’s a leap-of-faith for management to improve the Company’s recent dismal results. Before going into more detail about the potential turnaround, I should provide a summary about Caribou Coffee.
While Starbucks owns about 50% of the QSR beverage category market, this remains a highly fragmented segment in the restaurant industry, with over 40% of the category sales generated from chains with less than 50 locations. Caribou Coffee is the closest domestic coffeehouse competitor (in units) to Starbucks but you might not be familiar with Caribou Coffee despite it being the second largest company-owned specialty coffee retailer in the
Retail Commercial Franchise
Sales $240.3 $12.4 $4.1
EBIT ($11.3) (a) $2.3 $0.7
D&A $32.1 --- ---
EBITDA $20.8 (a) $2.3 $0.7
(a) Includes over $7M of store closing expense (i.e., “non-recurring”)
Note: The financial summary does not include unallocated corporate expense which totaled $22.1M in 2007
Unit level economics are key area of focus for potential improvement
Caribou’s unit level returns are well-below (at half) Peet’s Coffee and Starbucks. The primary issue for Caribou has been annual sales of only $600K per unit, on average, versus approximately or more than $1M at Starbucks and Peet’s. As CBOU continues to prune its underperforming units and focus on its most profitable clusters (e.g., market share leadership in
As with any operational restructuring, the numbers in the near-term won’t provide a clear trend. This idea is premised on changes in mix, likelihood for top-line reductions, but at improved profitability that more than makes up for reduction of unprofitable revenue. On a more specific basis, unit level improvements are being sought by focusing on product throughput, store prototype, labor deployment, growth capacity optimization, and equipment utilization. I anticipate that today’s call might provide more color on the benefit of these and other actions.
Recent changes to executive leadership team provide confidence regarding likelihood for successful turnaround
The concepts that are professed to improve operational performance seem plausible but ultimately it’s all about the execution. I think it’s often difficult for a company of CBOU’s size to attract high-quality executive personnel but these key management hires evidence appropriate experiences that improve the likelihood for a successful turnaround:
CBOU’s valuation at various stock prices is shown below:
$1.50 $2.00 $2.50 $3.00 $3.50 $4.00 $4.50 $5.00
Equity Value (a) $29M $39M $49M $58M $68M $78M $87M $97M
Adjusted Ent Val (c ) $17M $26M $36M $46M $56M $65M $75M $85M
Valuation Multiples (d)
$5M of EBITDA 3.4x 5.2x 7.2x 9.2x 11.2x 13.0x 15.0x 17.0x
$10M of EBITDA 1.7x 2.6x 3.6x 4.6x 5.6x 6.5x 7.5x 8.5x
$15M of EBITDA 1.1x 1.7x 2.4x 3.1x 3.7x 4.3x 5.0x 5.7x
LTM Revenue 0.1x 0.1x 0.1x 0.2x 0.2x 0.3x 0.3x 0.3x
(a) Based on 19.4M outstanding shares
(b) Based on Q2’08: $6.7M cash, $4.0M debt
(c ) Based on $29M of NOLs valued by rule-of-thumb at 33%; NOLs begin to expire in 2011
(d) Based on adjusted enterprise value at various amounts of EBITDA and LTM Revenue ($255.8M)
LTM Revenue and EBITDA Multiples among “Peer” Group
Ent EBITDA Rev EBITDA
Val Rev ($, margin) Mult Mult
Starbucks $10.0B $10.3B $1.4B; 13.2% 1.0x 7.4x
Tim Hortons $4.9B $1.6B $0.4B; 24.9% 3.0x 12.1x
Green Mtn $0.8B $0.5B $57M; 12.4% 1.7x 13.6x
Peet’s $0.3B $0.3B $31M; 11.1% 1.1x 9.6x
Farmer Bros $0.2B $0.3B NA 0.7x NA
One approach to put CBOU’s current enterprise value in perspective is highlighting that Green Mountain Coffee (“GMCR”), which trades at 1.7x LTM Revenue and 13.6x LTM EBITDA, announced in September the acquisition of Tully’s coffee brand and wholesale business for ~$40M. Based on the $30.4M of LTM wholesale sales through June 30th at Tully’s, GMCR’s acquisition amounts to 1.3x LTM Revenue. Caribou’s LTM wholesale (or “commercial” as characterized by CBOU) sales over the same period amounted to ~$15M. During the first half of 2008, CBOU’s commercial/wholesale sales grew by 55% versus the first half of 2007 (more than twice the rate of Tully’s wholesale business); over the same period, EBIT grew by more than 150% to $2.1M for the first half of 2008.
Assuming GMCR or another suitor would buy the commercial/wholesale business, I assume 1.5x LTM Revenue for these purposes. I use a higher multiple than the recent GMCR acquisition based on higher growth being generated at CBOU’s commercial/wholesale segment and more importantly the run-rate segment EBIT of $4.3M. Based on such, I estimate the value for CBOU’s commercial/wholesale at $22.5M (implies just 5.2x EBIT; this is an extremely low valuation but I recognize that the segment EBIT might be somewhat inflated since there is likely some unallocated corporate overhead at CBOU that would burden the commercial/wholesale business if indeed separated). The purpose of disaggregating the commercial/wholesale business is to frame one of the Company’s key areas providing downside protection at the current valuation.
If CBOU was forced to raise cash proceeds or sought to elevate the visibility of how undervalued the public market is pricing its stock, I am confident the Company could separate this segment to monetize it accordingly based on the strength of its brand coupled with existing and growing presence in numerous traditional and non-traditional distribution channels. Assuming such a hypothetical transaction, the remaining retail and franchise business is being valued at ~$10M (note I don’t include value for NOLs as I assume such would offset taxable gains associated with a sale of commercial/wholesale). Given the potential for improvements in the retail operations and ultimately franchise-based growth, this approach that frames the current valuation for the non-commercial business offers substantial downside and upside potential.
There are many issues beyond the fact that I am very bearish about consumer discretionary businesses (i.e., largest composition of my short book) and there is no disputing that visiting a Caribou retail unit is a discretionary purchase decision. The alternatives to making the visit to one’s neighborhood Caribou are numerous and, in addition to consuming home-brew (although CBOU might benefit via its commercial segment), include many competitors beyond Starbucks, such as lower-cost alternatives at venues like McDonald’s, Dunkin Donuts, and 7-Eleven. Caribou does operate within a large market (i.e., the specialty coffee market is substantial and growing) but there’s no disputing that current economic and competitive issues are and will continue to be challenging.
In August 2006, the Company formalized plans to shift to a franchise, rather than company-driven, development strategy. A move to franchising (now 15-20% of CBOU’s total unit mix) provides opportunities for CBOU to improve its business profile, returns on capital, and free cash flow generation. However, in this financing environment where we know even McDonald’s franchisees are troubled to access funding for their coffee expansion, I don’t ascribe any weight to franchising as a catalyst in the near-term relative to the well-documented financing challenges. That being said, it would only be upside versus no expectations. Another concern is that the Company has a poor track record of meeting or exceeding the Street’s expectations and the Company has already sought to improve performance (i.e., engage some turnaround measures) with two other CEOs in just the past 18 months. I am not oblivious to these issues but I think the current stock price discounts all the past issues and assigns virtually no probability to the potential that the current management team (one I deem to be much more qualified than prior) can achieve objectives sought—improve unit profitability, rationalize cost structure, optimize real estate, drive franchising (as noted, I don’t ascribe upside to franchising in the near-term but presumably no one else does and so anything is upside to expectations).
Arcapita and the Shari’ah principle is additional concern. The firm that owns over 60% of CBOU shares manages Caribou Coffee’s capital structure in accordance with Islamic principles, which means that the Company must follow certain business practices when it comes to employing debt (specifically constraining the use of debt) or hedging commodity needs. However, given the current credit crisis, one cannot disagree that the absence of substantial leverage is obviously a good thing and especially so given the bumps in the road that CBOU hit along the way pursuing its growth. Finally, the lack of liquidity in the stock is also a concern but that is primarily a portfolio sizing consideration. Despite these and other concerns I and you might have, I own CBOU and advocate the idea as a long-dated option providing substantial upside potential versus downside risk and therefore an extremely attractive risk/reward for the reasons I described above.
|Entry||11/06/2008 05:38 PM|
|As noted in the idea submitted today, CBOU was expected to report results after-market. My summary follows:|
Revenue was down yoy overall by 1.7% or $1.1M; this is a managed decline of the retail segment (down 6%) through prudent unit closures. The commercial/franchise segment grew by 64%. It is my opinion that Q2'08 results evidenced the first sign of the turnaround as growth in EBITDA reversed the previous trend. The same was evidenced in Q3 as EBITDA was $2.0M for the qtr versus a loss of $0.7M in the prior year. The $2.0M included the burden of $0.6M of closing costs.
As noted in the write-up, I anticipated that TBV of $51M would likely decline and it did indeed as impairment charges were incurred for sixty store units. TBV is now $42.3M.
The Company is focused on the same four turnaround principles outlined in the write-up. It's worth noting that total units are now 495, up from 473 in Q3'07; the mix of franchise units is over 16% now, up from less than 9% last year.
This was management's first earnings call and they sounded confident about the building blocks of the turnaround which includes a focus on rationalizing costs. They highlighted 15% of expense reductions have already been identified.
|Entry||11/07/2008 08:18 AM|
|Thanks for the write-up. I am fairly familiar with Caribou in Minnesota, and people definitely like it better than Starbucks. That said, I swear there are so many Caribou coffee stores there that the Starbucks joke "one on every corner" seems tame by comparison. Basically every stop along the interstate has one. I guess that begs the question of whether so many are needed, because they don't seem to be cutting anymore. Also, can coffee stores really make money? I've wondered whether their short sales times in the mornings (low sales) and having to be open all day (high costs) makes for a viable business model? Caribou also, anecdotally, has higher capex per store because to me they look much nicer than a Starbucks, so their economics may be even worse. Thanks in advance|
|Entry||11/07/2008 09:29 AM|
Thank you for your comments.
Re Minnesota, that is where the co is headquartered as you presumably know and was founded in 1992. At the end of 2007, 47% of CBOU's domestic units were located in MN. As noted on call yesterday, they def don't expect to open more units in MN and especially when their key emphasis is being prudent to close underperf stores throughout their portfolio. They haven't been specific regarding where stores are being closed but I don't think much in MN. Their substantial presence as you highlight dictates stronger unit profitability in MN.
Regarding whether coffee stores are or can be profitable. Industry research describes cash-on-cash returns for CBOU at only 30% and this is largely due to just ~$600K on average per unit versus $1.0-1.1M at Starbucks and Peet's. This is the key emphasis for newly hired mgmt to eliminate the underperf units and optimize unit profitability of the already profitable units. Excluding unallocated $22M corp overhead, the Company describes their retail segment revenue and profitability as follows (I have excluded $7.0M and $0.4M of closing expenses from 2007 and 2006, respectively).
In 2007, $240M of Rev was generated and $27.8M of EBITDA
In 2006, $226M of Rev was generated and $26.8M of EBITDA
As you'll note, the store-level EBITDA margin was much stronger in 2006 and this is consistent with my key message that this company has generated much more profitability on lower revenue in the past and I ascribe much weight to mgmt fixing the situation to return to similar levels. I am sure that $22M of unallocated corp overhead is too much and mgmt did comment on identifying 15% of potential expense reductions already.