Originally posted on Seeking Alpha
Summary
It’s time to make the move from hamburgers to hot dogs.
Sustained growth of revenues and earnings makes Nathan’s Famous Inc a compelling stock to own.
Insider ownership makes a huge difference in terms of shareholder-friendliness.
The Eulogy
McDonald’s (NYSE:MCD) investors have long enjoyed tremendous returns, thanks to billions and billions of burgers served across the United States and the world. But the growth that once came easy for this fast food pioneer is now officially hard to come by. In fact, thanks to changing consumer tastes, McDonald’s growth is dead.
Yes, the Big Mac is dead.
(…cue the hot dog.)
Are you serious?
Actually, I’m quite serious. But I never would have guessed it apart from Vailshire’s proprietary stock screening protocol. Once I got over the initial shock and disbelief that a hot dog and french fry company could make a great–not good–investment, my mouth started to water.
Though Vailshire Capital Management, LLC is fundamentally a value-oriented firm, our desire to discover (and own) unheralded growth companies with great stories is insatiable.
While McDonald’s will always have a faithful following of die-hard value- and dividend-seeking investors, the following comparison and discussion may persuade you to add Nathan’s Famous Inc. (NASDAQ:NATH) to your long-term portfolio.
Background please
But first a little background…
Incorporated in Delaware in 1992, Nathan’s Famous Inc. markets the “Nathan’s Famous” brand and sells multiple products for consumption. It’s edible products can be found at its quick-service restaurants, as well as within supermarkets and grocery-type stores.
In addition, you may be familiar with “Arthur Treacher’s Original Fish-n-Chips,” which is also owned by Nathan’s Famous Inc.
If its story is not enough to get your investment stomach growling, then maybe NATH’s growth and valuation metrics will.
Compare and contrast
To fairly evaluate NATH, Vailshire has selected fast-food pioneer McDonald’s, as well as the smaller-sized DineEquity Inc (NYSE:DIN)–owner/operator of Applebee’s and International House of Pancakes–and the nearly ubiquitous, Wendy’s Co (NASDAQ:WEN).
Going head-to-head with three more popular and/or similar-sized competitors draws out several important distinctions. (Note that these statistics were taken from gurufocus.com on 10/1/15.) I’ve highlighted the leading values that Vailshire deems most important when evaluating potential investments.
Market capitalization: Vailshire prefers to own companies with smaller market caps, as high levels of growth can generally be sustained for longer periods of time–resulting in an improved stock performance. The market capitalization of NATH is relatively small: only $168 million.
Price-to-earnings (trailing 12 months): For value investors, it’s simple: the lower the P/E, the better. At 17.55, NATH trades at a sizable 23% discount to MCD, the next-cheapest competitor.
Enterprise value to earnings before interest and taxes: Considered by some to be a more sophisticated version of P/E, an EV/EBIT of 11.35 means that NATH offers solid value at current prices.
Price/earnings to growth ratio: One of Vailshire’s favorite metrics, NATH’s PEG of 0.53 means that its P/E is really cheap when its earnings growth is factored in. Peter Lynch, the legendary mutual fund manager from Fidelity, would be proud. He liked to invest in companies with a PEG of less than 1.0. Note that NATH’s competitors are nowhere close.
Yield (%): One tangible measure of shareholder-friendliness, DIN offers the best dividend yield of 3.86% at current prices. MCD is a close second at 3.45%, which continues to entice dividend seekers in our current “zero-interest rate environment.”
Return on Assets (%): How much money does the company make off of all the stuff it owns? NATH leads the pack with a respectable 14.02%.
Return on Equity (%): Of the shareholder’s investments (equity), what kind of return does a company generate? NATH is at 180%, but generally ranges from 5 to 24%. The recent spike in ROE is likely related to NATH’s debt acquisition and special dividend, which will be addressed later.
Operating margin (%): This metric takes the company’s operating income and divides it by its revenue. NATH is in third place at 20.29%. However, margins have been expanding over the past five years; which is a great sign.
Net margin (%): What percentage of profits does a company make after deducting expenses? This often reflects the quality of management and its ability to control costs. Large revenues are one thing, but translating those sales into real earnings is quite another. MCD does relatively well with 16.07% net margins, while NATH is slightly better than its smaller peers.
5-year and 1-year revenue growth (%): Are company sales growing at a good clip, and is the growth sustained? Vailshire likes to see companies with revenue growth rates greater than 20% for at least 5 years. If growth is accelerating over the past 12 months, that’s even better. NATH is the clear leader in this arena, far outpacing its peers.
5-year and 1-year earnings growth (%): Does the company translate revenues into earnings, and has it done so consistently? Again, NATH is far superior to the competition in this important metric. If you see negative earnings and revenue growth over the past one and five years, you better have a good reason for holding the stock in your portfolio. If there is no believable turn-around plan or other upcoming catalyst, then it may be best to sell and move on.
Institutional ownership (%): Though rarely discussed, this is an important metric to consider before investing in a company. Large companies often have very high percentages of institutional ownership, which may add stability to share prices but often limits upside potential. If everybody and their mother, as well as every institution, already knows about a great stock, then the secret’s out… it may not have much further to run. As you can see, NATH has relatively low institutional ownership. So we can still get in while the gettin’s good.
Insider ownership (%): Another favorite Vailshire metric… how much skin does the owner/operator have in the game? Does the operator even own a real piece of the pie? If not, how can you be sure that the executives running the company, of which you are an outside passive minority investor, have your best interests in mind? You can’t! Thankfully, Nathan’s Famous executives currently own 24% of the outstanding shares. McDonald’s weighs in at less than 1%. Think about this difference before buying more MCD with your hard-earned investment dollars.
A lesson in shareholder-friendliness… special dividends.
If you are an astute observer, then you probably noticed the “0*” in the Yield row. As it turns out, the zero percent yield isn’t entirely accurate.
In March of 2015, Nathan’s sold $135 million in (10% coupon) bonds to help finance a $25 per share special dividend to its shareholders. That resulted in a whopping 35% yield on the closing share price that day!
You can debate whether or not it is financially wise for a company to take on debt to finance such an exorbitant pay-out. But one thing is certain, companies with high insider ownership know how to treat their shareholders (aka, “themselves”) well.
Can you even imagine MCD doing such a thing for the simple and obvious benefit of its shareholders? I can’t.
But then again, I’m just a doctor recommending a hot dog company to you as a long-term investment.
Vailshire’s opinion
If you look past the tube-shaped meat, greasy fries and breaded fish, and dig deep into the equally tasty financial statements, you will soon find that Nathan’s Famous Inc represents a fantastic long-term investment opportunity.
The relatively small market cap, consistently growing sales and earnings, cheap valuation and shareholder-friendly, skin-in-the-game management make NATH a must-own holding within your portfolio.
Additional disclosure: Vailshire Capital Management, LLC, with its many clients and flagship hedge fund: Vailshire Partners, LP, may also be long NATH.