Nathan’s Famous Inc. (NASDAQ: NATH) is an attractive investment opportunity for value-oriented investors. The company operates with an asset-light business model that requires little capital and provides stable operating cash flow. Plus, it’s a company that’s been around for over 100 years and I’m pretty confident it will be for decades to come. A company’s strong fundamentals are usually reflected in the stock price over a long period of time and NATH is no exception. This stock is a multi-bagger by Peter Lynch’s definition and has delivered a 25x return in the past, clearly outperforming the S&P 500 along the way. However, recent returns have been disappointing. I believe the current price offers an attractive opportunity to buy a quality company that has strong growth catalysts.
Nathan’s Famous is a licensor, wholesaler and retailer of products marketed under its Nathan’s Famous brand. NATH generates revenue from the following segments:
- The Product License Program contracts with certain third parties to manufacture, distribute, market and sell a wide variety of Nathan’s Famous branded products, including its hot dogs, sausages and corned beef products through retail grocery chains and stores clubs across the United States. NATH earns revenue through royalties from products sold by its licensees.
- The branded product program (“BPP”) offers foodservice operators in a variety of locations the opportunity to capitalize on the NATH brand by marketing and selling select Nathan’s Famous hot dog products. Along with the program, operators benefit from limited use of NATH brands. Unlike its licensing and franchise programs, NATH does not generate revenue from royalties, but rather by selling its hot dog products either directly to foodservice operators or to various foodservice distributors.
- Operation of quick service restaurants as Nathan’s Famous.
- Operation of franchised restaurants are responsible for the franchise of the Nathan’s Famous concept. NATH collects royalties from restaurant sales at these locations.
NATH’s products are currently marketed in approximately 79,000 locations in the United States and eighteen foreign countries.
The market opportunity
A quick-service restaurant is a restaurant that offers certain food items that require minimal preparation time and are delivered through quick service. Typically, quick service restaurants have a limited menu that can be cooked in less time with as little variation as possible.
Global QSR Market was valued at USD 610.23 Billion in 2020 and is projected to grow at a CAGR of 5.1% to reach USD 815.6 Billion by 2026.
NATH’s revenue comes primarily from products sold through its branded merchandise program, company-owned restaurants, as well as royalties from its retail licensing business. Because the NATH brand is widely recognized, it allows the company to expand its food offering beyond its iconic hot dogs and achieve a price premium. In addition, this activity has the advantage of requiring little capital to operate. If we look at the balance sheet, NATH ended the last quarter with total assets of $114.5 million, of which about 75% were cash and short-term investments. PPE’s net worth was only $11.4 million, which was 9.5 times less than NATH’s LTM revenue. As a result, the company spends very little money on capital expenditure. To give you an idea, the company has spent less than $1 million in the last 12 months on CapEx.
This business strategy has been the recipe for success in the past. The company is now on track to more than double its revenue from FY12. Also, as the business grows, economies of scale begin to kick in and increase profitability. NATH today has a gross margin above 40% whereas 10 years ago it was around 33%. The combination of increasing revenues and expanding margins has allowed NATH to more than double its EPS over the past decade.
NATH has embarked on a number of new initiatives to promote the Nathan’s Famous brand and position itself for future growth:
Virtual kitchens – NATH has partnered with Franklin Junction, which connects host restaurants to digital brands, and has also collaborated with REEF and Ghost Kitchen Brands to expand into the US and Canada.
New York Wings – The company launched the Wings of New York, a virtual concept offering New York-style chicken wings via third-party delivery services.
Digital business – In FY21, NATH enhanced its capabilities by expanding its partnerships with third-party delivery services. Digital sales, which include customer delivery and pickup, at three of four company-owned restaurants accounted for 11% of sales at those locations in FY21.
International expansion – In FY21 and as part of its international expansion program, NATH entered into a license agreement with Mezzan Holding KSC, one of the largest food and beverage manufacturers and distributors in the region of the Gulf. Additionally, the company has entered into an agreement with Damhus, a German manufacturer of quality meat products, to manufacture and distribute Nathan’s World Famous Beef Hot Dogs across Europe.
The company recently released FY22 third quarter results. Overall, the business has performed well. Revenue increased from $18 million to ~$26 million year-over-year, an increase of approximately 44%. So far this year, NATH has generated strong cash flow from operations. The company managed to increase its cash from operating activities from $5.7 million to $9.9 million, representing an increase of approximately 74% year-over-year. Additionally, NATH opened 15 new franchise outlets, 32 new branded menu program outlets, and 164 shadow kitchens in FY22. In my opinion, the company is executing its growth strategy well and is on track to achieve its goals. If you want to know more about the last quarter, you can click here.
Based on 4.12 million shares outstanding and a price of $55.5 per share, the company has a market capitalization of approximately $229 million. In this part, I used a discounted free cash flow model to value the business. The following assumptions were made in the model:
- Estimated free cash flow for FY22 of $14 million.
- An 8% growth rate over the next four years to FY25, which is slightly lower than the company’s historical revenue growth rate to be conservative.
- A terminal growth rate of 2%.
- A discount rate of 8%.
According to my model, the fair value of the stock is around $72 per share. Considering the current price, NATH is undervalued in my opinion. Also, I think my model provides a conservative number since I didn’t take into account any takeovers the company is doing. At the current price, you also get a dividend of around 3.2%, which is much better than what the market is offering.
Key points to remember
In summary, NATH has an attractive business model which should continue to provide stable cash flow. I think EPS could realistically grow 6-8% per year over the next 5 years as NATH expands its reach and taps into unpenetrated markets. In terms of valuation, I think the stock is well priced to provide a long-term return of 8-10% per year.