FATBP - FAT Brands: Staring Into The Abyss Of Income

2023-03-27 12:30:49 ET

Summary

• FAT Brands is paying out quarterly cash dividends to its common shareholders through the accumulation of more debt.
• The company is structurally unprofitable and held total debt of $1.21 billion as of the end of its fiscal 2022 fourth quarter.
• Whilst the preferreds seemingly offer more stability, their payouts also stand to be suspended as the company's balance sheet is set for deterioration.

FAT Brands (FAT) last declared a quarterly cash dividend of $0.14 per share , in line with its prior payout and for a 7.7% forward yield. Whilst dividends are traditionally associated with profitable and highly cash-generative firms looking to return value to their common shareholders, the Beverly Hills-based owner of several fast casual and casual dining restaurant brands realized a net loss for each of its last four quarters. Fiscal 2022 fourth quarter earnings saw its net loss come in at $70.8 million , a sequential increase from a loss of $23.4 million in the third quarter and a 260% increase from the year-ago quarter. Indeed, FAT's fiscal 2022 net loss came in at $126.2 million, a new record and an increase of 300% from the prior fiscal year. What's happening?

FAT currently owns 17 restaurant brands including Fatburger, Johnny Rockets, Hot Dog on a Stick, Twin Peaks, and Hurricane Grill & Wings. The company also franchises these worldwide. Growth has been aggressive, with 142 new stores opened in 2022 and the addition of 362 stores to its now 1,000-unit development pipeline. FAT intends to open at least 175 stores in 2023 and is franchising over 2,300 units worldwide.

Declining Margins And Total Debt

Fiscal 2022 fourth quarter revenue came in at $103.8 million , an increase of 39.9% over the year-ago comp but a small miss of $983,000 on consensus estimates. This came on the back of system-wide year-over-year sales growth of 22.1% with year-to-date same-store sales growing at 2.7% over its year-ago comp. With same-store sales growth less than inflation, gross profit of $30.5 million declined sequentially from $36.8 million in the third quarter despite revenue being higher.

Gross profit margin during the fourth quarter was 29.3%, down 635 basis points from 35.66% in the third quarter and from 36.9% in the year-ago comp. Food inflation has been running hot and this has had a negative impact on margins with same-store sales, which can be driven by menu price increases, largely insufficient so far to protect margins. This comes as quarterly interest expenses jumped to $25.6 million during the fourth quarter, a new record and set to move higher on the back of a still rising Fed funds rate.

To be clear here, FAT's still-rising quarterly interest expense formed 25% of its revenue during the fourth quarter and has driven its net losses to new highs. Total debt as of the end of the fourth quarter stood at $1.2 billion, up from $1.08 billion in the year-ago period. This is 10x its current market capitalization of $118 million with forward interest expenses of at least $100 million now expected. The company stated that much of its debt sits as a 30-year nonrecourse securitized debt at a fixed rate. Hence, the overall impact of rising rates, while negative, will be somewhat limited. Negative cash flow from operations during the fourth quarter came in at $10.8 million, a deterioration versus positive operational cash flow of $4.7 million in the year-ago comp. With capital expenditure at $8.1 million during the quarter, cash and equivalents was at $28.7 million as of the end of the quarter. This was an increase from $23.9 million in the third quarter, but declined by 49% from $56.7 million in the year-ago period.

Growth At All Costs Faces Inflation

FAT Brands 8.25% Series B Cumulative Preferred Stock ( FATBP ) pays a $2.0625 annual coupon for a 13.6% yield on cost. Any future dividend cut should be mostly borne by the common shareholders as the preferreds rank higher on the capital structure. However, the core risk here is that the company is also forced to suspend these. Management stated during their earnings call that they will not provide guidance for 2023 on the back of the inflation environment. This was followed by CEO Andy Wiederhorn stepping down . It's hard to see the prudence of the company maintaining a $0.14 per share quarterly dividend payout at the same time as trying to raise cash through a failed equity offering .

FAT is essentially taking on debt to fund growth and a $2.3 million quarterly common dividend payment bill and trying to raise cash at the same time by diluting shareholders. The big risk here is heightened by continued food inflation potentially disrupting earnings and sales just as debt and interest expenses continue to grow on the back of aggressive expansion plans. Critically, the company's near-term cash position is restricted and provides a very limited cash runway. The new CEO will have to make a decision on the dividend payment to both the common and preferred holders because both cannot be maintained in this inflationary environment.

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