Second Cup - SCU

[Phaceliacapital]

Given that a lot of Canadians browse this board I was wondering whether any of you have looked at Second Cup?

 

It is bouncing around its 52 week low (also its all time low) and seems to have "disappointed" on earnings due to an impairment charge that it took on its trademarks (make up most of the balance sheet) due to a declining stock price and a decline in sales in comparison to projections (which you can find in the most recent Q filing).

 

I have only done some few back on the envelope calculations but currently come up with

 

Revenues around 26 M

Operating Income before impairment: 7M (Operating margin around 26.74%)

EBITDA: Around 7.67 M (a 29% EBITDA margin, which is quite nice for a commodity business)

 

Current MCAP is around 39M (shares are trading at 3.94).

Cash 6.376

Debt 10 (Term loan with fully hedged interest rate)

EV somewhere around 42

 

Giving you:

 

EV/EBITDA: 5.475

EV/Revenues: 1.615

EV/NormOI: 6-ish

 

Dividends paid last year = 4*0.085 = 0.34 / 4 (current price) = 8.5% yield

 

CFO looks strong enough to service debt, FCF is probably around 3.5 - 4 M

 

+ it appears their most profitable quarter is in the fourth quarter..

 

Some recent news flow:

 

New cooperation with Kraft:

 

http://www.prnewswire.com/news-releases/more-ways-to-bring-home-the-second-cup-coffee-youve-come-to-love-224386701.html

 

New CFO:

 

http://www.newswire.ca/en/story/1223313/second-cup-announces-appointment-of-new-chief-financial-officer

 

 

I'll have to take a closer look later tonight to double check the numbers..

[moore_capital54]

Own it and really love it down here.. Ripe for a buyout. Good eye.

[tengen]

I live in BC and Second Cups are pretty rare out here (only 3 locations in Vancouver, none in Victoria). They are much bigger in the rest of Canada. When I worked downtown, there was one in the food court right next to my office building so I would go there quite regularly. It was pretty busy during the morning rush. Seemed decent in terms of the service, coffee, and other items for sale. As a part-time coffee snob, I would rate their coffee slightly above Starbucks but well below the best coffee you can get in Vancouver (e.g. JJ Bean). If they wanted a bigger BC presence, they might want to think about buying the privately held Blenz chain.

[xtreeq]

They also have about 10M in net lease commitments.

[Guest bengrahamofthenorth]

This caught my eye too. Seems very poorly managed, my mom said the store reminded her of 'old bookstores'. I have a friend that works in the industry and she cited the lack of a universal experience for consumers. The stock is pricing in some crappy results going forward but management and the board don't really seem to care that profits are a fraction of their peak. The CEO went on undercover boss Canada, I don't remember anything exactly about it but I remember being unimpressed overall. Could remain sleepy for a while, I might visit the company when I head home (toronto) for thanksgiving or Christmas and follow up on this if the stock keeps falling.

[Yours Truly]

Can we put this thread in the Investment Ideas category?

 

Back on topic, Second Cup locations in Ontario are pretty hard to find and are usually located at small booths within malls, campus and hospitals IMO, it will always be third/forth fiddle to Starbucks, Tim Horton's, Country Style.

[Uccmal]

I echo the prior two sentiments on Second Cup.  This one crops up on my radar every few years, in its various incarnations. 

 

Not only are they behind Sbux, And TH, there is also Timothy's in the Greater Toronto Area.  They got into the hospitals, and such via the Cara connection.  All three of the above companies keep opening outlets at a rapid clip.  Second Cup completely lost mindshare over the last ten years, and isn't going to get it back in this operating climate.  Now there is Macdonalds to contend with as well. 

 

Just to show at they are up against in Canada: Tim Hortons sells some 50 % within the fast food category in Canada, and above 70% in the coffee/baked goods category.  The left overs are carved up amongst the rest. 

 

 

Lost cause IMHO. 

[finetrader]

A few years ago on Mont-Royal street in Montreal there was 2 Second Cup coffee shop an no Starbucks, and financials of SCU were doing fine. Today, I've notice that there is now three Starbucks coffeee shops near those two Second Cup on Mont-Royal. And SCU financials results are now struggling.

[augustabound]

The CEO went on undercover boss Canada, I don't remember anything exactly about it but I remember being unimpressed overall.

 

I saw the episode and thought the same as you, generally unimpressed. 

Even keeping in mind it was "reality TV" and there was editing done, I found it hard to believe she was a CEO and that goes for the entire management team that was in the boardroom at the end.  But, who knows how much is scripted and they may very well just be a bunch of poor actors.  ;D

 

As for the stores, the one here in Newmarket is in a Walmart plaza close to the road and is always empty.  I've been in there at 8 AM on a weekday and a weekend, same thing, empty.

 

They had a few years where they shared a space in the Home Depot, that experiment ended earlier this year due to poor sales.  (Heard from a friend who works at the Home Depot that was the reason)

 

Edited to add Starbucks has 2 stores within a 1 KM radius and they're both busy. 

The Second Cup in the mall is usually pretty busy come to think of it.

[Uccmal]

I was giving this some more thought.  Second Cup has some really good captive locations.  There are two in a Queens Park office (Ontario gov't bldg).  The government doesn't buy its workers coffee so these outlets are insanely busy.  There were two at Sunnybrook Hospital when I was last there, also insanely busy.  These leaseholds are probably very long with protection from competition.  These outlets will also provide coffee for meetings etc. 

 

The street locations, are not so good, as compared to your average Sbux. 

[turar]

I tried reading their annual report, but couldn't deal with all that visual overload, Martha Stewart style.

[Yours Truly]

I was giving this some more thought.  Second Cup has some really good captive locations.  There are two in a Queens Park office (Ontario gov't bldg).  The government doesn't buy its workers coffee so these outlets are insanely busy.  There were two at Sunnybrook Hospital when I was last there, also insanely busy.  These leaseholds are probably very long with protection from competition.  These outlets will also provide coffee for meetings etc. 

 

The street locations, are not so good, as compared to your average Sbux.

 

One block south of queens park lies in wait two Starbucks and three Tim hortons locations... It's quite a busy area for coffee fiends

[hardcorevalue]

This reviewer on Yelp summed up Second Cup's problem pretty well I think:

 

"I like Second Cup flavored coffees. But you get a mixed bag in terms of stores with Second Cup. Being all franchise run, some owners maintain their places but most have pretty scary bathrooms. Starbucks has fewer surprises and a more uniform presentation. But then their coffee costs more."

 

In addition to Second Cup's tired looking stores, I've also heard a fair amount of complaints about the quality of the coffee. Management doesn't seem really concerned about it either. Stacey Mowbray (CEO) only has $170k in stock. Her salary has doubled in the past 3 years while operating income has fallen by a third. :|

 

Paul Phelan owns 12% of the shares. There was an in-depth globe article in 2003 about him the inheritance issues involving Cara Operation.

 

http://www.theglobeandmail.com/report-on-business/the-fight-for-caras-soul/article1167819/?page=all

 

I've attached his shareholding history as well. (no major moves in the past 3 quarters).

 

Seems like a tough industry.

 

Cheers, HCV.

 

PS. I'm a long time lurker and a huge fan, I've learned so much from this board and its members. Thanks.

[Uccmal]

This is an interesting article in this months Canadian Business Mag.  About second cup expanding into areas where America is a bad word: Pakistan for example

 

http://www.canadianbusiness.com/companies-and-industries/a-second-chance-for-second-cup/

[HeresyValue]

This is an interesting article in this months Canadian Business Mag.  About second cup expanding into areas where America is a bad word: Pakistan for example

 

http://www.canadianbusiness.com/companies-and-industries/a-second-chance-for-second-cup/

 

Second Cup international is completely separate from the publicly-traded SCU. SCU is ONLY the Canadian franchise.

 

This is a business that I decided on writing up several times (and still have an almost-completed version in draft) but never published due to the fact that this will continue to be a horribly run business without a catalyst investor. Problem is, David Phelan is virtually guaranteed to oppose any catalyst investor because he is intent on acquiring SCU via stealth-acquisition. This has the potential to be a very, very good cash-generative business with highly localized captive markets that can resist (and has resisted) the onslaught of Starbucks. However, this is NOT a growth business. The sanctity of the dividend has ensured that over the past decade the management and Board have traded future earnings for short-term cash return and have failed to invest even remotely satisfactory amounts into the business (marketing, renos, etc.). This can only change if/when an activist takes them to task and is able to out-vote David (his proxy on the Board is his former secretary, iirc).

 

I own shares simply because of it's valuation and to force myself to follow the company more closely. However, returns elsewhere in the market and particularly in the small-cap deep value space easily outweigh the potential return here UNLESS you are THE activist or can piggyback off him/her.

[Uccmal]

Thanks for the clarification.

 

That also explains the insider buying.

[siddharth18]

http://online.wsj.com/article/PR-CO-20131220-906735.html

 

One person's take: http://heresyvalue.blogspot.ca/2013/12/an-undervalued-company-for-cup-of.html

[mcliu]

Seems like a losing battle for SCU. There's no real competitive advantage or brand loyalty for SCU, if Starbucks opens a location across the street from each Second Cup, which will probably happen eventually, it's game over.

[alertmeipp]

Seems like a losing battle for SCU. There's no real competitive advantage or brand loyalty for SCU, if Starbucks opens a location across the street from each Second Cup, which will probably happen eventually, it's game over.

 

actually, they have no issues competing with Starbucks head to head, at least in mMontreal

[StubbleJumper]

Seems like a losing battle for SCU. There's no real competitive advantage or brand loyalty for SCU, if Starbucks opens a location across the street from each Second Cup, which will probably happen eventually, it's game over.

 

actually, they have no issues competing with Starbucks head to head, at least in mMontreal

 

 

Coffee is a bit of a strange bird.  There are plenty of places in urban areas where you can walk down the street and come across a coffee shop literally every 200 feet.  For whatever reason, all of those coffee shops seem to be viable and the market does not seem to be saturated (ie, there are still line-ups).  Even in suburban areas, in some places it's getting to the point where there's a Starbucks, Second Cup or Tim Horton every 500 meters, and somehow they all seem to stay in business. 

 

[Guest 50centdollars]

MISSISSAUGA, ON, Aug. 5, 2014 /CNW/ - The Second Cup Ltd. (TSX:SCU) ("Second

Cup" or the "company") reported financial results today for the 13 weeks (the

"quarter") and 26 weeks (the "year to date") ended June 28, 2014. In order to

focus on growth and maximize long-term shareholder value, the company announced

it is suspending its quarterly dividend effective immediately.

 

Quarterly Highlights

 

* Completed the reorganization of its Coffee Central support office resulting in

$1.6 million of one-time restructuring costs and estimated annual savings of

$2.3 million.

* Restructuring savings will be redeployed to franchisees primarily via reduced

royalties.

* System sales of cafés decreased by 3.9% to $45.8 million compared to a year

ago. Same café sales decreased 5.0%.

* Adjusted basic and diluted earnings per share of $0.08 compared to $0.14 a

year ago.

* Adjusted EBITDA of $1.5 million compared to $2.1 million a year ago.

* Announced the August launch of single-serve Keurig K-Cup compatible coffee

capsules.

 

Alix Box, President and CEO commented, "As I previously communicated, we have

embarked on a journey to restore Second Cup to a leadership position with growth

in sales and profitability.  Already we have completed a number of important

steps including the downsizing and restructuring of our Coffee Central team,

improving franchisee profitability, and assembling a talented new leadership

team.  We are all passionately dedicated to delivering the best specialty coffee

experience for our customers.

 

We are in the early stages of Second Cup's transformation and I am proud of our

progress to date. We are developing a "store of the future" which will introduce

exciting new levels of innovation and excellence for Second Cup and the Canadian

coffee lover.  Later this year, we will unveil a new and very different Second

Cup store in downtown Toronto.  It is our plan to roll out its best attributes

across the country in the coming years. Together with my team, we are crafting a

detailed strategic plan for Second Cup's future.

 

When I commenced as CEO a few months ago, I was very excited about Second Cup's

prospects for the future.  I understood that this would be a journey filled with

challenges.  Today, I am even more excited about our company's potential. There

is much work to do and it will take time, but I am confident that we can build a

brighter future for the Second Cup brand, for our valued franchisees, and for

our shareholders."

 

Dividend

 

As Second Cup transforms towards a new era of growth in sales and profitability,

the company is seeing the emergence of attractive opportunities to invest

capital. Accordingly the company believes it is prudent to retain available cash

resources for redeployment into investments that will maximize long-term growth

in share value. Given this renewed focus on growth, the Board of Directors

decided to discontinue the dividend payout.

 

 

[tengen]

As Second Cup transforms towards a new era of growth in sales and profitability,

the company is seeing the emergence of attractive opportunities to invest

capital. Accordingly the company believes it is prudent to retain available cash

resources for redeployment into investments that will maximize long-term growth

in share value. Given this renewed focus on growth, the Board of Directors

decided to discontinue the dividend payout.

 

I wonder what they have in mind? Investing in pot cafes down south?

[beerbaron]

As Second Cup transforms towards a new era of growth in sales and profitability,

the company is seeing the emergence of attractive opportunities to invest

capital. Accordingly the company believes it is prudent to retain available cash

resources for redeployment into investments that will maximize long-term growth

in share value. Given this renewed focus on growth, the Board of Directors

decided to discontinue the dividend payout.

 

I wonder what they have in mind? Investing in pot cafes down south?

 

How candid is the CEO, could it simply be that the company is tight on cash, they want to expand but will need to open corporate stores to test the concepts?

 

BeerBaron

[tengen]

How candid is the CEO, could it simply be that the company is tight on cash, they want to expand but will need to open corporate stores to test the concepts?

 

Sounds like a reasonable conjecture. They slashed costs by reducing the head office count by about one third and passed the savings on to the franchise owners. Introducing new stores to test concepts will help revitalize a stagnant brand. They'll quickly run through their cash if they open a couple of stores so cutting the dividend makes sense. On the other hand, I predict pot cafes will become the next big thing (and I'm half serious here).

[Guest 50centdollars]

Since the stock has dropped a lot the past few days, I decided to take a closer look at the company and i don't like their balance sheet at all. The have negative working capital and the majority of their assets ($62m out of $74m) are intangible assets. They had an impairment charge of $13m last year so I doubt those intangibles are valued correctly on the balance sheet. The have a negative tangible BV. I was thinking about buying into this but I think its a value trap. Anyone else have an opinion?