Nathan's Famous Goes Dutch

By Will Ashworth | December 09, 2011 AAA
One of the biggest events on July 4 every year is the Nathan's Famous International Hot Dog Eating Contest. Contestants from around the world stuff as many hot dogs and buns as is humanly possible in just 10 minutes. The winner in 2011 was Joey Chestnut, the undisputed King of hot dog eating, who managed to eat 62 hot dogs and buns in the allotted 10 minutes. Nathans Famous (Nasdaq:NATH) is synonymous with hot dogs. These days, however, it's Nathan's Famous' stock that's garnering all the attention. This little micro cap is going places. (For related reading, see How To Evaluate A Micro-Cap Company.)

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Dutch Auction

Nathans Famous announced Dec. 5, 2011 after the market closed, that it was commencing a modified Dutch auction tender offer on December 8 lasting through December 12 that would purchase up to 500,000 shares between $20 and $22 a share. With $32 million in cash and marketable securities, management obviously feels this is the best use of its cash. Investors seemed to like the news sending its stock up 9.1% on Dec. 6, 2011. With the news of the auction, investors have begun to speculate that there's more to the story than a simple stock buyback. Some believe this is the first move in a going private transaction. Others see this as a move by management to prevent a low-ball buyout offer. Whatever the reasons, long-time investors have to be thrilled.

Current Situation

Business is good. For the first six months of the year ended September 25, revenues increased 16% to $37 million while non-GAAP earnings per share were up 13.2% to 77 cents. In the first two quarters it opened 35 new franchised units including the first Canadian outlet. The Nathan's restaurant system now sits at 287 units including five company-owned locations. Nathan's Famous makes money through the sale of its hot dogs to franchisees and foodservice customers, from franchise fees and royalties and lastly it receives license royalties from its retail licensees who sell Nathan's Famous to grocery stores like The Kroger (NYSE:KR) and Wal-Mart's (NYSE:WMT) Sam's Club stores. Approximately 82% of its revenues come from the sale of hot dogs. In the first six months of the year its gross margin declined 330 basis points to 22.0% due to unusually high beef costs. The great part about its business model is that the second and third revenue streams mentioned above generated much higher margins than the sale of hot dogs. The power of the Nathan's Famous brand ensures that it generates a minimum amount of profits annually regardless of the price of beef. That doesn't mean management is happy about rising costs, just that its pricing power and brand awareness allows it to pass these costs on to the end user.

Future

From where I sit, the future looks great. If not for its $4.9 million litigation expense in fiscal 2011, diluted earnings per share would have been $1.29, 33% higher than in 2010. By the end of March 2012, its diluted earnings per share should be at least $1.47, translating into a P/E ratio of 14.3. How does this compare with the big boys? McDonald's (NYSE:MCD) and YUM Brands' (NYSE:YUM) December 2012 forward P/E's are 16.8 times and 18 times, respectively. Neither are growing revenues as fast as Nathan's Famous, yet its price-to-sales ratio is also lower than the both of them. Lastly, its enterprise value is currently 6.8 times EBITDA compared to 11 times for both McDonald's and Yum Brands. Nathan's Famous might he a micro-cap with low visibility and thinly traded, but it's consistently profitable and deserving of a higher valuation. (For additional reading, check out 5 Must-Have Metrics For Value Investors.)

The Bottom Line

I see management's move to repurchase shares in a Dutch auction as killing two birds with one stone. In the near-term, it buys 500,000 shares at a reasonable price. In the long-term, it sets itself up to entertain serious offers by a strategic buyer. If you currently own its stock, I'd think twice about selling.

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At the time of writing, Will Ashworth did not own shares in any of the companies mentioned in this article.

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