Nathan's Improves, but Downside Remains Prevalent

Warren Buffett loves the idea of buying commodities and selling brands. Nathan's Famous (NASDAQ: NATH  ) , while technically not a commodity business, produces its own products and licenses out its famous name for lucrative royalties. The result is a restaurant business with smoothed-out long-term earnings due to consistent royalty payments. The company recently negotiated a new royalty deal with John Morrell & Co. -- worth a bare minimum of $10 million this year and more in the coming years. Healthy sales at the restaurants and other business segments are keeping both the top and bottom lines on an upward trend. The tough question facing investors is whether the company can fulfill the expectations baked into the richly valued stock price.

Hot-diggity
With the aforementioned licensing deal in place -- worth a guaranteed $10 million and likely more, according to management -- Nathan's has a bonus on top of its capital-light business model. Its stores are almost entirely franchise locations (a structure that aids gross margins), and its handful of company-owned stores are recovering fast from Superstorm Sandy.

Nathan's iconic flagship restaurant is back on line as of May 2013. The seven-figure-grossing store had been substantially damaged during Sandy and this past year was closed for eight weeks for continued repairs and renovations. Still, in its comparable operating weeks, the Coney Island Nathan's saw nearly 17% higher sales than in the year-ago 30-week period.

In the just-ended quarter, the company posted a 4.3% gain in adjusted EPS -- up one penny to $0.24 per share. The top line grew more impressively at 23.3%.

The quarter outperformed analyst expectations, but Nathan's wasn't concluding a banner year. Franchise revenues were flat year over year, which is especially tepid in light of the fact that the company added 26 new franchised locations around the world. Also weak for the full year was the company's gross profit -- down 20% due to higher beef costs. Management intends to level the playing field by raising prices, but could not guarantee this would mitigate the effects of heightened costs.

Better times ahead?
Nathan's new licensing agreement is a substantial improvement over its former one with SMG (in the just-ended year, SMG licensing revenue was less than $6 million). With sustained franchised location growth in the coming years, investors can reasonably expect to see sales figures rise comfortably, though the troubling cost environment will likely keep pressure on margins.

At a glance, the company looks richly valued for a fast-food business -- trading at a trailing EV/EBITDA of more than 15 times. Investors should note, though, that franchise fast-food businesses, with the exception of McDonald's, are holding relatively high valuations and nearly all are enjoying brisk growth. Burger King Worldwide, for instance, trades at almost 18 times trailing EV/EBITDA. It is possible that the sector at large is a bit overvalued. Recent market pariah McDonald's trades at less than 11 times EV/EBITDA. While it is certainly experiencing a blip in its otherwise steady growth, the company's long-term remains compelling; Nathan's easily has the potential to grow faster than McDonald's due to the size difference between the two companies. Still, it's hard to imagine the significant pricing premium is worthwhile.

Nathan's has recovered fast from the tragic Superstorm Sandy. The company also is in a much better position on its licensing front -- more than doubling its royalty percentage of sales. Still, the market has given the company and some of its peers big shoes to fill. With a lack of downside protection, Nathan's isn't a buy today.

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  • Report this Comment On February 22, 2014, at 1:00 AM, Spankyter wrote:

    I owned Burger King before it was taken private. At the time it had a manageable debt load and a low p/e before being bought. The private equity group loaded it with debt and brought it public at an exorbitant p/e to sell to the the brainless ipo market which includes your outfit. Bkw has a huge debt load which is being completely ignored by mr. Mkt. Nathans has no debt and close to $7 per share in cash which u fail to mention. Factoring the cash per share and potential eps growth from the new deal, the valuation can start looking real cheap. I'm not the only one who thinks so...Mario Gabelli owns all he can via various funds..Teton, gamco, ect. Funny u also mention mcd, which I have owned for over a decade...I probably bought it before u were out of school.

  • Report this Comment On February 26, 2014, at 1:41 PM, hflproperties wrote:

    So Michael you talk about the stock being richly valued. I understand P/E is far from perfect, but using that as a starting point do you mean that a P/E of ~26 is too high and you would look more to some traditional range of 18-20? With the ~4 million additional earnings what would the current P/E be assuming the rest of the income stream was flat? There are what 5 million shares, so 4 mil means an additional 80 cents, add that to TTM and you get 2.68 and 2.68 * (18-20) and you get a stock price range of 48.24 to 53.6. Am I getting the gist of your overvalued comment?

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