Small Cap Retailer is a Free Cash Growth Machine

MTY Food Group Inc. (TSX:MTY) has a strong history of deploying capital in order to make cash flow accretive transactions

Capital Ideas Media | December 9, 2019 | SmallCapPower: Companies with growth by acquisition strategies usually split market sentiment. Growth and momentum investors love the go-go nature of the stocks, but more value-leaning investors often disparagingly call these serial acquirers roll-ups, complain about a lack of organic growth, and assume these types of businesses will struggle when they run out of targets to buy.

(Originally published on Capital Ideas Media on October 29, 2019)

Those are some of the reasons why Raymond James calls food court restaurant retailer MTY Food Group Inc. (TSX:MTY) “controversial” as it initiates coverage with a “buy” rating and a price target of $65, which gives the stock more than 22% upside potential.

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This is a company we’ve noted before that we first covered in May of 2016 after it purchased Kahala Brands for $300 million (U.S.), which roughly doubled the size of MTY, when the stock was trading in the low $40s.

The shares got as high as $73 in November of last year before settling back to what Raymond James considers to be a compelling entry point at just under $53.

MTY shares stumbled recently following its quarterly earnings report as it integrates the $190 million purchase of Papa Murphy’s.

But Raymond James is bullish, calling MTY a “free cash growth machine.”

Here now are some highlights from the Raymond James report on MTY Food Group:

“MTY can be quite controversial at times given an ongoing debate among investors about both the sustainability and ultimate benefits of its aggressive M&A strategy.“

Our constructive view is driven by a combination of factors, including:

A strong and tangible history of deploying capital towards cash flow accretive M&A.

  • A management teamthat has a tremendous amount of experience acquiring and integrating restaurant franchise businesses that require some attention.
  • A very active pipelineof increasingly larger transactions which offer upside to our current forecast.
  • A heavily discounted valuationwhich is driven predominantly by investor focus on a singular metric: same-store-sales-growth.

MTY has a strong history of deploying capital in order to make cash flow accretive transactions, and we believe M&A is the core growth strategy that the company will keep pursuing.“

For investors looking for a demonstrated track record of growth in free cash per share, we would view this as a core holding.

MTY stock has corrected quite significantly since the company released Q3 results on Oct. 10. It appears integration of Papa Murphy’s was not adequately reflected in some estimates.

As management indicated on the Q3 conference call, Papa Murphy’s should generate three times the EBITDA in Q4 versus Q3, which we believe represents a lift to $10-12-million from $3-4-million sequentially.

We often hear pushback from investors that MTY’s stock, which is currently trading at a multiple of 11 times fiscal 2020 and 2021 estimated EBITDA, is expensive. We disagree with this sentiment.

Franchising restaurant stocks in general trade at fairly elevated multiples, with the U.S. quick-service peers trading at an average multiple of 15.2 times 2020 estimated EBITDA and 15.0 times 2021 estimated EBITDA.

This implies a relative trading discount of four times for MTY stock, which is one of the wider valuation discrepancies in the space.

This discount is despite a free-cash-flow yield of 7% and a five-year free-cash per share compound annual growth rate of 19%.


“Management indicated on the Q3 conference call, Papa Murphy’s should generate three times the EBITDA in Q4 versus Q3, which represents a lift to $10-12 million from $3-4 million sequentially.”

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