RICK - RCI Hospitality: Stellar Execution And An Attractive Valuation

Summary

• RCI Hospitality Holdings, Inc.'s strong execution has led to all-time high free cash flow and revenue.
• RCI Hospitality’s 2 largest acquisitions, Lowrie and 5 Texas clubs, have been paid off by its share buybacks made in the last 4 years.
• RCI Hospitality incurred $2.3m of stock-based compensation expense during the quarter, which is not a concern for now.
• There was an unusual borrowing from Ed Anakar and Allan CHhay in Oct 2021, though the company has cash on its balance sheet.
• With 30% FCF CAGR expected in the next 3 years, RCI Hospitality Holdings, Inc.'s current valuation is attractive.

Investment Thesis

RCI Hospitality Holdings, Inc. (RICK) is a prime consolidator of nightclubs in the U.S. Its favorable capital structure, management’s deep industry expertise, and the increasingly ready sellers in the sector positions RICK as the preferred buyer of choice. Bombshells, its sports-bar restaurant business, has an industry-leading margin and it is expanding by building more company-owned and franchise units in FY23.

Both businesses are producing tons of free cash flow (“FCF”). There are 500 clubs in the U.S., and RICK has a long runway to grow. With the company set to grow its FCF at 30% for the next 3 years, its current valuation is attractive.

In this article, I am diving into its most recent fiscal 4Q22 earnings call , and in short, I am pleased with the execution and the favorable outlook in FY23. RICK remains one of my top picks going into 2023.

Nightclubs

Revenue Growth

Nightclub 4Q22 revenue grew 40% Y/Y to $56.6m, reaching an all-time high. This was driven by Lowrie’s acquisition made on Oct 2021, which contributed $35.4m of revenue in FY22, and a strong rebound in both new and existing clubs.

After the announcement of its 4Q22 result, the management made the acquisitions of 5 Texas clubs (i.e., 2nd largest acquisitions in history), Heartbreakers Adult Nightclub in Texas, and a RICK Cabaret Steakhouse and Casino .

However, investors are expressing their concerns that management is spreading itself too thinly. In my view, I’d prefer to monitor the execution, and what matters to me is that the management is still focused on the core businesses. A plus point is that CEO Eric Langan is aware that this is out of his circle of competence, and he is looking to hire casino experts :

“…We're bringing in some casino experts. We've got a great firm that we're in negotiations with the consult with us on not only the casino setup, but all of our system setups and those types of things…we're always looking for opportunities to expand and grow in areas…if we can't get an acquisition done…we can open this business and we can open this business…we can keep our growth consistent and never let our growth dip below our 10% to 15% planned rates…”

At the same time, I do also admire the management’s growth-mindedness to pursue additional growth opportunities.

How RICK’s 2 Largest Acquisitions Have Paid off With Its Share Repurchases Over The Years

From FY19 to FY22, RICK made a total of 773,274 share repurchases at a total purchase price of $17.2 million and a price per share of $22.29. These share repurchases have paid off, as RICK paid a total of $46m for both Lowrie and 5 Texas Clubs at a per-share basis of $65.71. This also did not come at the expense of diluting shareholders.

Bombshells

Bombshell's revenue declined sequentially to $14 million due to the increasing number of other restaurants re-opening. Management expects the building of new units to be delayed due to higher construction costs, and by FY24, 5 to 6 company-owned units are expected to be built out.

Its first franchise unit was opened in San Antonio in Jun 2022, and 8 more to expect in the next 1 to 3 years, according to its FY22 10-K.

Management did a new acquisition of a Denver Food Hall with a brewery and video game arcade. CEO Eric stated that games have impressive cash-on-cash returns, and I like how he is thinking from a “cash on cash” return perspective.

Profitability

(Source: RICK 10-Q.)

The overall operating margin (“EBIT margin”) fell sequentially due to the weaker growth from the lower-margin Bombshell. In 4Q22, its nightclub EBIT margin was stable at 40%, while Bombshell's margin fell to 15%.

The nightclub's stellar margin is led by the strong resumption in high-margin service revenue. From FY21 to FY22, its nightclub’s gross margin rose from 88% to 90%, as shown in the 10-K .

30% Expected CAGR In The Next 3 Years

With CEO Eric working on multiple club deals, new company-owned bombshell units, and the re-opening of existing clubs, these should set them up for 30% FCF CAGR in the next 3 years:

“ …2023, we've got some great growth factors…The 15 locations that we bought, especially the 11 that we bought from Lowrie had just come out of COVID openings….so we had a huge step-up in revenues...we're actually pushing to grow at 30%-plus for at least a three-year period here…2023 growth is pretty much in the bag…We've been working very hard on 2024…with the new Bombshells…new Rick's Cabaret Steakhouse Casino…we're also still lining up acquisitions…We're talking with the operators of all sizes from $1 million EBITDA deals to $30 million EBITDA deals…we're trying to reach out to some of them. Some of them are reaching out to us……any acquisition we do is really going to boost growth in 2024…by the end of 2023, we'll be focusing on 2025 growth.”

Stellar Free Cash Flow Generation

As of FY22, RICK's free cash flow has reached an all-time high of $58.9 million, and in terms of FCF margin, it increased from 18% in FY21 to 22% in FY22. On a per-share basis, its FCF per share grew 67% Y/Y from $3.80 in FY21 to $6.38 in FY22. This is just stellar execution from the team, and it serves as an indication of the value they have created for shareholders.

Stock-Based Compensation, Not A Concern For Now

For the first time, RICK incurred a $2.3m stock-based compensation (“SBC”) expense in 4Q22. This is less than 1% of its total revenue. According to its FY22 10-K:

“On February 9, 2022, the board of directors approved a grant of 50,000 stock options each to six members of management subject to the approval of the 2022 Plan…As of September 30, 2022, we had unrecognized compensation cost amounting to $7.1 million related to stock-based compensation awards granted, which is expected to be recognized over a weighted average period of 4.4 years.”

While SBC expense is still an insignificant amount, I feel that this should not be added to its adjusted EBITDA, as it is a real cost to shareholders. Ideally, I want to see SBC be kept at a minimum.

Unusual Lending From Ed Anakar and Allan CHhay in Oct 2021

This was brought up in a discussion with my friend regarding the company’s borrowing from Ed Anakar, RICK’s Director of Operations, and Allen Chhay, brother of CFO Bradley Chhay. It was an unusual transaction given the company has lots of cash on the balance sheet . Just something to note and consider.

Valuation

My valuation remains unchanged from my previous articles . Instead of a DFCF valuation model, I’m doing a forward 1-year valuation based on management’s projected FCF in FY23. 30% growth gives me $76.3 million of FCF in FY23 and a forward multiple of 13.9x.

A company that has 22% margin and a long runway to compound FCF at 30% annually in the next 3 years does command a higher multiple, in my opinion. With where the multiple is today, shareholders should be rewarded in the long haul.

Conclusion

RCI Hospitality Holdings, Inc. management has shown their ability to execute by gushing out tons of FCF for the business, and there is still further room for higher FCF generation given the sheer deals they are working on today.

It's absurd that RCI Hospitality Holdings is still trading at the multiple today given the strong executions and 30% FCF growth in the next 3 years. I believe RICK represents one of the most attractive opportunities.

What are your thoughts on the quarter? Let me know in the comment section below!

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