GTIM - Good Times Restaurants: Solid Business Fundamentals Fuel Stock Price

Summary

• Good Times Restaurants Inc. has seen its share price drop over 50% even as its underlying business looks increasingly solid.
• While net income is persistently negative, GTIM is generating cash. Management continues to use this cash for share repurchases.
• Given solid business fundamentals, I believe GTIM is poised to see an increase in its share price.

A Tale of Two Strategies

Good Times Restaurants Inc. ( GTIM ) operates two restaurant concepts, Bad Daddy’s Burger Bar (BDBB) and Good Times Burgers & Frozen Custard ((GT)) in several states in the United States. Management implements a distinct strategy for each concept. While BDBB is a full-service casual restaurant (think Cheesecake factory ( CAKE )), GT is a quick service restaurant (like McDonald's ( MCD) ). After analyzing these concepts separately and valuing them together, I believe the company's fundamentals appear solid. This, along with management's actions at gradually buying back shares, makes me assign a Buy rating on GTIM stock.

Bad Daddy’s Burger Bar - Expansion

While GTIM was formed in 1996, the company had only opened its first Bad Daddy's store in 2014. BDBB quickly expanded its footprint, opening and acquiring its franchisees at a rate of ~6 stores per year from 0 stores at the end of 2013 to 37 stores at the end of 2019. As of Fiscal Year 2022, the company owns 40 BDBB stores. This expansion was funded by a mixture of debt and equity issuance. Equity was the main form of financing between Aug 2013 and Dec 2016, with ~8.77 million shares issued for $35.5 million, at an average of ~$4/per share. Post 2016, the company financed its expansion through debt, racking up $12.85 million in debt through 2Q 2020. This is where GTIM got lucky.

As you know, 2020 was a COVID-stricken year which, among other things, prompted the government to launch a series of quantitative easing measures to increase the country’s financial liquidity. Among these efforts was the Paycheck Protection Program , which grants loans to small businesses to pay their employees during the COVID-19 crisis. The company was granted a PPP loan to the amount of $11.8 million, which was subsequently forgiven. This funding essentially wiped out GTIM’s debt, leaving zero debt in the balance sheet that we see today. With all this financing, the company grew Bad Daddy’s revenues and owned store count from zero to $103.5 million and 40 stores.

Good Times Burgers & Frozen Custard - Profitability

On the GT side, store count has been on a rather steady decline since 2014, when they had 37 stores (26 company-operated) to what it is today (31 stores; 23 company-operated). The company has focused on driving profitability through menu price increases for this segment. From FY 2017 through FY 2022, menu prices have increased 28%, resulting in an increase in same store sales (SSS) by 25% and average check sizes doubling. During this span, the company has reported positive EBIT in 5 out of 6 years with a range between 0.1% and 10.5% of revenues. The company has been content to see its GT concepts maintain a positive EBIT without much additional investments as it pursues its expansionary strategies in Bad Daddy’s.

Operating Results

Since 2014 (the birth of Bad Daddy’s), GTIM has reported negative net income and a growing accumulated deficit in every year but one, when they showed a positive net income of $18.4 million in 2021. While it may seem that the company has been losing money year after year, upon deeper inspection, investors will find that the company could have been net income positive had it been for some adjustments and more importantly, is generating cash.

Net Income… Positive?

“We have incurred losses in 29 of our 34 years since inception.” - FY 2022 10-K

Anyone reading the statement above would correctly shudder and move onto the next stock. The company’s SEC filings continually show that the company is making losses, as they have been showing a net loss in their bottom line. However, in recent years, much of the losses were due to non-cash impairment charges. In simple terms, impairment occurs when a company believes that the value of their asset (fair value) may be lower than its stated value (book value). When these discrepancies between fair value and book value arise, the company expenses it in their income statements.

In the past 5 years, GTIM’s net loss in 2 out of the past 4 instances of net loss (they had one year of positive net income) could be attributed to impairments. The table below shows a simple view which compares net income to impairment.

There are several things that occur as a result of negative net income, two of which are:

1. Lower taxes - Lower taxes means that the company has more money to spend for expansions, or stock buybacks. This will be explained a little more in a later section of this article.

2. Lower stock prices - Some investors who use net income as a gauge of whether or not a stock may be worth spending any time over would quickly skip to the next name on their list. After all, who wants to purchase a company with negative net income, especially within the small, illiquid micro-cap space? With depressed stock prices, the company can buy back more stock with the same amount of cash. This will also be explained a little more in a later section of this article.

Cash Generation

Adjusted for pre-opening costs, the company has been generating free cash flow since 2018. Akin to a previous write-up by Kingdom Capital , we define Free Cash Flow as “cash flow run-rate without expansion costs”. However, we take a different approach to the linked article by beginning our FCF calculation from EBIT, (i) netting off capex and depreciation costs, (ii) adjusting for non-cash items, and finally (iii) adding back growth capex in the form of pre-opening cost and development cost. We remove development costs as they are mainly one-time costs related to the development of new stores, rather than the maintenance of stores that are already built.

Despite what the income statement says, Bad Daddy’s and Good Times has been generating positive free cash flow for the past 5 years, with BDBB and GT averaging a 5.7% and 6.2% FCF yield respectively since 2018 through FY2022.

*Estimated based on average development cost of ~$1 million per store.

At current prices, the company has a FCF yield of 20% and an EV/FCF multiple of 4.87. As a bonus, the company’s balance sheet is devoid of debt and the company’s FCF will be unaffected by interest rate hikes. Furthermore, with a healthy cash pile (~$8.9 million in FY 22), the company is able to expand its operations without dipping into debt or selling any equity; a rare case especially in micro-caps.

Source: Company 10K filings, 2022

Shareholder Value Creation

As mentioned above, the company’s negative net income had a couple of benefits. First, it helped reduce GTIM’s tax rate to essentially 0%, thus freeing up some extra cash to create shareholder value. Second, it helped in the company stock remaining under the radar, since potential investors may rather spend their time looking at other micro-cap stocks which are in the green. With these two factors combined, the company has slowly bought back shares.

A previous article noted that the company had previously attempted to buy back a significant amount of shares through a tender offer on 13 Aug 2021. The tender offer was 1.4 million shares for $4.60 apiece. At the time, the shares were trading at ~ $4.39. At the end of the tender period, 10 Sep 2021, the shares traded at $5.18 apiece. The company managed to buy back 333,241 shares, leaving ~$5 million of the budget unused.

Afterwards, in Feb 2022, the company authorized a share repurchase program for up to $5 million, to which ~$962,000 had been used to repurchase 316,000 shares (~$3.05/share). This represents a buyback of ~3% of shares outstanding. More importantly, by continuing their steady pace of buybacks, this again shows the company’s willingness to create shareholder value. In addition, at its current price of $2.85, the company would be able to purchase an additional ~1.4 million shares (~12% of shares outstanding).

These stock buybacks increase shareholder value by decreasing the number of stocks outstanding. In doing so, when the company eventually reports a positive net income, earnings per share would be higher in comparison, which will translate to a higher stock price.

Headwinds / Risks

There are several headwinds and risks to this company. We will explain some of them here.

1. Colorado minimum wage increase

All 23 company-owned and operated Good Times restaurants and 12 out of 40-owned Bad Daddy’s restaurants operate in Colorado, which had just raised its minimum wage . From 1 January 2023, tipped employee minimum wage will increase from $9.54 to $10.63 per hour, a 14% increase. This will increase payroll costs and lower operating profits as the company would need to spend more on hiring more qualified employees.

2. Commodity prices remain high

The company’s food margins have been pressured by the increase in prices of several commodities partly due to the war in Ukraine and other macroeconomic inflationary pressures. Three key commodities affecting the company that have risen are: i. ground beef, ii. chicken breast, and iii. bacon. The rise in commodity prices have caused increased cost pressures, resulting in lower margins on food sales. This impact can be seen in table below which shows that food costs have increased 260bps and 240bps in BDBB and GTIM respectively.

However, commodities have begun/continued to drop, with the prices of chicken breast and bacon prices down ~10% from recent peak, and ground beef prices slowly decreasing ~3% from recent peak. We are cautiously optimistic that with inflation rates steadily dropping, the worst is behind us. As such, the company should see higher margins on their food sales.

To counteract the effect of cost pressures from minimum wage hikes and higher commodity prices, the company has raised menu prices. Year over year, menu prices in GT and BDBB have increased by 7.7% and 5.7% respectively. While these price increases may seem to be rather steep, they are still a net plus for the concepts with same store sales increasing by 1.1% and 11.2% in GT and BDBB respectively. However, it should be noted that these price increases may not be sustainable especially for GT, where such price increases have come at a cost of a decrease of 6.13% in volume of orders. Nevertheless, as supply-side inflationary pressures recede, we will see the company's food margins start to expand through decreased food input costs, thus boosting operating incomes.

3. GTIM is a micro-cap stock

Micro-caps are considered to be risky investments with both great upside and downside potential. Investors should be aware of the pros and cons of investing in micro-caps. While the stock trades in NASDAQ and has ~12 million shares outstanding, it is extremely illiquid, with very thin trading volumes. As such, any single investor may be able to cause large swings in the prices in their attempt to accumulate or exit the stock.

Conclusion

Over the past decade, GTIM has built a new concept which now surpasses its legacy restaurant brands. It’s growth has been fueled by stock issuance and debt. By having its loans forgiven, GTIM boasts a clean balance sheet and what essentially amounts to a government-paid expansion. While net income remains negative, the company is generating positive fee cash flow in both concepts, and is buying back shares at current levels. The current stock price provides potential investors the opportunity to purchase the company’s stock before it reports positive net income and begin trading at higher valuations.

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