RICK - Greystone Capital - RCI Hospitality: Short-Term Bumps Should Pave The Way To Grow Earnings Power

2023-07-31 13:10:00 ET

Summary

• RCI Hospitality is integrating acquisitions, evaluating M&A deals, and advancing new projects to boost revenues and free cash flow.
• RICK's unit economics are strong, with high-margin alcohol sales, profitable nightclubs, and ownership of real estate.
• While there has been a decline in same store sales, there are levers to offset this and strengthen the business for future growth.

The following segment was excerpted from this fund letter.

RCI Hospitality ( RICK )

RCI Hospitality, a top five holding since inception, continues to chug along, integrating recent acquisitions, evaluating M&A deals, and advancing new projects, all of which should have the effect of boosting revenues and free cash flow moving forward. When compared to similar businesses and peers in the restaurant space, RICK’s unit economics are tough to match. Their food/beverage mix skews significantly towards higher margin alcohol, nightclubs boast 40% operating margins, they own the real estate for all their clubs and restaurants, they earn 20-33% cash on cash returns through M&A deals, and Bombshells unit volumes remain attractive (while same store sales numbers have likely reached a trough).

Early in Q3, RICK disclosed their sales figures for both Nightclubs and Bombshells, which were admittedly weaker than I expected and represented the first same stores sales decline following nine straight quarters of positive figures. Up until this point, RICK’s operating results have been largely insulated from both the economy and broader restaurant sector, but a continuation of this trend of same store sales declines would not bode well for the stock. Projected results through 2023 may prove to be unfavorable, but I believe there are levers to pull in order to offset any softness in near term results. Short-term bumps in the road will ultimately pave the way for RICK to continue strengthening the business and setting themselves up to grow earnings power over time.

During periods of share price weakness, shareholders have been rewarded with strong capital allocation in the form of large share buybacks, and M&A deals, which typically accelerate across the industry during periods of economic weakness. As a reminder, RICK completed their largest deal to date (the 11-club Lowrie acquisition) in mid-2021, following the rough year and a half period when many operators were forced to shut down or exit the business. As another reminder, RICK is aiming to deploy $200mm per year during the next few years to continue consolidating the industry with the goal of doubling the company’s EBITDA profile from $100mm to over $200mm. These levers being pulled will serve to grow the company’s earnings power now and into the future, at which point the current valuation will look even more favorable.

We also remain invested alongside a smart owner-operator with plenty of skin in the game and capital allocation prowess. I believe there are multiple ways our downside is protected, and I continue to have a clear eye toward what the company can accomplish during the next few years.

Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.

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