RUM.V - Rocky Mountain Liquor

[deleuze68]

Share Price: $.085 (traded on TSX Venture Exchange)

Shares Outstanding: 47,489,937

Market Cap $4.037 million

 

Background

 

Rocky Mountain Liquor (RUM) currently owns 26 liquor stores in Alberta. These stores are mainly situated in high traffic areas in smaller towns where there tends to be less competition. In total there are approximately 1500 liquor stores throughout Alberta, all privately run. The largest player is Alcanna (CLIQ.TO) which owns 194 stores. So RUM's share of the pie is relatively small (about 2% vs Alcanna's 13%). Over the past few years RUM has been rebranding their stores under the name of Great Canadian Liquor (GCL). Currently 18 of RUM's 26 stores operate under this brand. These are discount stores that focus primarily on high margin/low cost product.

 

Management

 

This is not a glitzy company but they do a very fine job communicating their business objectives in their annual and quarterly MD&As. At this point management’s primary focus is disposing of non-core stores and focusing on revenue growth and margin expansion in their core stores (GCL). From 2016 to 2019 they have reduced their store count from 42 to 28 while experiencing a 2% decline in revenue and a 350% increase in operating margin. RUM has also shifted away from print advertising by embracing social media (digital) marketing. Not only has this reduced their SG&A expenses but it has created a captive community that identifies with the GCL branding. RUM also eliminated $6.8 million in debt last year by converting their debentures into common shares at the price of 19 cents (3.8 cents pre-consolidation of shares). Right after conversion the co-founder and executive chairman Peter Byrne purchased 1.88 million shares on the open market at 10 cents (2 cents pre-consolidation). Mr. Byrne currently owns 15.6% of the outstanding shares. The CEO Alison Bradford owns 3.3%.

 

 

Valuation

 

Trailing 12 months (TTM) data:

Revenue: $46.63 million

Gross Profit: $10.5 million

Operating Margin: $3.73 million

Gross Profit Percentage: 22.52%

Operating Margin Percentage: 8.01%

Cash Flow (Operating Margin - Finance Costs - Rent): $1.49 million

Debt: $6.9 million drawn on credit facility (as of August 20) with TD at around 6% interest. The debt is mostly covered by inventory of $6.1 million. (Alcohol inventory is pretty much as good as cash).

 

RUM is currently trading at 2.7x TTM cash flow

 

For comparison, Alcanna has an operating margin of 5.5% and is currently trading at around 12x TTM cash flow for their liquor operations. Since RUM has streamlined their operations and focused on their discount brand GCL they have consistently outperformed Alcanna by 200-300 basis points on operating margin.

 

Cash Printing Machine - The New Normal

 

The 2nd quarter of 2020 for RUM was a blowout quarter with revenue up 19% and gross profit up 25%. With expenses being pretty much fixed most of the increase in gross profit flowed to the bottom line resulting in cash flow of $1.08 million, up over 400% from last year (notably finance costs were down 250K due to year over year improvement in the balance sheet).  The second quarter generally represents about a quarter of annual sales for liquor sales (sales are significantly lower in 1st quarter and slightly higher in 2nd half of year). So it is generally a good proxy to take 2nd quarter financials and multiply by 4 to get annual results going forward.

 

But this quarter was quite unusual due to Covid. With no bars and restaurants open for the first half of the quarter the primary option for alcohol consumption was off premise through liquor store purchases. Bars and restaurants began re-opening mid-May yet according to Alcanna’s recent conference call this did not translate to a reduction in liquor store revenue. People did start going out to eat - albeit in reduced numbers - but they weren’t drinking while out. Instead they would drink beforehand and continue the party at home after dinner. Furthermore Alcanna does not see this trend reversing for the foreseeable future even if a second wave does not materialize. Alcanna also sees sales maintaining strength through the winter as the preferred method for drinking and socializing will be in the home (no grand office parties, no patios). There will also be a general population boost over the winter as Alberta snowbirds most likely will not be travelling south.

 

What this all means is that elevated sales will most likely continue until at least until next summer. As evidence that these elevated sales have at least continued through August RUM has already decreased their credit facility balance to $6.9 million as of August 20. This is a reduction of $900K from June 30th. Of note RUM did also sell 2 underperforming non-GCL stores subsequent to June 30 leaving them with 26 stores currently. But to be conservative I’ll model 10% elevated revenue due to the “new normal”  over the next year, down from the 19% experienced in the recent quarter. I’ll also adjust for the two stores sold under the assumption that they affected the top line more so than the bottom line.

 

Q3/2020

Revenue: $12.6 million

Gross Profit: $2.9 million (at 23% - this could easily be higher due to the sale of 2 underperforming stores)

SG&A: $1.6 million (this will also drop a bit as RUM ended their hero pay June 30)

Operating Margin: $1.3 million

Finance Costs + Rent: $510K (down a bit due to 2 fewer stores)

Cash Flow = $790K

 

Q4 2020

As above although revenue could be slightly higher as Q4 is generally the strongest season for sales. Finance costs will continue to trend lower as the credit facility is paid off from the cash flow.

Cash Flow = $790K

 

Q1 2021

Revenue: $9.5 million

Gross Profit: $2.19 million

SG&A: $1.55 million

Operating Margin: $640K

Finance Costs + Rent: 500K

Cash Flow = $140K

 

Q2 2021

Again as Q3 2020 but with reduced finance costs.

Cash Flow = $800K

 

In sum, over the next 12 months I expect RUM to conservatively generate $2.52 million in free cash flow. This could be used to reduce their credit facility and/or rebrand their remaining 8 non-GCL stores. Maintenance cap. for RUM is quite low, less than 100K year. I believe they also have enough tax loss deferrals to offset the earnings. So assuming normal capital investments I would expect them to reduce their amount drawn on the credit facility to around $5 million by June 30th of next year. At which point their tangible book value should be between 5 and 5.5 cents/share.

 

RUM is essentially adding 1.25 cents/share to their book value per quarter. This reminds me a lot of Evergreen Gaming (TNA.V) back in 2015. Through operational efficiency and the right market conditions over 4 years they were able to grow their book value from negative to 20 cents/share. The stock price in that time went from 5 cents to 45 cents and it was set to be sold for a premium (But then Covid happened which of course was a big negative for casinos).

 

Going Forward post Covid

 

Looking past Q2 2021, even with a return to the old normal RUM should still be able to generate significant cash flow. Over the last 2 years RUM has executed successfully renewing their credit facility with TD at favorable rates plus converting their debentures at 19 cents/share (more than twice the current market price). Rebranding the stores to GCL and effectively adapting digital marketing has allowed them to stay ahead of the competition. Over the last 4 quarters they have consistently outperformed Alcanna both in same store revenue growth and operating margins. They are now a lean organization focused on organi revenue growth and continual margin expansion. Heading into summer of 2021 with a book value of 5 cents/share (and SOP liquidation value of at least 3 cents being inventory minus debt) and best in class operational efficiency RUM should be able to retain at least 60% of their Covid world cash flow or $1.5 million annually. At 6x free cash flow (half of Alcanna’s valuation) + SOP liquidation value it would result in a share price of 22 cents. This is conservative with plenty of opportunity for expansion. It is also not out of the question for Alcanna to swoop in and buy them out as Alcanna has been consolidating the industry over the last 18 months with purchases of Ace Liquor and Solo Liquor.

 

 

Risks

 

The two biggest risks are; 1) competition;  and 2) the Alberta economy. With respect to competition RUM has consistently been gaining market share over the last 2 years. The rebranding to GCL has resonated with customers. Underperforming stores have been sold creating a much leaner company with best in class operating margin. Regarding the Alberta economy it is mostly true that alcohol consumption is recession proof. And the GCL brand does capture a more price conscious consumer. However, there is the risk that the towns where RUM has stores could contract due to a drawn out economic downturn. This would have the obvious effect of fewer customers and hence, lower sales. However in the near future the current Covid economic climate could potentially help with negotiating lease renewals and possibly whittling down the competition.

 

[Foreign Tuffett]

Thanks for taking the time to write all that.

 

I don't quite understand how you are valuing this. Can you help me understand why you are putting a multiple on free cash flow and then adding liquidation value on top of that? Management is either going to run the company and generate free cash flow OR it is going to liquidate, but I don't understand why we should give it credit for both possibilities. Or maybe I am just misinterpreting what you wrote? 

 

Also, is there anything about the Alberta liquor market that would allow this biz to do well over time? What is the competitive moat? I skimmed a few old press releases and in early 2014 they had 47 stores -- but now they only have 26. That is just a tremendous downsizing of the store base over an extended period of time.

 

I pulled up a few of their stores on Google Maps and they looked more down-market than up-market. Literally just cases of beer stacked up on the floor and cheap looking shelving. 

[bizaro86]

Thanks for taking the time to write all that.

 

I don't quite understand how you are valuing this. Can you help me understand why you are putting a multiple on free cash flow and then adding liquidation value on top of that? Management is either going to run the company and generate free cash flow OR it is going to liquidate, but I don't understand why we should give it credit for both possibilities. Or maybe I am just misinterpreting what you wrote? 

 

Also, is there anything about the Alberta liquor market that would allow this biz to do well over time? What is the competitive moat? I skimmed a few old press releases and in early 2014 they had 47 stores -- but now they only have 26. That is just a tremendous downsizing of the store base over an extended period of time.

 

I pulled up a few of their stores on Google Maps and they looked more down-market than up-market. Literally just cases of beer stacked up on the floor and cheap looking shelving.

 

No barriers to entry for Alberta liquor stores. All the grocery chains have liquor stores, Costco has liquor stores (which you don't need to be a member to use iirc), etc. If they are the only player in small towns they might do ok.

[deleuze68]

I'll try to answer your questions.

 

1) By liquidation value I was pretty much trying to approximate net cash as inventory minus debt. Previous Alberta liquor store transactions have been priced as a 4-wall ebitda multiple + inventory.

 

2) There is no competitive moat so that is always going to be a risk. RUM does have the advantage of being a first mover and also the experience of operating stores over the last two decades. It appears they have figured out where and how to operate stores to generate the highest operating margin. At one time RUM did fall into the trap of expanding indiscriminately before realizing that it was better to focus on a select few stores that could generate higher margin and were operating in a less competitive environment. This led to pretty much exiting Edmonton and Calgary and focusing on the discount market. The stores aren't pretty I agree but neither are dollar stores . . .

 

I would like to see a few more quarters of earnings just to confirm what I believe to be best in class operating margins. However, with cooler months coming and the coronavirus still altering people's behaviour I believe there is a tremendous tailwind for the business that isn't going to fade anytime soon.

 

 

[DW1234]

Any idea why they closed a GCL store in Q1 2020? I'm trying to estimate the economics of opening up a GCL store, it looks like they've found a way to create a relatively high ROI, but it's not great if certain locations fail, even with their new concept.

[DW1234]

Thanks for the idea. Couple things:

 

* It's clear that margins are way better since rebranding. However this coincided with a more economically prosperous year in their area (looking at their competitor) as well. It's therefore up in the air how sustainable these numbers are.

* They only net added 3 GCL stores since April 2018. Would've been nice to see a bit quicker growth. They have been slow rebranding their remaining stores. Why is this?

* Looking at cash and inventory like they're almost the same doesn't feel right to me. They need the inventory to run their business, so it's nowhere as liquid as cash.

 

I feel like there's a bit of downside protection missing here:

- Competition (also online)

- Worse economy

- Simply buying this at the top of sales and margin numbers

- Failing at being a pricefighter

 

OTOH I do like how they've improved their business and capital allocation. There's upside of them opening up more very high ROI stores as well as acquisition upside.

[deleuze68]

I believe the store sold in Q1 and the 2 sold subsequent to Q2 were all non-branded GCL stores.

 

I think there are 2 reasons why the re-branding has come to a halt. First, since 2018 a main focus has been to sure up the balance sheet before allocating more capital. This was accomplished in 2019 with the debenture conversion and this year with the renewal of the credit facility. Second, there is no point in converting stores that will have undesirable economics due to size, location, competition, etc. These stores are being disposed in due course.

 

It will be interesting to see if they will return to a more capital intensive expansion in the future (it didn’t work before, and the competitive landscape in Alberta makes it tough) or just continue narrowing their focus to the core stores and further improving those margins.

[Nelson]

I think it's incredibly risky to assume a terrific few months will translate into a lucrative new normal for the company. Will the at home drinking market ever be this good again? I would think it drops off significantly once we're all comfortable going out to bars again.

 

As Bizaro pointed out, the barriers to entry are nonexistent. If this new normal is indeed permanent, it'll attract new competition. Even in small towns.

[bizaro86]

I keep coming back to this, as I really want to like it (and I've traded the debs in the past). I think my biggest concern is actually their higher gross margins. All liquor stores in Alberta buy at the same prices from the same AGLC monopoly distributor. So if they have higher gross margins that means they are charging higher prices. It seems to me that eventually they will get competitors in their best markets, and their competitors (Alcanna, the grocery chains) all have lower overhead per dollar of sales and way lower cost of capital. That gives this a risk of being a shrinking ice cube, where the best play would be to sell off the stores individually. Probably to local entrepreneur types, maybe at 3-4X EBITDA + Inventory. Alcanna cherry picked Solo Liquors best locations at  <3X trailing EBITDA + inventory. They seem like they are doing this (selling worst locations, which is good), and COVID has been a huge tailwind here obviously. I think it might have been a bigger tailwind for them than the industry. I know the rural people I know are making less "stock up" shopping trips to the city right now. If that is generally true, local higher margin retailers might be getting a further boost. Given the price difference (of everything!) in rural AB compared to the cities, I'd expect those trips to resume once things quiet down on the COVID-19 front.

[deleuze68]

Alcanna provided an update this morning. Pretty much confirms what they were forecasting after Q2.

 

"Alcanna's liquor stores in all regions continued to register sales and margins significantly higher compared to the prior year. The Company anticipates that same-store liquor sales for the three months ended September 30, 2020 will be approximately 15% higher than the prior year and total liquor gross margin as a percentage of sales will be consistent or slightly higher than those reported by the Company for the three months ended June 30, 2020. The Company believes this was primarily a result of shifting customer consumption habits due to more people dining and entertaining at home and continuing to stay away from on-premise liquor establishments (restaurants, bars, lounges, sports venues, etc.). The Company further believes these new consumer behaviour patterns have become entrenched in people's lifestyle choices and expects consumer behaviour to continue in this manner for as long as COVID-19 remains a threat to the health of Canadians."

 

Alcanna reported an increase of 13% in SS liquor sales in Q2. So growth has accelerated a slight bit this quarter while maintaining margins. The stock has now reached a new 52 week high today. This all bodes well for RUM who have consistently outperformed Alcanna in both SSS growth and operating margin. I expect another huge quarter from RUM when they report next month.