FRII - Freshii

[peterHK]

Freshii was a hot IPO in Canada as it was a consumer discretionary stock, and there are few of those, so institutional people were all over it. It debuted with high expectations on sales growth.

 

They operate as a QSR, "healthy" restaurant (albeit one that has a few items with a lot of salt and sugar in them), where the publically listed entity is a franchisor. The result is that the public entity is high margin, capital light, and with ~$38mn of net cash, has a good balance sheet that can support continued expansion of the store base.

 

The unit economics of the stores are supposedly very good, with some franchises earning 30-40% cash on cash returns. In addition to this, the company is partnering with Air Canada to serve meals on flights, and has a number of these deals in the works which offer low cannibalization ways to grow the concept.

 

The subsequent crash has been a result of dialing back growth expectations, and in the most recent quarter reporting same store sales of 0.9% vs. what they had historically run at which was in the range of 3-4%. They are still aiming to grow stores to ~750 by the end of 2019, system-wide sales of $280 million, and EBITDA of $12-14 million for the public company. This implies same store sales growth of 3-4%.

 

They currently have 421 stores, with 185 in the pipeline to open, bringing high visibility to getting to ~600, and they have historically been able to open 25 or so net a quarter, so there's another 100 in 2019. Perhaps they don't get to 750, but they can get close enough.

 

FOr valuation, assuming $12 million in 2019E EBITDA, you have a business growing ideally at 3% + 100 stores a year = close to 20% a year, trading at 8.75x 2019E EBITDA that is a capital light, high margin franchisor run by an owner operator with significant stock ownership. Peers with lower growth prospects trade at much higher valuations, though they're larger so that is some of why that discrepancy exists.

 

Peers trade closer to 15x forward EBITDA, so if FRII garnered an in-line multiple that balanced its smaller size with its superior growth prospects, it'd be a $7 stock, that still could grow 10-15% a year, so you'd realize nice IRR's.

 

So that's the bull thesis in a nutshell that I've heard from a few folks.

 

My issues are:

 

1) I don't like the food, it's completely average (I live and work in downtown Vancouver and there are literally dozens of better options available from Tractor to PokeTime/PokeRito, Hubbub etc.)

 

2) They're overpriced relative to the quality of the food. I have eaten there once as part of due diligence and never was compelled to go back.

 

3) The locations I've been into (a few as part of DD), particularly the one on Georgia Street in downtown are uninspiring and look not far off from a 10 year old Subway.

 

4) They have no rabid fan base like MCD, SBUX, or CMG.

 

5) Because they have no rabid fan base, I think they have almost zero competitive advantage; to me living in Vancouver, it's just another (poorly executed) healthy eating option which competes on price and location.

 

6) Management has a history of overpromising and under-delivering. They did it first with store number growth, and last quarter, we saw SSS slow very rapidly, which they said was due to trouble in the US (where they compete with lots of players, including a CMG that is trying to win back share).

 

So my problem is this. I love the business model: high FCF, very high margin, high multiple, capital light, can compound very well etc. But I don't like this company.

 

Am I missing something?

 

 

 

 

 

 

 

[scroogeMcdollar]

I looked at Freshii as a investment before & I agree with you on your issues.

 

I can personally add for a micro perspective, having gone two at least 5 different locations (Alberta region), they have very little franchise consistency or quality consistency over their franchises (which I think is a big reason why they don't have the 'rabis fan base' you mention). I've had decent-to-mediocre meals there followed by a completely butchered bad version of the same menu item at another location.

 

Take this with a grain of salt: I also was able to look at their franchisee package through a friend restauranteur couple years ago(try to find one online, maybe has changed since), it's terrible, no franchise protection and a bunch of bad support with very little due diligence in terms of franchise rights holders (at one point I've heard they were approaching new undergrads at universities to coax them to open a franchise as a 'first business' a few years ago). Which I think is part of their 'aggressive' store opening strategy.

 

Another thing is density, I honestly have seen freshii's within 1-2 block within each other, to the point where it would be considered canibalising sales (also could be why same store sales are down maybe?). More freshiis in a radius than Timmies or McDonalds, which to me is unsustainable for the franchisees and imo bad practice. Just checking their locations page, I can see small cities with 5+ locations within a km of each other. Seems they are handing out franshises like candy to 'new franchisees' without any area provisions (my guess).

 

 

I don't think they will get anywhere near their target if this is their strategy.

My two $

 

 

 

 

 

[Rod]

I looked into the stock about a year ago and ended up passing for most of the reasons you listed. Coincidently I was planning on stopping into a nearby Freshii today for lunch and it had closed. That alone doesn't prove very much, but it doesn't inspire confidence. I don't know what the franchise rules are. Can you sell a Freshii franchise privately to a new owner? If so, I would look at Freshii locations that are for sale and see if the price being asked is low. That would be a big red flag. Companies like this always look seductive based on the capital light royalty model and the growth potential. But it all comes down to the success of the franchisees. If they aren't doing well it's a house of cards IMO.

[rb]

I'm not very enthusiastic about the company. It's not a place that I frequent. It seems to be popular with the millennial crowd. I was there meeting my sister for lunch once and I couldn't figure out how to order food. I wasn't that hungry so I passed.

 

Now, maybe I'm not part of their target market. But I wouldn't buy the stock.

[peterHK]

Glad I'm not alone in my concerns.

 

The contrarian in my says this might be all priced in, but I don't want to buy bad businesses so I think I'll be staying away for the time being.

[whistlerbumps]

The interesting thing is that all of these issues have existed for a while but franchisee health seemed very solid until recently with good same store sales until Q2 18. 

 

Does anyone have any experience with Subway in the early years (book or personal) in the early years with how it was perceived?  Obviously Subway subs are horrible compared to niche sandwich shops and there are a lot of decrepit subways.  However, neither of those things stopped them from getting to 20k locations.  Perhaps replicable mediocrity is enough if you can roll-out quickly?

[Rod]

The interesting thing is that all of these issues have existed for a while but franchisee health seemed very solid until recently with good same store sales until Q2 18. 

 

Does anyone have any experience with Subway in the early years (book or personal) in the early years with how it was perceived?  Obviously Subway subs are horrible compared to niche sandwich shops and there are a lot of decrepit subways.  However, neither of those things stopped them from getting to 20k locations.  Perhaps replicable mediocrity is enough if you can roll-out quickly?

 

I think the fast food industry is just more competitive today. It's much harder to be unique and everybody has learned how to execute at the highest level. When Subway was expanding was there anything much like them out there operating at any kind of scale? Not sure that there was.

[peterHK]

Glad I trusted my gut on this one.

[whistlerbumps]

Yup... that was an ugly qtr