RICK - RCI Hospitality Holdings: Short-Term Pain Long-Term Winner

2023-07-13 10:00:00 ET

Summary

• RCI Hospitality crashed 10% after presenting disappointing preliminary results.
• The company saw same-store sales drop by 9.6% and spooked the market about the consumer's spending habits.
• RICK is positioned to benefit from a downturn as the preferred buyer of clubs in the market.

On July 11th, RCI Hospitality Holdings ( RICK ) reported an underwhelming sales update sending the stock lower. Should investors be worried or is this a buying opportunity? If you want to learn more about my basic investment case for RICK, check out my prior coverage as well.

What happened?

RICK usually reports a preliminary update on quarterly sales at the start of each quarter. The update disappointed the market this quarter and raised fears of a consumer recession.

Nightclub sales were $62 million, an increase of $7.7 million/14.1% year over year (YoY). While this may sound good initially, $12.2 million were from acquisitions and $1.1 million from reopened clubs (both not included in Same-store-sales (SSS). SSS declined by 7.3% YoY, and a $0.5 million headwind from three smaller Texan clubs closed temporarily for remodeling. This ended a nine-quarter streak of rising SSS for the nightclub segment.

Bombshells were hit even worse. Sales of $14.4 million were down $1.4 million/9%. This resulted in an 18.2% SSS decline if we account for the San Antonio Bombshells and the Grange Food Hall acquisitions that aren't included in SSS.

Combined sales of $76.4 million increased $8.9% YoY, but SSS declined 9.6%. This now spurred questions about the consumer, as many people see RICK's business as an indicator of the consumer's spending behavior. As the company is taking on more debt, some people are also worried about their ability to pay service it.

As a last note, the company updated investors on the progress of the licenses of its Casinos: The liquor license process has begun and gaming licenses are continuing through the progress. The planned opening for both locations is in FY24.

CEO Eric Langan said the following about the quarter:

Third quarter sales reflected the benefit of acquisitions, partially offset by macroeconomic uncertainty, which negatively affected same-store sales. Projects coming online should contribute new sales in 4Q23 and FY24.

How bad is it?

First off, let's take a look at the debt situation. RCI currently has $246 million in debt at an average interest rate of 6.52%. This results in $16.04 million of interest expenses annually. If we compare that to trailing EBITDA of $87 million and $60 million in Free Cash Flow, we can see that they have ample room to service their debt. Debt maturities also don't provide an issue, with just $9.9 million in FY23 and $23.7 million in FY24. Debt isn't a big issue, in my opinion.

Let's not sugarcoat it, a 9.6% decline in SSS is not good, but it isn't a disaster. The last quarters have been great and RICK knows how to handle a recession. Even if the environment continues to cool down, I doubt it'll get as bad as the lockdowns in 2020. Even then, RICK showed a 10% FCF margin and did not lose money during the worst of the lockdown quarters. RICK is a play on the consolidation of the industry and bad times will be as bad for the other players. This might lead to a better deal flow, which RICK can exploit.

Acquisitions

RICK set the goal to deploy $200 million of capital each year for the next three years. The year started strong with over $93 million invested in mainly club acquisitions and some bombshell development. RICK wants to use a mix of FCF, debt and equity to achieve this. In my latest article, I talked about how they could accomplish that. With the current situation, I believe management wouldn't want to deploy more shares, as the stock price is depressed and within the company's buyback range. This could mean that RICK won't be able to meet its expected goal of capital deployment. If all incremental capital comes from debt, that will leverage the company up quite a bit more. RICK owns around 85% of its real estate, so debt isn't bad, but I prefer them to stay under three times debt/EBITDA. Generally, RICK aims to acquire clubs at 3-5 times EBITDA. The company trades at nine times forward EBITDA, so there is a nice arbitrage opportunity here. With a worsening environment, I could see coming deals getting closer to the lower end of the bar.

Additionally, a lot of the clubs are owned by older men where the family doesn't want to continue the business and they might be eager to get out before things get worse. While it might get ugly in the short-term, RICK is prepared to gain long-term benefits from panic in the market, be it with club acquisitions or buying its own stock above 10% FCF yield. I continue to rate RICK a strong buy as long as management sticks to the strategy. That being said, I'm not too fond of the development of Bombshells, like I said in the prior article, and wouldn't be opposed to a spin-off eventually. I am here for the high-margin clubs with large moats.

Last quarter, management gave an FY24 FCF range of $68-78 million. If we're conservative and use just $62 million, 10% under the lower end of guidance, we get a forward FCF yield on the market cap of 9.5% and on enterprise value of 6.7%. This looks pretty attractive, given the large reinvestment opportunity into clubs with large moats and the intention to own them for the long term.

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