Brazil Fast Food Company Is Substantially Undervalued and Has A Moat

In this article I will be talking about Brazil Fast Food Company (BOBS.OB).  Bob’s was founded in 1952 by American tennis player Bob Falkenberg and serves hamburgers and sandwiches with a Brazilian twist, shakes, French fries, and other typical fast food offerings.  BOBS has grown to become the second biggest fast food chain in Brazil with operations in every state of the country, Angola, and Chile.

When I talk about BOBS in all capital letters I mean the company as a whole.  When I refer to Bob’s it means just the fast food burger chain.

A fellow value investor mentioned on my blog that I should research BOBS as a possible investment since I have already researched and written articles on a couple fast food companies; Jack In The Box (JACK) and Wendy’s (WEN).  Also with my recent turn towards concentrating on micro caps he thought I might find this company interesting.

I have found BOBS to be very interesting and it has turned into only the fifth company I have bought into this year as it meets most of my criteria for things I look for in a potential investment.  Some main points of interest are: I have found BOBS to be substantially undervalued, I believe BOBS to have a competitive advantage, or moat that has been growing in the past several years, the company is very small and under followed, and its sales and margins have also been growing in recent years.

Introduction

For the better part of the last 60 years Brazil Fast Food has been operating and franchising only its Bob’s fast food burger chain and expanding the chains reach throughout Brazil.  Here is a history of BOBS up to 2004 that goes over its many struggles and near death multiple times. Very interesting read especially when you consider what they have become now.  After updating its stores, changing the Bob’s logo, enacting cost cutting and efficiency measures, and changing its strategy to become a multi-brand restaurant company with partnerships to bring KFC and Pizza Hut restaurants to Brazil, and through acquiring Doggi’s and Yoggi’s, BOBS has expanded its restaurant count dramatically and expanded from just selling burgers, sandwiches, shakes, and fries, into selling KFC’s chicken related products, pizza’s, hot dogs, frozen yogurt and smoothies to become the second largest fast food chain in Brazil.

As we found out in my Wendy’s article, growth is not always a good thing if your cost of capital is very high due to debt and other costs.  Luckily, BOBS debt is at a very manageable level and BOBS has been lowering its costs over the last few years.  The growth in the amount and type of products along with the growing restaurant count has helped grow revenues and margins at pretty substantial percentages over the last several years.  Most importantly of all, I believe BOBS is growing at less than its cost of capital because as it has grown its store count and sales it has become more profitable.

Also helping to grow BOBS as a whole is that I believe that it has at least some minor competitive advantages which it has had for a while now but has only recently been fully unleashed due to BOBS growing scale as it pertains to its growing number of restaurants, and its cost cutting and efficiency measures over the last several years.  At this point I cannot say for certain whether the small moat I see for BOBS is sustainable for the long term, but this is the first company I have evaluated in a while where I see some kind of very clear moat.

Overview of Operations and Subsidiaries

Before 2007, Brazil Fast Food Company just comprised of Bob’s burger chain which I described above.  In 2007 BOBS as a whole started on its path towards becoming a multi-brand restaurant operation as it agreed with Yum Brands (YUM) to open KFC restaurants in Brazil.  In 2009 BOBS further expanded to include operating some Pizza Hut’s in Brazil and it also acquired Doggi’s hot dog chain.  In 2012 BOBS further expanded as it acquired Yoggi’s frozen yogurt and smoothie company.  Since its beginnings as a regional company in Brazil with the bulk of its operations in the Southeastern portion of the country, BOBS has grown into the second biggest fast food chain in Brazil behind only McDonald’s (MCD) with operations in every state in Brazil.  BOBS has also started to grow outside of Brazil as it now has operations in Chile and Angola.  Below is a chart showing how BOBS has grown its restaurant count since 2007.

122112_0045_NumberofRes1.png

Restaurant count has grown by 7% annually since 2007.  Its growing size and now countrywide operations have enabled BOBS to sign some very favorable agreements with suppliers.  Here are some direct quotes from BOBS 3Q 2012 10Q about the favorable relationship with its trade partners.  Emphasis is mine.

“We enter into agreements with beverage and food suppliers and for each product, we negotiate a monthly performance bonus which will depend on the product sales volume to our chains (including both own-operated and franchise operated). The performance bonus can be paid monthly or in advance (which are estimated), depending on the agreement terms negotiated with each supplier. The performance bonus is recognized as a credit in our Consolidated Statements of Operations (under “Revenues from Trade Partners”). Such revenue is recorded when cash from vendors is received, since it is difficult to estimate the receivable amount and significant doubts about its collectability exists until the vendor agrees with the exact bonus amounts.”

‘The rise in the number of franchisees, from 774 on September 30, 2011 to 916 on September 30, 2012, together with the expansion of the multi-brand concept, has given the Company’s management greater bargaining power with its suppliers. Such increase of point sales did not derived an increase on Revenue from Trade Partners from 2011 to 2012, because the Company had agreements with new trade partners during 2011 and 2010 which originated bonus paid in advance. The bonus recorded during 2012 was from the regular business since no further advances were received during 2012.”

BOBS also has several exclusivity agreements including with Coca-Cola (KO).

“We participate in long-term exclusivity agreements with Coca-Cola, for its soft-drink products, Ambev, the biggest Brazilian brewery company, Farm Frites, the Argentinean producer of French fries, and Sadia, one of the biggest meat processors in Brazil, as well as with Novartis Nutrition for its Ovomaltine chocolate. These agreements are extensive from four to five years. The Coca-Cola agreement was amended in 2008 to extend the exclusivity period to April 2013.”

“Amounts received from the Coca-Cola exclusivity agreements (see note 12) as well as amounts received from other suppliers linked to exclusivity agreements are recorded as deferred income and are being recognized on a straight line basis over the term of such agreements or the related supply agreement. The Company accounts for other supplier exclusivity fees on a straight-line basis over the related supply agreement. The Coca-Cola agreement was amended in 2000 to extend the exclusivity period to 2008.  Later amended and extended until April, 2013. Performance bonuses may also include exclusivity agreements, which are normally paid in advance by suppliers.”

Due to its growing size and economies of scale BOBS has gained a competitive advantage over competitors by being able to receive “bonus payments” in advance from some of its suppliers.  Its size and scale has enabled the company to sign these preferential and exclusive agreements, which have helped expand BOBS competitive position and moat in my opinion.  Another reason I think BOBS has at least a minor moat is because it has been able to raise prices in recent years without losing sales which has helped to raise margins.

BOBS has had these preferential agreements in place for years, and hopefully will be able to continue them for years to come.

Due to BOBS growing store count, the agreements above, and the moat that I think it has, BOBS has been able to improve its sales, reduce its costs, and improve margins in recent years.  Numbers in below charts are taken from Morningstar or BOBS filings.

122012_0603_BOBSRevenue1.png

122112_0359_BOBSCOGSand1.png

122012_1741_BOBSMargins1.png

As you can see in the above charts as BOBS restaurant count has grown, it sales have gone up, costs have gone down, and margins have gone up, substantially so since 2008.  As BOBS continues to grow the same three things should continue to happen as BOBS should continue to compound its economies of scale: More restaurants means more sales, more restaurants means more compact grouping of restaurants which means lower costs and higher margins.  It seems that BOBS has taken some lessons on how to cultivate and grow competitive advantages from companies such as Wal-Mart (WMT).

Margins

All numbers are taken from Morningstar, Yahoo Finance, or BOBS financial reports unless otherwise noted.

Gross Margin TTM

28.00%

Gross Margin 5 Year Average

24.12%

Gross Margin 10 Year Average

24.53%

Op Margin TTM

8.43%

Op Margin 5 Year Average

7.26%

Op Margin 10 Year Average

5.39%

ROE TTM

31.64%

ROE 5 Year Average

31.35%

ROIC TTM

23.76%

ROIC 5 Year Average

21.43%

My ROIC Calculation With Goodwill

45.10%

My ROIC Calculation Without Goodwill

48.30%

My ROIC TTM With Goodwill Using Total Obligations

15.56%

My ROIC TTM Without Goodwill Using Total Obligations

15.25%

FCF/Sales TTM

-3.54%

FCF/Sales 5 Year Average

-1.43%

FCF/Sales 10 Year Average

-1.39%

P/B Current            2.5
Insider Ownership Current

70.36%

My EV/EBIT Current

2.72

My TEV/EBIT Current

6.75

Working Capital TTM     22 $R Million
Working Capital 5 Yr Avg    0.4 $R Million
Working Capital 10 Yr Avg   -3.1 $R Million
Book Value Per Share Current

$3.17

Book Value Per Share 5 Yr Avg

$1.89

Float Score Current

0.88

Float Intensity

0.6

Debt Comparisons:
Total Debt as a % of Balance Sheet TTM

16.78%

Total Debt as a % of Balance Sheet 5 year Average

16.40%

Current Assets to Current Liabilities

1.56

Total Debt to Equity

1.71

Total Debt to Total Assets

72%

Total Obligations and Debt/EBIT

4.36

Margin Thoughts

Please reference my Wendy’s or Jack in the Box articles linked above to see how BOBS compares to the other fast food companies.  TEV/EBIT and last three debt numbers talked about also include total obligations.

  • Almost across the board BOBS margins have been improving over the 5 and 10 year periods I looked at.  Especially impressive are its ROE and ROIC.
  • In comparison to the other fast food companies I have evaluated, BOBS margins are at worst about at the industry average or better than those companies.
  • My estimates of ROIC make the company look absolutely exceptional as I estimate that without total obligations its ROIC is 45.1% with goodwill, and 48.3% without goodwill.  Even if I count total obligations its ROIC with goodwill is 15.25%, and without goodwill is 15.56%.  Numbers that are close to McDonald’s ROIC.
  • Even if we just count BOBS 5 years average ROIC using Morningstar’s numbers of 21.43%, which is what I used when I evaluated the other fast food companies, its margin is 6.35% points better than the industry average, and better than McDonald’s by 4.05% points.  Its ROIC is only bested by Yum Brands ROIC which is inflated by debt unlike BOBS.
  • FCF/Sales for BOBS is worse than the industry average by 8.78% points and regularly negative over the past several years, and still negative this year.
  • I think that its FCF/Sales margin is negative due to cap ex related to renovating and updating some of its restaurants.
  • BOBS P/B is lower than the other fast food companies by a substantial margin.  The only company with a lower P/B is Wendy’s which as I talked about in my article on them, should be higher.
  • Insider ownership above 70% for BOBS is fantastic, especially in comparison to the other fast food companies.  BOBS is effectively a controlled family run company as four individuals own a combined 63.2% of BOBS as of the 2011 annual report: Ricardo Figueiredo Bomeny; the CEO and CFO of BOBS.  Jose Ricardo Bosquet Bomeny; father of Ricardo and brother of Gustavo, business partner with Romulo and owns 20 of BOBS franchised restaurants.  Romulo Borges Fonseca; owns 22 of BOBS franchised restaurants and business partner with Jose.  Gustavo Figueiredo Bomeny; brother of Jose and uncle of Ricardo.
  • I am estimating BOBS EV/EBIT to be only 2.72 and it’s TEV/EBIT to be only 6.75.  BOBS EV/EBIT is lower than any company I have evaluated thus far and it is lower than the other fast food companies I have evaluated whose EV/EBIT average including Wendy’s is 20.12.  As I have stated before, I like to buy companies that have EV/EBIT and TEV/EBIT ratios lower than 8 so BOBS on a relative basis looks very cheap, especially when you consider it’s very high ROE and ROIC and other margins that have been growing.
  • Book value has been growing and BOBS debt levels look very sustainable to me.

Due to the sales and margin growth mentioned above, working capital has gone from negative for the better part of the past decade to now being solidly positive, BOBS accumulated deficit has almost disappeared and shareholders equity has improved drastically, all of which can be seen in the chart below.

122012_0555_WCSEandAD1.png

Other Things Of Note

  • BOBS intends to focus its efforts on expanding both the number of its franchisees and the number of its franchised retail outlets, neither of which are expected to require significant capital expenditure. In addition, the expansion will provide income derived from initial fees charged on new franchised locations.
  • BOBS franchise agreements generally require the franchisee of a traditional Bob’s burger restaurant to pay us an initial fee of $R 60,000, which is lower for kiosks and small stores, and additional monthly royalties fees equal to 5.0% of the franchisee’s gross sales.  Bob’s fast food burger restaurants make up the vast majority of total restaurants in BOBS system.
  • Lowered franchise fee in recent years from $R 90,000 to $R 60,000 to help attract more franchisees.
  • BOBS has bought back shares recently and is authorized to buy back more shares.  I think management has bought back shares at reasonable prices and I think now would be a good time to buy back even more shares.  On December 5th, 2012 Mr. Romulo Borges Fonseca bought an additional 30,500 shares in the open market.  I love to see buys from insiders who acquire their shares in the open market.  Insiders generally only buy for a couple reasons: They think the company is undervalued, and/or that the company is going to perform well into the future.
  • Operating margin for franchises used to be over 80%.  Recently it has dropped into the mid 60% range and it seems to have stabilized in that area.  It looks like the drop in franchise operating margin is due to franchise related costs rising.
  • BOBS has been an OTC listed company for years, and this year it deregistered its shares with the SEC to save money every year, approximately $300,000.  BOBS management says that it will continue to provide quarterly and annual reports to shareholders and that it will retain its reporting standards at the level they are at now.  BOBS management has been in place for nearly 20 years so these things do not bother me that much as management has done a good job running the company over the years.
  • There are only 51 current shareholders of BOBS stock so the company is very under followed.
  • BOBS has substantial tax loss carry forwards NOL’s: As of December 31, 2011 relating to income tax were R$31.6 million, $1.88 per share, and to social contribution tax were R$57.6 million, $3.42 per share.  Social contribution tax is similar to the corporate tax here in the US.
  • Due to its small size with a market cap around $65 million, only 51 shareholders, and it being a controlled company with 70% of BOBS owned by insiders and/or affiliates of the company, average daily volume is only 2,000 shares, and in the past two weeks about half of the days the market has been open there have been no shares traded.
  • Same store sales have been rising in the 4% range every year since 2007.

Intrinsic Valuations

These valuations were done by me, using my estimates and are not a recommendation to buy stock in any of the companies mentioned. Do your own homework.

Valuations were done using BOBS 2011 10K and 2012 third quarter 10Q. All numbers are in millions of Brazilian Real, except per share information, unless otherwise noted.

Low Estimate of Intrinsic Value

Numbers:
Revenue:

237

Multiplied By:
Average 5 year EBIT %:

7.26%

Equals:
Estimated EBIT of:

16.99

Multiplied By:
Assumed Fair Value Multiple of EBIT:                 8X
Equals:
Estimated Fair Enterprise Value of STRT:

135.92

Plus:
Cash, Cash Equivalents, and Short Term Investments:

28.4

Minus:
Total Debt:

21

Equals:
Estimated Fair Value of Common Equity:

143.32

Divided By:
Number of Shares:

8.1

Equals:17.69 R$ per share.
Equals:$8.48 per share.

Base and High Estimate of Intrinsic Value

EBIT and net cash valuation

Cash and cash equivalents are 28.4

Short term investments are 0

Total current liabilities are 38.7

Number of shares are 8.1

Cash and cash equivalents + short-term investments – total current liabilities=

  • 28.4-38.7=-10.3/8.1=-1.27 R$ per share=-$0.61 per in net cash per share.

BOBS has a trailing twelve month EBIT of.

5X, 8X, 11X, and 14X EBIT + cash and cash equivalents + short-term investments:

  • 5X21.2=106+28.4=134.4/8.1=16.59 R$ per share=$7.93 per share.
  • 8X21.2=169.6+28.4=198/8.1=24.44 R$ per share=$11.69 per share.
  • 11X21.2=233.2+28.4=261.6/8.1=32.30 R$ per share=$15.45 per share.
  • 14X21.2=296.8+28.4=325.2/8.1=40.15 R$ per share=$19.20 per share.

From this valuation I would use the 8X and 11X estimates of intrinsic value as my base and high estimates of intrinsic value respectively.  None of the above valuations takes into account BOBS $5.30 per share worth of NOL’s or BOBS future growth.

Relative Valuations

  • As I said above, I like to buy companies whose EV/EBIT and TEV/EBIT ratios are lower than 8 and BOBS ratios are at 2.72 and 6.75 respectively.  BOBS EV/EBIT ratio is the lowest I have found out of the companies that I have done full evaluations on.
  • Its P/B ratio is also quite a bit lower than other fast food companies.
  • BOBS P/E ratio of 9.1 is less than half of the industry P/E of 19.8.

I found BOBS to be cheap on an intrinsic value basis and it also looks to be equally cheap on a relative valuation basis.  On an EV/EBIT basis, BOBS is the lowest valued company I have fully analyzed which is a bit shocking considering its high ROIC and other margins, and the moat that I think it has.

Competitors

  • McDonald’s (MCD): The number one fast food chain in Brazil and fast food behemoth around the world always provides stiff competition to smaller companies.  Here is some information on Arcos Dorados (ARCO)the largest operator of McDonald’s restaurants in Latin America and the world’s largest McDonald’s franchisee.  As of its 2011 10K it had 662 McDonald’s restaurants in Brazil.  Arcos Dorados’ margins are quite a bit worse than BOBS margins.  Overall McDonald’s has more than 1,000 restaurants in Brazil.
  • Giraffas: A private company with around 400 restaurants most of which are in Brazil, it has recently started opening restaurants in South Florida.  Serves similar food as Bobs burger chain.
  • Yogoberry: Another private company who has more than 100 restaurants in Brazil.  Will be competing with BOBS latest acquisition Yoggi’s in the frozen yogurt and smoothie arena.
  • Various other fast food offerings including from Japanese, Middle Eastern, and other typical fast food restaurants.

The fast food service industry is very competitive in Brazil as it is here in the US with peoples income being sought after by a plethora of restaurants and fast food companies.  I think the major threat is of course McDonald’s as BOBS other local competitors are generally quite a bit smaller than it.  I think that due to the moat I see within BOBS, along with its growing size, and expansion into pizza, frozen yogurt, and chicken, that it can compete very well with the competition it has in Brazil, and continue to grow its store count profitably.

Pros

  • BOBS is cheap on an intrinsic value and relative value basis.
  • I think BOBS has a small and growing moat that should continue to grow as BOBS restaurant count gets bigger.
  • BOBS margins generally have been growing over the past five years.  In some cases by multiple percentage points.  Some of BOBS margins are even better than McDonald’s and quite a bit better than Arcos Dorados’ run McDonald’s restaurants in Latin America.
  • BOBS has signed exclusivity agreements with several companies including Coke, and also enjoys preferential agreements with its suppliers.
  • BOBS has $5.30 per share worth of NOL’s that are not even counted in any of my valuations.
  • BOBS has a low and sustainable amount of debt.
  • Its book value per share has been growing.
  • BOBS has almost eliminated its accumulated deficit, made its working capital positive after it being negative for most of the last decade, and substantially increased shareholders equity.
  • COGS and total restaurants costs and expenses as percentages of sales have been lowered by multiple percentage points in recent years.
  • The company is effectively controlled by four individuals who have thus far done a very good job of running the company.
  • BOBS has bought back some shares and has the authorization to buy back more shares.
  • BOBS can grow its restaurants through franchisees at minimal cap ex expenses.  Franchise operating margin has been in the mid 60% range recently.
  • Brazil has a growing middle class that should help grow sales further.

Cons

  • Although I think BOBS has a small and growing moat, it may not be a long term sustainable competitive advantage due to competition and possible loss of exclusivity and preferential trade partner agreements.
  • BOBS does not create consistent positive FCF.
  • BOBS FCF/Sales margin is below the average of the other fast food companies I have evaluated and it is also negative.
  • Franchise operating margin has dropped from over 80% to the mid 60% range in recent years.
  • Stiff competition including McDonald’s in Brazil.

Potential Catalysts

  • Confederations Cup in 2013, FIFA World Cup in 2014, and the Olympics in 2016, all of which are in Brazil, will bring millions of tourists to Brazil which should help grow BOBS revenues further in the short and medium term.
  • BOBS growing franchise store count will help grow BOBS moat as margins are very high and cap ex is very low when opening new franchised restaurants.
  • BOBS moat may not be sustainable over the long term due to competition and possible loss of exclusivity and preferential trade partner agreements which would most likely hurt the company.
  • Brazil’s growing middle class should also help grow sales.

Conclusion

Brazil Fast Food Company, BOBS, has turned out to be a very interesting company to me. From its near death experiences in the mid 90’s and early 2000’s, to now being the number two fast food chain in Brazil, its growing store count and margins, and the various other things I have talked about in this article I have come away very impressed with BOBS as a whole and its management.

I think that BOBS is very undervalued on an intrinsic value and relative value basis and I think that it should conservatively be valued somewhere between $11.50 and $16.00 per share, not including the $5.30 per share in NOL’s that it currently has.  Adding the NOL’s to my estimates of value would take its estimated value up to between $16.50-$22 per share which is the range that I think BOBS should be selling at, and what I think its private market value is.  Even leaving the NOL’s out of the equation, BOBS is selling currently at only $8 per share which is a 32% discount to the absolute minimum I think BOBS is worth at $11.50 per share.  I think that BOBS has a moat that could possibly grow over time, and that the company has catalysts in the short and medium term that could help unlock some of its value.

Warren Buffett always says that if you buy good companies that have some kind of moat at fair prices, that you will do very well investing over the years.  I think BOBS is a good company with a moat that is currently selling at a very cheap price and I think I will do very well holding it over the years as I have bought its shares in my personal account and the accounts I manage.

12 Replies to “Brazil Fast Food Company Is Substantially Undervalued and Has A Moat”

  1. Dividends? Will have to do some dd on Brazil and dividend expectations. Has BOBS ever paid one? Is it common to do so in Brazil? Under what circumstances do you think they would start to payout something? The concentrated ownership seems like it would make dividends appealing, but the growth and capital needs pull in the other direction…

  2. Thanks for your comments.

    BOBS does not pay a dividend and probably has no plans to pay one as it renovates and updates its already standing restaurants and continues to expand the number of its restaurants. I don’t know about other companies in Brazil as that is not something I have looked into before since this is the first Brazilian company I have bought into but I would expect that some companies do pay dividends.

    I will be happy without a dividend as long as management continue to grow its store count, profits, and moat. I also think that buying back shares would be much better than paying dividends at this point though because I think the shares are pretty undervalued.

  3. Jason, thanks for the interesting write-up/idea. A few concerns:

    + Relative to its trading history over the last twelve years, BFFC seems fairly valued
    – It’s trading at 5.2x FV/EBITDA vs. at median from 1/01 to 7/13 of 5.1x
    – Back-up here: https://www.dropbox.com/s/jd84dpoisivi15f/BOBS_Market%20Data_vMaster.xlsx

    + Relative to EPV, it seems fairly valued
    – I calculate R$40mm of adjusted EBIT and use a 15% discount rate

    + Most of the EBIT growth from a shift mix has already played out
    – It’s much harder to increase the mix from 93% to 98% vs. 88% to 93%
    – Growth required is exponential

    + Projected and 2012A capex doesn’t square with the mix shift story
    – 2012A capex was R$18mm (the highest in the ´09 – ’12 period) a
    – Projected capex is R$26mm

    My full thoughts are here: http://www.texantiger.com/post/55473800333/brazil-fast-food-corp-the-easy-moneys-been-made, and my financial model is here: https://www.dropbox.com/s/ugibjw62brvtq2c/BOBS_vMaster.xlsx

    I’d love to hear your thoughts if you get a minute. Thanks again for the idea!

    1. Thanks for your well thought out comment Will.

      Going back and using BOBS historical numbers back as far as you did doesn’t make much sense to me in this case since it has completely transformed itself from a horribly run nearly bankrupt company in the mid 90’s and early 2000’s to a very well run, multi restaurant company, that has focused a lot more on expanding its very high margin franchised restaurants, improving profitability, and reducing costs pretty substantially. Even as closely back as 2007 BOBS was still mainly a single company restaurant entity. So taking their historical numbers from 2001 makes little sense to me.

      Even putting all of that aside though and just concentrating on how they were operating when I wrote the original article in December (Its numbers and results have actually improved pretty dramatically since my original article and BOBS is even better off now than they were) if you think that they were fairly valued at that time that would mean that you think that a) It wouldn’t keep up its more recent improved profitability over the last 5 or so years, b) that it has no competitive advantages at all, c) that its NOL’s are worth nothing, d) that its current operations, cash, and cash equivalents were worth less than 5X EBIT, e) that the company that was selling at an EV/EBIT of 2.72 and a TEV/EBIT of 6.75 were fairly valued. By the way the EV/EBIT of 2.72 is still the lowest EV/EBIT I have found when doing my full evaluations of all the companies I have researched.

      BOBS should actually be able to continue to improve its profitability since it is now concentrated almost fully on expanding its franchised restaurants which have a currently garnering around a 60% EBIT margin and cutting costs in recent years. Its sales and profitability should also continue to improve due to the recent Confederations Cup and upcoming World Cup and Olympics all within the next several years.

      Assuming that BOBS has no moat at all is a safe assumption and is actually what I based my analysis off of.

      Even if you discount BOBS NOL’s by 50%, which is a very very conservative estimate, you get an extra $2.15 per share added to the companies valuation. Which would mean that for BOBS to be fairly valued its operations, cash, and cash equivalents + NOL’s would have to be valued at approximately 3-4X EBIT. This in my opinion is way too low of an estimate considering how well the company has been doing in the last 5 years or so and would mean that you think that its operations, cash, cash equivalents, and NOL’s are adding very little value to the company. You would struggle to find anything more undervalued than this, especially when it is running as well as BOBS is now and I have not found anything this well run that has been even close to that undervalued.

      Along with the above is that BOBS EV/EBIT of 2.72 is by far the lowest of any company I have done a full evaluation on. If you think that is a fairly valued company you are a far more conservative investor than I am and I am one of the more conservative value investors that I have come across and you would struggle to buy much of anything except during a recession.

      The company requires more cap ex because of all the restaurants it has been opening lately and some updating of its current restaurants.

      Please post your thoughts back as I would love to spark a discussion about this here and thanks a lot again.

      1. Jason,

        Thanks for your response. To be clear, I am evaluating this as an investment today, not when you wrote up the company.

        My issues are as follows:

        + While I agree that the company has undergone a transformation, I prefer not to invest in a company based on the concept that the market will re-value the company at a multiple at which it has not valued the stock historically

        – To argue that BOBS is cheap at 5.8x FV/EBITDA (note my 5.1x number was based on a stale R$/US$ exchange rate), you have to argue that going forward, the market will rate this company at a higher multiple than it has over the last ten years
        – For what it’s worth, the market may very well re-rate this stock because management has transformed the business, but I’m not a believer in the notion that the stock is cheap assuming the market will re-rate it
        – Again, here is the Excel back-up on multiples over time:
        https://www.dropbox.com/s/jd84dpoisivi15f/BOBS_Market%20Data_vMaster.xlsx

        + With the conservative assumption that EBIT/store is constant, the number of stores required to double the base of R$30mm is 3x larger than the number of stores that were required to double an EBIT base of R$10mm

        – Opening stores 950 – 1200 is more difficult than opening stores 600 – 950, as markets become saturated
        – Half of the EBIT that management added from ’09 – ’12 came from a one-time franchise mix shift that they will not be able to replicate
        – Again, here is the Excel model in full:
        https://www.dropbox.com/s/ugibjw62brvtq2c/BOBS_vMaster.xlsx

        + The company should not require R$26mm capex to open franchised restaurants, so I’m left to conclude that they are opening/renovating owned-operated stores

        – Franchised restaurants require minimal investment by the franchisor (that’s the beauty of the model)
        – They’ve disclosed that (a) they are targeting opening 150 stores in 2013 and (b) expecting to spend R$26mm in capex; in 2010, they opened 90 franchises with capital expenditures of R$5mm, and in 2011 they opened 101 with capex of $9mm
        – Of their owned-operated stores, both Bob’s and Pizza Hut operate at much lower EBIT margins than the franchised stores (2.7% and 15.5% 2012A EBIT margins, respectively), so I’m a little worried that they’re putting R$26mm of cash into them. KFC has been a negative EBIT business for the last five years, so hopefully, they aren’t allocating any capital to it.

        + Maybe, I’m just too conservative on the NOL front, but I have a hard time buying into the idea that 20% to 40% of the value of the company ($2.15 to $4.30) is in the NOLs

        Basically, on a go-forward basis, I’m left to conclude that for this stock to be a double to triple in the next three years, I must believe one or more of the following: (a) there is enough white space for the company to open a lot more franchised restaurants (i.e, 600+), (b) management will drastically improve the profitability of their owned-operated stores (i.e., owned-operated EBIT margins rise from ~10% to ~20%), or (c) the market will permanently re-rate the multiple of this stock (i.e, to 9x FV/EBITDA) going forward. To me, it’s a perfectly valid investment thesis that any of or all of these three things happen; that being said, given that (a) the stock currently trades in-line with its historical multiple and its intrinsic value (as estimtaed by EPV) and that (b) an investment in Bob’s is now predicated on growth or on a multiple re-rating, I just don’t see the stock as cheap.

        One final point/question: when you talk about an EV/EBIT ratio of 2.72x, is “EV” Equity Value? If so, I don’t think an Equity Value/EBIT ratio is appropriate, as EBIT is available to all of the company’s owners of capital (both lenders and shareholders) whereas equity value is only available to the shareholders.

        I’d love to keep up the conversation—please let me know your thoughts when you get a moment. Thanks again for the write-up!

        Best,
        Will

        1. Great discussion here and if anyone else has something to add feel free to jump in.

          I am not valuing the company expecting Mr. Market to rerate its multiple, I am valuing the company based off of a very conservative estimate of its operations, cash, cash equivalents, and NOL’s now. None of that is based off expecting Mr. Market to rerate its value.

          Why would you continue to use its historical valuation range going back 12 years when the company has completely transformed itself for the better by your own admission in the last 5+ years?

          In my valuations and analysis I do not look out into the future and try to guess how many restaurants they will expand to or what their margins will look like. My valuations and analysis are based off of the present and to some degree on the past but anything in the future is just icing on the cake in most circumstances to me. I do think that BOBS will continue to grow its franchise base and that the upcoming huge events in Brazil will help its results in the short and medium term but as long as the company keeps growing efficiently and profitably like they have been than I do not really care how many restaurants it has because it will continue to gain value if those things happen. I do agree that it is going to be a bit harder to open a bunch more restaurants due to more competition but Brazil is a gigantic country, almost the size of the US, so there is still plenty of room to grow. The Brazilian middle class is growing pretty substantially too as I linked to in the original article which should also help.

          EV is enterprise value in that calculation. That EV/EBIT, and also TEV/EBIT which is total enterprise value, is a way I use relative valuations to see how it stacks up against other companies. BOBS EV/EBIT of 2.72 is by far the lowest valuation using this metric that I have found up to this point. Stated another way if you think that BOBS is fairly valued at an EV/EBIT of 2.72 than I would not have found any company to buy into yet in almost 5 years of doing research. That is of course just one of the valuations I use but I found it to be undervalued by pretty much everyone of my other valuations as well.

          What’s the matter with NOL’s adding substantial value to a company? Anything that adds value to a company and is tangible I am all for. My conservatism is why I discount NOL’s as well.

          Looking forward to your thoughts again.

          1. Got it. Thanks. A couple questions and thoughts:

            + What’s the difference between enterprise value and total enterprise value?

            + Can you provide back-up for your calculations for EV/EBIT, EV/EBITDA, TEV/EBIT and TEV/EBITDA? I’m currently getting that the company is trading at 5.9x Firm Value / LTM EBITDA and 7.3x Firm Value / LTM EBIT (for what it’s worth CapIQ has pretty similar numbers, and the only difference is the exchange rate from R$ to US$)

            – I’ve got an equity price of US$13.50 with shares out of 8.129mm for a market cap of US$109.7mm
            – Firm Value of adjustments of R$38.6mm (US$17mm of cash), R$16.3mm (US$7.2mm) debt and $4.5mm (US$2mm) of NCI
            – Thus my firm value is US$101.9mm (US$109.7 – US$17mm + US$7.2mm + US$2mm)
            – I’ve got LTM EBITDA at R$39mm (US$17mm) and LTM EBIT at R$32mm (US$14mm)
            – With a firm value of US$101.9mm, LTM EBITDA of US$17.2mm and LTM EBIT of $14mm, I get FV / LTM EBITDA of 5.9x and FV / LTM EBIT of 7.3x
            – Please break-out the NOL value, as I do not include NOLs in my analysis
            – To see my Firm Value / LTM EBITDA and Firm Value / LTM EBIT calculations, please refer to the overview tab of the BOBS_vMaster.xls file to which I linked above

            + I think we are talking past each other when you say that you are not basing your analysis on the market’s re-rating the company: if the company has traded at 5.1x firm value / EBITDA over the last twelve years, and it currently trades 5.9x firm value / EBITDA, then it cannot be cheap relative to its historic multiple

            + Now you can argue that its historical multiple isn’t relevant because the stock has undergone a transformation—this point is, in fact, what you implied when you asked “Why would you continue to use its historical valuation range . . . when the company has completely transformed”–but by arguing that the historic multiple isn’t relevant, you’re arguing that the market will value the company at a higher multiple in the next twelve years than it has in the last twelve years, i.e., that the market will re-rate the company at a higher multiple

            + I use the historic multiple because it is more conservative than assuming that the transformation will cause the market to view the multiple differently going forward or that it will cause the market to value the company more aggressively going forward

          2. Will

            I will get back to you later today or tomorrow about what I value BOBS at now since I have not revalued them at all since my original article and just got back from vacation yesterday.

            I calculate everything myself now and the major calculations I use are below.

            ROIC=EBIT/(Equity-goodwill+debt-cash) or ROIC=EBIT/(Equity+debt-cash)

            Enterprise Value=Market cap+debt+minority interest+preferred shares-cash and cash equivalents

            EV/EBIT is the above calculation divided by EBIT or operating margin and I use it as one of many relative valuations to see how a company stacks up valuation wise to other companies. Generally the lower the better and I love this number to be below 8 when considering buying into a company.

            Total Enterprise Value which I learned from Red’s wonderful The Red Corner Blog. I cannot recommend going back to the beginning of his blog enough, going through all of his posts, reading, and taking notes. I still do to this day actually.

            TEV=Market cap+all debt equivalents (including the capitalized value of operating leases, unfunded pensions, etc) – cash, cash equivalents, and short term investments-long term investments-net deferred tax assets.

            TEV/EBIT uses the above calculation and divides it by EBIT. This is one of my favorite metrics to use because it incorporates a companies total debt and obligations and I think shows a much truer picture of a company. Again I love his number to be lower than 8.

            Earnings yield-either EBIT/EV or I prefer EBIT/TEV. I like this to be in the ~15%+ range.

            The TEV number in the above calculations is almost always a more conservative number than regular EV.

          3. @willbeuttenmuller:disqus

            After revaluing BOBS with its updated numbers I have decided to turn it into a mini article and plan to post my findings next week. I think you will be very interested to see what I have found.

  4. BOBS needs to reinvest approx 15% of operating profit to generate 6% growth. Dividend norms in Brazil are similar to US norms and it isn’t unreasonable to expect a dividend policy that pays out ~2/3 of earnings.even as it grows.

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