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Friday, November 13, 1998

An Investment Opinion
by Warren Gump

Rising Profits at Pizzeria Uno

Time once again to let Mr. Stomach lead me to another investing idea. You will probably notice that many of my ideas are consumer related. This is no crazy conspiracy to introduce you to everything I like. Rather, it is because some of my most successful investing comes from placing money where I am a consumer.

It is important to note, however, that just because you like a product doesn't mean other people will. Investors need to dig behind the numbers to see what is happening at a company. Let's take a look at Uno Restaurant Corp. (NYSE: UNO). I've loved this restaurant (it operates Pizzeria Uno) since first being introduced to it over a decade ago. It hasn't, however, been a great stock to own. Since the end of 1995, while the S&P 500 has provided an 85% return, little old Uno had the amazing return of zilch!

What happened? After a couple of successful years, Uno had a tough 1996 when EPS fell from $0.58 to $0.13 (included a charge that, taxed at 37%, would be $0.19). The primary culprit of this decline was falling same-store sales, slowed unit openings, and higher food and labor costs due to the rollout of a broadened menu (with numerous entrees outside of pizza). Off the low 1996 base, EPS rebounded modestly in 1997 to $0.22 (including a charge of approximately $0.22), but were still far short of those in 1995.

In the recently completed fiscal year, which ended in September, Uno appears to have finally turned the corner. Same-store sales were actually positive for the year (albeit off of a low base), with company units posting a 1.3% increase. More importantly, sales have been improving steadily since the June systemwide introduction of the company's "bigger, better menu." Management stated that average weekly sales had increased for 23 consecutive weeks since the new menu rollout, with a 7% increase in October that was trending higher in November.

Finally, after much tweaking and reworking, the company's menu changes are positively flowing through to the income statement. Reported EPS for the year ending in September (fiscal 1998) were $0.49, but that included a $0.06 charge related to the way companies expense preopening costs (a much less nefarious hit than the prior charges, which were related to bad investments).

Along with sales increases, margins are moving in the right direction. Comparing fiscal 1998 to the prior year, Uno increased its operating margin (excluding charges) by 0.4 percentage points to 6.6% from 6.2%. Behind this move were two variables. Cost of Goods Sold (food) increased by 0.6 percentage points because of soaring cheese costs and new menu items. At the same time, fixed costs such as occupancy, depreciation, and general & administrative expense decreased 1.7 percentage points as same-store sales and efficiency improved. In the fourth quarter, operating income reached 8.1%, up 0.5 percentage points from the prior year.

Now that store-level operations seem back on track, Uno is looking to again grow the chain. On its base of 96 owned and 64 franchised units, Uno expects to open six to eight new company and 10-12 new franchised units in 1999. Looking out further, the company expects to increase store operating weeks by 10% in 2000 and 2001. Cash from operations should be more than sufficient to cover capital expenditures over the next twelve months.

You may have expected the stock price to have jumped up now that Uno appears back on a growth track. So far, at least, investors have decided to stick to the sidelines. Potentially this is because all the Wall Street analysts have dropped coverage of the stock. (Talk about fair-weather friends!) Without any estimates from wise gurus, we will rely on management's estimates that Uno can improve EPS by 25% in 1999 and at least 20% annually over the next three years. Since management predictions tend to be optimistic, I have tempered my own expectations for the company to 15%-20% growth.

There don't appear to be too many people interested in selling Uno stock below the current price. When the stock dipped down to $6 a share in September, the company announced plans to repurchase 1 million shares for up to $7 in a tender offer. Most of the folks owning Uno stock wanted to stay on board, however, as only 274,721 shares were tendered. Given these results, I would be surprised if the stock were to trade much below $7 a share unless company performance dramatically shifts. As an aside, insiders (primarily Chairman Aaron Spencer) hold over 59% of company stock.

The casual dining segment of the restaurant business is brutally competitive, but can be quite lucrative if executed correctly. Given anemic fundamentals, staying away from Uno stock over the past three years was a great idea. As noted above, just because a product or concept is good doesn't mean the company that produces it is worth investing in. You do, however, have a birds-eye view of changes and can be one of the first in the door when positive trends develop. With the stock trading at 13x trailing earnings (excluding the accounting charge) and a growth rate of 15%-20%, it may be time to bite into more than Uno's great pizza.