Description

Opportunity

MTY Food Group currently trades as if it is a sit-down restaurant company. However, last year, MTY Food Group acquired the 5th largest U.S. pizza chain concept, Papa Murphy’s. Papa Murphy’s is â…“ the size of Papa John’s and 1/7 the size of Domino’s in the U.S.

And—according to our channel checks—Papa Murphy’s has started experiencing same-store-sale comps of +15% to +20%, while MTY’s stock is down 60% post Covid.

We think investors are mistakenly trading MTY Food Group as if it’s a pure-play fine-dining restaurant stock, while over half its sales are not derived from sit-down restaurant concepts. We think it’s a short matter of time before the company reports the performance of Papa Murphy’s and MTY’s stock re-rates. 

Investment Overview -  Papa Murphy’s

During the Covid-19 outbreak and market sell-off earlier this year, restaurant stocks were decimated as investors properly feared restaurants would be one of the hardest hit industries and many locations wouldn’t survive. However, investors quickly learned a fine point of differentiation: while fine dining establishments shut down, certain QSR/fast food restaurant concepts—especially pizza—began to thrive.

While dine-in restaurant stocks experienced -80% to -100% same-store-sale comps as they closed or substantially reduced seating capacity, prominent pizza brands actually produced significant positive comp growth, since they were still able to offer take-out or delivery options. Below are the March, April, May and June YoY positive SSS comp numbers for Domino’s and Papa John’s (Papa John’s just posted their update this morning): 

Due to this, you can see the huge divergence in how sit-down restaurant stocks performed versus pizza stocks. While dine-in restaurant stocks such as Cheesecake Factory (CAKE), Dine Brands (DIN), Darden Restaurants (DRI), Bloomin Brands (BLMN), etc. are all down around 50% YTD, pizza stocks such as Domino’s (DPZ) and Papa John’s (PZZA) are up 25% YTD.

However, note where MTY is on that chart. It’s at the absolute bottom, trading along with the other sit-down restaurant stocks. We think this indicates investors are missing the fact that MTY recently acquired the Top 5 largest pizza brand in the U.S., which accounts for 26% of MTY’s system sales. And hence lies the opportunity in MTY’s stock. Our channel checks indicate that Papa Murphy's same-store-sales are comping +15% +20%, in-line with the comp numbers that Domino’s and Papa John’s have recently reported.

Thus, the magnitude of MTY’s relative share price decline in the face of Papa Murphy’s strength is what we think investors have missed and a major reason why we think the shares are mispriced.

Cold Stone Creamery

Furthermore, MTY’s second biggest brand—after Papa Murphy's pizza—is Cold Stone Creamery. Ice cream is a restaurant concept that does not require sitting down in a restaurant, but is a grab-and-walk treat—perfect for individuals and families that are canceling their travel activities this summer and going for walks outside, as the few activities that are currently considered safe to do. Our channel checks are showing this restaurant concept also performing well. And Baskin-Robbins, a close comp to Cold Stone Creamery, recently reported their SSS numbers:

“As of the week ending May 23, 2020, quarter-to-date comparable store sales declines were negative 10.5 percent for open stores. For the week ending May 23, 2020, Baskin-Robbins U.S. comparable store sales were approximately flat representing a sequential improvement from the negative 10 percent comparable store sales for the week ending April 25, 2020, which was also reported on the Company's first quarter earnings call. [Dunkin Donuts June 3rd, 2020 8-K]”

As you can see, Baskin-Robbins is no longer suffering from the Covid-19 shutdown, but actually gaining strength.

Together, Papa Murphy’s (pizza) and Cold Stone Creamery (ice cream) make up ~42% of MTY’s system sales. We think investors will very soon realize and appreciate the stark positive performance of MTY’s two biggest concepts during the company’s next earnings release (or possibly a performance update before then). Put simply, if around half of MTY’s business is not experiencing the negative 55% same-store-sales decline that restaurant stocks are, MTY’s 55% stock price decline is not justified.

Canada’s CECRA rent-relief stimulus program

Lastly, 39% of MTY’s locations are in Canada (54% are in the US and 7% internationally). And a further significant development that is currently not being baked into MTY’s stock price is that—unlike in the U.S.—Canada recently passed a stimulus program that allows franchisee restaurants to only pay 25% of their rent for three months. This is a stark contrast to the U.S., where investors’ worry whether restaurants can afford to cover their fixed rent expenses. Read more about Canada’s recent CECRA stimulus program at this link: https://www.cmhc-schl.gc.ca/en/finance-and-investing/covid19-cecra-small-business

MTY’s Track Record

MTY has been one of the best performing restaurant stocks of the past decade, generating a 17% annualized return, thanks to the execution of its management team. 

MTY has an impressive track record of growth. Noteworthy, over the last 10 years, MTY has grown EBITDA, EPS, FCF & book value at a CAGR of 21%, 18%, 21% and 23% respectively. These metrics highlight the strength of MTY’s business model.

Organic Growth Initiatives Were Showing Success Prior To COVID-19

Noteworthy, MTY went into the current virus induced industry slowdown from a position of strength. Since being named CEO in November 2018, one of the major priorities of Eric Lefebvre has been organic growth, which a major portion of his compensation is tied to achieving. Under his leadership, the company’s internal operations were restructured, and—at the franchisee level—new marketing initiatives were launched, improved customer interaction training was instituted, new offerings were implemented and certain brands were relaunched. As illustrated below, the company’s February 2020 quarterly results marked the fourth consecutive quarter of improved same store sales—with the biggest improvement in the US, and with Canada posting positive same store sales growth for the 10th consecutive quarter.

The company’s momentum appears to have continued into the recent quarter. According to CEO Lefebvre—when discussing the previous quarter’s results—the first two weeks in March were the two best weeks in the company’s history. 

MTY Food Group’s Brands 

At the end of the March quarter, MTY had ~7,300 locations with a broad and diverse portfolio of brands (see chart below) across Canada and the US—but with Papa Murphy’s and Cold Stone Creamery brands accounting for 42% of MTY’s system-sales.

Putting aside Papa Murphy’s and Cold Stone Creamery, a lot of MTY Food Group’’s brands are QSR take-out/delivery or frozen treat concepts (e.g. Baja Fresh, Blimpie, tcby, sweetFrog, tasti D-lite, pinkberry, Jugo Juice, Planet Smoothie).

For MTY’s remaining concepts that are fine dining (such as Mikes, Scores, Baton Rouge), we expect them to track OpenTable bookings in the U.S. and Canada, which is showing a consistent recovery:

As a quick and important sidepoint, we’d point out that countries such as Australia and Germany have already begun to comp positive YoY growth on OpenTable bookings.

And China’s restaurant recovery has been very strong as well:

These data points support our view that as lockdown orders are lifted (albeit in a choppy manner), consumers will return to restaurants at a healthy cadence.

Valuation / Upside Potential

In 2019, MTY generated $4.06 in adjusted EPS. (GAAP/IFRS EPS was $3.27, but the company has ~$29 million a year in non-recurring intangible amortization expenses, which adds back $0.79 of post-tax EPS.) 

At 19x earnings (MTY’s 5 year average multiple), that is $77/share, which is roughly 210% upside from today’s price.

As evidenced by the 55% decline in MTY’s share price, similar to the declines of dine-in restaurant stocks, the market has already priced in a bleak near-term financial picture that pure-play restaurant stocks are exhibiting. What the market has not priced in is that over half of MTY’s sales do not come from dine-in restaurants. Given the above data, we think MTY should produce FY2021 EPS similar to its FY2019’s $4.06 adjusted EPS. If so, MTY is trading at 6x forward earnings, while it traded at 19x earnings pre-Covid.

Insider Ownership + Yesterday’s Share Buyback Announcement

Lastly, we’d just point out that the insider ownership of MTY’s stock is over 20%, with the CEO recently purchasing shares.

Furthermore, the company just announced a renewal to its share buyback program yesterday.

Catalyst

• Papa Murphy’s pizza brand posting significant positive SSS growth;

• Cold Stone Creamery brand posting better than expected SSS;

• Investors realizing the recent rent forgiveness program in Canada.