MTY Food Group (MTY.TO): Fast food, faster growth

MTY Food Group is a collection of fast food franchises.  A large part of its growth has come from buying second-rate and third-rate food franchises.  MTY is a very good operator as purchased concepts have generally become much more profitable and have grown into much larger franchises since being bought.  The company’s CEO and founder, Stanley Ma, has been referred to as “the king of the food courts”.

Return on equity: around 22.75%.  (The company has virtually no debt.)
Growth in book value from 1996 to 2012:  21.5%/year.
Growth in share price from 2003 to today:  Over 100X.  (Yes, over one hundred times!)

*Disclosure:  Long 1 share as a tracking position.

Company history and MTY’s lost decade

I don’t have a full picture of MTY because the financials on sedar.com only go back so far.  But here’s what I have figured out so far.

When Stanley Ma immigrated to Montreal Canada with his family, he dreamed of opening his own restaurant.  At the age of 29, he opened Le Paradis du Pacifique (the paradise of the Pacific) in 1979.  The restaurant (now closed) offered Chinese and Polynesian cuisine.

In 1983, Stanley Ma branched out into fast food thinking that it would be more profitable.  He opened Tiki-Ming, which would later become a franchise with more than 40 locations.  Later on, he thought that it would be a good idea to use the stock market to raise money to help fund further expansion of his restaurant chain.  Here is where things get murky.

In 1986, the predecessor company was incorporated as Golden Sky Resources Inc.  It began trading on the Vancouver Stock Exchange (now TSX Venture) in 1989.  I blindly assume that Golden Sky Resources didn’t find anything and became a shell company.  I don’t think that Stanley Ma was involved in the company until 1993 (or later), when he first became a director.  In June 1994, the company renamed itself to Golden Sky Ventures to better reflect what it did.  The TSX Venture company summary states Ventures’ business description:

Golden Sky Ventures is licensed to distribute parking control systems, shoplifting prevention equipment, garage door openers and commercial software programs in the Peoples Republic of China and elsewhere on the Pacific Rim.

I am guessing here but I think that Golden Ventures bought or merged with Stanley Ma’s restaurant business.  In 1996, Ma owned only 3.76% of outstanding shares (a small fraction of what he owns today).  Golden Ventures was originally a mismash of businesses that frequently lost money:

  1. Selling parking equipment in China.
  2. Selling and installing software in Hong Kong.
  3. Chasing the Internet bubble providing computer programming and IT services.
  4. Restaurants.

The early years were definitely a ‘lost decade’ for Stanley Ma.  The information I could find in sedar.com goes back to 1996, where the company had retained earnings of -$4.7M.  In 2000, retained earnings hit a low of -$6.0M.  It was only until five years later that retained earnings turned positive.

In 2001, investors “let” management reprice options at a lower price.  These deals are typically unfair to shareholders because insiders and officers are basically being given free money for terrible performance.  This practice remains somewhat popular today.

In 2002, the Internet bubble had definitely collapsed and the NASDAQ hit a bottom.  MTY actually started buying back a small number of its shares at below book value.

In 2003, Stanley Ma and Claude St. Pierre (the former CFO and current COO) started buying shares of the company hand over fist.  They were also being granted lots of options to buy shares.  In a massive private transaction, Stanley Ma bought 3.1 million shares at $0.2548 per share (search sedi.ca for insider trading information).  These shares are now worth $33.20 (over 130X his purchase price!!!).  Through all of his open market purchases, private purchases, and stock option exercises, Stanley Ma now owns 25.55% of the company.

stanley-ma-insider-trading

Also in 2003, the company renamed itself to MTY Food Group and got rid of its money-losing Internet bubble business.  It became a pure play restaurant company.  I’m sure that 2003 was a landmark year for Stanley Ma.

Since 2003, the underlying business has rapidly expanded.  The stock has gone up by roughly 100 times.  It hasn’t attracted much attention from analysts or Bay Street.  The company is currently returning capital to shareholders via dividends.

In 2010, the company listed on the TSX Exchange.

A different version of events

The Globe and Mail has a very interesting profile piece on Stanley Ma.  It comments on the company’s IPO history and this version of history doesn’t mention the money-losing non-restaurant businesses.

MTY went public in 1995 through a reverse takeover of a shell company in Vancouver, when it had about 70 restaurants. The idea was to be able to tap into investors’ money for expansion, although over the past decade and a half most of its growth has come from its own cash.

Mr. Ma acknowledges that, in hindsight, he could have kept MTY tightly controlled. “We don’t really need money from the public to support MTY,” he said, “[But] I’m comfortable with [being public] now” and he sees no reason to go private. Indeed, to please investors the company recently paid out its first dividends, although it retains enough cash to replenish its war chest for more acquisitions.

Ma makes an interesting comment about how MTY didn’t need to go public at all.  Definitely one of the problems with going public is that he became entangled in other money-losing businesses.  One of the other problems is that the cost of a public listing is a huge burden for very small companies.  Nowadays the overhead isn’t a concern as MTY is much larger.  Ma is probably happy with the way things have worked out as his stock is worth over $160M.  But what a wild ride!  His stock didn’t go up for a decade before going up over a hundred times.

My take on the restaurant business

I don’t think that the restaurant business is a great business to be in.  There are some industries in the world where there is an oversupply of new entrants because the industry has some type of appeal to it (e.g. Hollywood visual effects, independent movies, airlines, etc.).  I believe that the restaurant business is one of them.  Many people dream about owning their own quaint little restaurant.  And many of those restaurant owners don’t want to stop at just one.  Some franchisees will buy more franchises even though the first is losing money.

Overall, I am pretty jaded about the restaurant business from watching the TV show Kitchen Nightmares (the UK version is more business-oriented than the US version) and from reading Anthony Bourdain’s book Kitchen Confidential.  There is a huge amount of misery from people who lose their life savings.  Famous people involved with food such as David Chang (Momofuku), Ray Kroc (McDonald’s), and Howard Schultz (Starbucks) have written books where they say that they lost money or didn’t make money in the very beginning.  Food-related industries strike me as extremely Darwinian: it’s survival of the fittest.

However, the restaurant business is one where the skilled restauranteurs are much more profitable than their peers.  So there is actually a part of the restaurant industry that does make money for its owners.

Franchising

In theory, franchising helps improve the odds for budding entrepreneurs.  Franchises provide a proven system for franchisees to follow.  Franchisees save themselves a lot of work and money as they don’t have to re-invent the wheel and figure out what does and doesn’t work in the restaurant business.  They save money against through the volume purchasing power and economies of scale of the overall system.

In practice however, franchises often don’t help.  Sometimes bad franchise locations are peddled onto first-time business owners who don’t know better (e.g. Sam Walton made this mistake when he overpaid for his first retail franchise).  Sometimes the franchisor takes such a large cut that it is extremely difficult for franchisees to make money.  Sometimes the franchise isn’t very good to begin with, again making it extremely difficult for franchisees to make money.  There is an ugly segment of the franchise industry where the franchisor makes money at the expense of its franchisees.  Cold Stone Creamery and Tim Hortons (THI) are major franchises that have been disproportionately accused of this.  I am wary of investing in franchises because sometimes the franchisor will put short-term profits ahead of its long-term viability.  For example, franchisors can exploit their franchisees by taking kickbacks from the franchisees’ suppliers; franchisees have little defense against this behaviour.  “Note 23” in MTY’s 2012 annual report corresponds to these other revenue sources.  The company generated $15.1M in “other franchising revenue” (which include “supplier contributions”) on top of the $34.4M of royalties.

I’m not entirely sure here but I believe that MTY does generate value for its franchisees.  For example, the first Tiki-Ming opened in 1983.  The chain has expanded over the next three decades.  It’s unlikely that a shady franchise company would last that long.  The MTY website is not that promotional in pushing franchises and hasn’t been redesigned in several years.

However, MTY does buy franchises that have been a little shady and more aggressive in signing up franchisees.  The people selling franchises to MTY are usually selling because the underlying businesses aren’t doing so well.  For this reason, MTY owns franchises that don’t have the best operations and haven’t been run with the highest integrity.  I believe that this is a reason why MTY sometimes posts poor metrics.  Its same-store sales have been very mediocre in the past few years and have been falling behind inflation.  The company has seen many of its franchisees give up and close their stores.  MTY may need to slow down its growth a little and focus more on improving its operations.  For the company to be healthy in the long-term, same store sales need to keep pace with inflation and it would be nice to see organic growth in store count.

Is management ethical?

The only negative thing I can say is to point out the options repricing in 2001.  Otherwise, I think that Stanley Ma has been a class act.

Insider compensation is pretty low, especially for a company that originated from the Vancouver Stock Exchange / TSX Venture.  (Most of the insiders in TSX Venture companies are wildly overpaid.)  Stanley Ma is clearly one of the best CEOs in Canada and deserves pay in the top percentile.  His 2012 pay of $439,415 is arguably low given his skill.  The board of directors costs only $40,000/year for the non-executive directors, which is extremely low for a company with a $633M market cap.  There are many companies with $63M and $6M market caps with similar compensation levels.

MTY as an investment

The price to book ratio is a little over 5 and the price to earnings ratio is 25.  This is a little on the high side.  It seems even more expensive considering that this company used to trade at under 30 cents and below book value.  But you know what?  It’s better to buy a wonderful business at a fair price than it is to buy a fair business at a wonderful price.  I think that this stock will go a lot higher in the next 10 years as long as Stanley Ma is still the CEO.

I don’t see myself buying this stock unless the P/E drops to something like 20 or 15.  My kneejerk reaction is to be patient and wait for a fire sale price (e.g. when the company is buying back shares).  Waiting for a better price could pay off as wonderful companies often sell at discounts.  Liberty Media (LMCA, previously LCAPA) traded at substantial discounts to its private market value from 2009 to 2013.  Berkshire Hathaway announced share buybacks twice in its history.  Of course, being the genius that I am, I missed out on both of those opportunities.  In 2009 I owned some far-out-of-the-money call options on LINTA that expired worthless.  I managed to lose money on a stock that would go up several times in the next few years.  Rightly or wrongly, I will try to wait for a better price on MTY.

At the end of the day, I think that MTY is a wonderful company that is definitely worth watching (and even worth buying at the current price).

MTY related links

An excellent VIC writeup on the stock.  I have no idea why the author exited the stock.

Globe and Mail newspaper profile on Stanley Ma.  The CEO seems very modest and is passionate about fast food.

French-language profile piece on Stanley Ma – Use Google Translate to read it.

Unhappy MTY franchisee stories

All franchisors have unhappy franchisees.  It’s so easy to blame other people for your problems.  On the other hand, some of these franchisees likely do have legitimate grievances.

News article about an unhappy La Cremiere franchisee.  La Cremiere is now owned by MTY.

News article about a family which bought two Jugo Juice franchises in 2009.  Jugo Juice was purchased by MTY in 2011.

Franchising-related websites

A hub page about one person’s UK franchise nightmare (not related to MTY).

An excellent analysis of SBA loan default rates (I’ve provided the archive.org link).  The data provides some hints as to which franchisors deliver the most value for its franchisees.  Some of the companies mentioned are publicly traded (MCD, JMBA, THI, BWLD, etc.).

An anti-Cold Stone Creamery website.

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One thought on “MTY Food Group (MTY.TO): Fast food, faster growth

  1. Pingback: The TSX Venture explained | Glenn Chan's Random Notes on Investing

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