Thursday, November 06, 1997

Schlotzsky's, Inc.
(Nasdaq: BUNZ)
Phone: 512-469-7500
Website: http://www.bestbuns.com
Price (11/5/97): $18 3/8


HOW DID IT DOUBLE?

After going public at $11 a share in December of 1995, this deli franchisor saw its stock sit around for the next 18 months. These BUNZ didn't start heating up until last May, when investors started believing this company could make them some dough.

While the stock was quiet, Schlotzsky's was carrying out a rapid expansion leading to soaring systemwide sales. Best of all, as one-time franchise and developer fees have bottomed out, the company has continued to deliver souped up earnings growth around 50% thanks to increasing royalty payments on steadily improving sales and new sources of revenue. Plus, Schlotzsky's has managed this growth without taking on a lot of debt, unlike a restaurant franchisor such as BOSTON CHICKEN (Nasdaq: BOST).

Third quarter numbers reported Oct. 15 highlight the recent trend. Earnings were up 50% to $0.21 per share, a penny ahead of estimates, on 53% revenue growth. Average weekly sales rose 10.2% to $8,958, while stores open at least 18 months scored a 4.6% jump in revenue. Royalties increased 33%.

Altogether, Schlotzsky's has managed to keep the sour dough in its stores and out of shareholder's brokerage accounts.

BUSINESS DESCRIPTION

Based in Austin, Texas, Schlotzsky's is a franchisor of delis specializing in made-to-order sandwiches, sourdough crust pizzas, soups, and other items. There are now 644 Schlotzsky's Delis, about 200 located in Texas. Nearly all are owned and managed by franchisees.

With the help of 40 area developers who line up franchisees, the chain has expanded rapidly in the last few years, adding 120 stores in 1995, 135 stores in 1996, and 78 stores during the first nine months of this year. The company plans to open another 50 stores by year-end. During this period, systemwide sales have grown from $142.5 million in 1995 to $202.4 million last year and $198.5 million for the first nine months of 1997. Average store sales have also increased, from $368,000 in 1995 to $410,000 in 1996 and $221,000 for the first six months of this year.

Schlotzsky's Turnkey Program has aided a move away from strip mall stores to freestanding, upscale restaurants. Through this program, the company has developed about 40 new stores, most of which have now been sold. About 50 new properties are now in development.

On Oct. 15, the company raised about $30 million in a secondary offering of 1.7 million newly issued shares and nearly a million shares offered by selling shareholders. Of this, $6 million will be used to develop company-owned stores, another $1.5 million will go to repay bank debt, and the rest will go into the Turnkey Program. Insiders still own more than a third of the stock.

FINANCIAL FACTS

Income Statement
12-month sales: $28.3 million
12-month income: $4.3 million
12-month EPS: $0.76
Profit margins: 15.2%
Capitalization: $108.2 million*
(*Based on 5.89 million shares. Does not account for the recent secondary offering)

Balance Sheet*
Cash: $7.6 million
Current Assets: $14.9 million
Current Liabilities: $2.9 million
Long-term Debt: $3.6 million
(*As of June 30, 1997. Does not include $30 million raised in secondary)

Ratios
Price-to-earnings: 24.2
Price-to-sales: 3.8

HOW COULD YOU HAVE FOUND THIS DOUBLE?

Take a good franchising concept with a profitable history. Now shift it into overdrive through rapid expansion. Chances are good the franchisor will capture Wall Street's attention, and probably a Double.

That doesn't necessarily mean you're looking at a good investment, but ambition counts for something. In Schlotzsky's case, ambition was also creating triple-digit growth with rising margins, which you could have spotted in the Foolish Workshop beginning in July 1996.

WHERE TO FROM HERE?

First Call shows consensus earnings estimates at $0.80 per share for FY97 and $1.07 for FY98. That suggests growth roughly in line with one analyst's long-term estimate of 32%, giving us a PEG of 0.77 based on growth over the next five quarters and a YPEG fair value of $34.

Schlotzsky's appears to be in good shape financially, too, with limited long-term debt. It is liable for a $14 million construction loan for a limited partnership in which it owns a 40% interest, but the secondary provides a nice cushion, including a wad of dough for new sandwich shops.

Plus, the company has rolled out additional financing deals for its franchisees, with the FRANCHISE FINANCE CORP. OF AMERICA (NYSE: FFA), the nation's largest independent company focused on financing restaurant chains, stepping up on October 8 with $25 million to buy 25 new Schlotzsky's delis.

Licensing fees from the sale of private label foods to franchisees has also created a growing source of new revenues. Plus, average weekly store sales are growing by 10% annually, ahead of still strong same-store sales, which were up 4.6% in the third quarter versus 2.8% for the first six months of the year. The development of slightly larger, more prominently located stores also appears to be paying off.

Delis, of course, have all kinds of competition. But Schlotzsky's successful expansion thus far suggests that a Fool with a taste for franchisors might want to take a closer look at these shares.

- Louis Corrigan, TMFSeymor@aol.com

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