1/28/2009

Ark Restaurants Corp: An Enviable Economic Moat

Ark Restaurants Corp (ARKR) has evolved over its 25 years toward being one of the best, if not the best, shareholder-friendly restaurants. CEO Mike Weinstein was an investment banker before creating the publicly traded Ark Restaurants. The CEO’s leadership can be credited for its successful management team and outstanding capital allocation.

The company has a wide range of restaurant styles without a single identifiable concept. CEO Mike Weinstein has stated "I don't know how to build brand equity and don't want to". ARKR currently has 20 full scale restaurants with chefs and executive chefs, 30 fast food themes, catering operations and wholesale / retail bakeries. Its upscale restaurants are stylishly designed at landmark locations, including Bryant Park Grill located behind the New York Public Library, the Grill Room with majestic views of the Hudson, 1000 seat Sequoia along the banks of Washington D.C.'s Potomac River, Gallagher’s Steakhouse located at Resort Hotel and Casino in Atlantic City, and others.

Management is not complacent and will quickly close an establishment or ask the landlord for concessions if the location is not generating positive store level operating cash flows. Based on its pristine and conservatively managed balance sheet, the company is reluctant to place large amounts of shareholders capital at risk. Mike Weinstein and team further enhance shareholder value by weighing the benefits of share buybacks, dividends, and the long term profit generating opportunities from investing in a new restaurant. Given the current economic conditions, the company continues to perform well but recently made the decision to suspend the dividend as it sees better use of the cash. The company has a good cash position and if it was complacent could easily fund the existing dividend and avoid the challenging task of optimizing the allocation of shareholder capital.

The restaurant environment is difficult now, but it’s encouraging to hear management state there “will be some wonderful opportunities”. Having cash on its balance sheet with outstanding cash flow and credit availability will help create an advantage when negotiating or finding new deals. Mike Weinstein (CEO) has stated “If something comes our way that is a fat softball coming across the plate, we will take a swing at it but nothing else.” The CEO’s insightful response to an analyst’s pressure about additional share buybacks highlights some of the reasons to align your capital with ARKR management. His response was as follows:

"The question is always if you buy back your own stock, is it creating value for shareholders? Without a question, it is creating value. Is there more value in finding something that gives you a fairly good flow of income for 10, 15 years as opposed to buying stock, buying somebody else’s operation with the cash flow is significant and recurring and reliable. That’s what we are looking for. If we can’t, we will buy more stock. And by the way, one doesn’t preclude the other. If the shares are attractive in terms of where we think they are attractive, we will buy more stock if it comes in."

ARKR fits the criteria set by several respected value investors; Joel Greenblatt (high ROIC coupled with a high earnings yield, Kenneth Fisher (low P/S), James P. O'Shaughnessy (value with growth) and others. Let’s take a closer look.

Earnings Yield and related measures; “Favorable” rankings out of 55 restaurants

EBITDA/EV = 3.69/12.29 = 30.02% (1st Favorable)
CFFO/EV = 3.25/12.29 = 30.90%
OI/EV = 3.08/12.29 = 25.06% (1st Favorable)
FCF/EV = .94/12.29 = 7.65% (4th Favorable)
CFFO/NI = 3.25/2.16 = 1.50%

Out of 55 companies I reviewed in the restaurant industry, ARKR has the highest EBITDA/EV at 30.02% with consistent high quality of reported earnings evidenced by the supporting cash flow from operations, CFFO/NI = 3.25/2.16 = 1.50%. Couple the bargain price with a high return on capital and the stock is screaming "I’m a well managed company selling for a bargain." ROA (return on assets) will help measure return on capital. ARKR is near the top or about number 6 out of 55. The four year average is consistent at 15.59%. The after tax ROIC tells the same story and averages 18.61% over the same 4 year period.

Joel Greenblatt uses a combination of earnings yield and return on capital to rank companies to filter potential investments for further research. His book “The Little Book that Beats the Market” is based on this concept. I took the earnings yield and ROIC for all 55 restaurant stocks and applied Mr Greenblatt’s ideas and ARKR was ranked number one. NATH (Nathans) made the number two position.

Kenneth Fisher is credited for emphasizing the price to sales ratio as a useful forecasting tool. ARKR ranks as number 5 out of 55 for the best EV/Sales ratio. The top 4 may have slightly better P/S measures but there balance sheets were weak. Furthermore the P/S ratio for ARKR when compared to the last 4 years has improved significantly from an average 4 year P/S over .80 to the current .30. James P. O'Shaughnessy did his own research and concluded that the strongest and best indicator of solid appreciation in stocks were low PSR's (Price-to-Sales Ratios) which was first emphasized by Ken Fisher in Super Stocks. Mr Fisher no longer believes this ratio deserves the weighting he gave in the past.

It’s not immediately evident but ARKR has an enviable economic moat and this thought is supported by their consistent high ROIC. Management has developed the ability to handle complex operations which include negotiating and attracting developers on new projects, serving thousands of high quality meals daily, and even improve existing establishments with small amounts of capital by making minor changes.

The above positive attribute is even further enhanced by the YOY quarterly 6.90% revenue growth. There are virtually no shares short or a change in shares outstanding since 2004.

Value Institutions holding shares with their balance reported as of 10/01/08:

LOEB ARBITRAGE MANAGEMENT INC. 7.99% (recently selling)
ROYCE 4.74% (recently increasing position to 5.07%)
PRIDE CAPITAL PARTNERS 10.66%
FIDELITY LOW-PRICED STOCK FUND 4.66% (recently increasing position to 5.35%)

Positive Insider Activity over past 12 months: 18,315 shares purchased directly for 248,242 at a average price of 13.55; 6,350 shares purchased indirectly at average price of 13.29.

Catalysts

Institutional recognition of the deep value and future earnings opportunities
Accretive acquisitions opportunities to fuel future growth
Additional share buybacks
Takeover target
Reinstate dividend
Mean reversion; 210% off 52 week high, -65% 52 week return

Risks
Exposure to the New York high end restaurant market that could impact overall results as the financial sector job losses are realized coupled with cancelled parties and client entertainment
Rising food prices and a reversal of reasonable gas prices
Forced institutional selling
Sharp decline in tourism from the worldwide recession and weak foreign currency exchange rates for the Pound and Euro
Reduced domestic travel and spending to casinos located in Vegas, Foxwoods, and Atlantic City where ARKR has restaurants

Conclusion

In summary, there are potential short term risks to the stock price but I believe even now the shares are attractive. I will use further weakness to add to my existing position. Mike Weinstein and his team have proven they can take a business with low barriers to entry and create an economic moat. A restaurant that can post 18.46% after tax ROIC since 2004 has proven they have an advantage that few others in the same industry can match.

The potential acquisition opportunities in this economy will play into the hands of a well capitalized and experienced management team. Even if those opportunities don’t present themselves I believe share buybacks will increase if the stock weakens. So at this time it’s the high earnings yield combined with a consistently high ROIC, quality earnings, low P/S, insider buying, top line growth, ownership held by quality value institutions at higher prices, no dilution, virtually no shares short, mean reversion and an outstanding proven shareholder friendly management that makes ARKR attractive.

Additional Valuation Measures
Price = 10.90
PER Share Values
Price = 10.90
EV = 12.04
Sales = 35.77
GP = 12.36
EBITDA = 3.69
Operating Income = 3.08
NI = 2.16
CFFO = 3.25
FCF = .94
AR = 1.19
Cash = .85
Total Liabilities = 4.64
Market Cap = 39.22 million
EV = 42.019 million
Share outstanding = 3.49 Million
No dilution as the amount is virtually unchanged from 2004.
Industry Rankings out of 55 restaurants
EV/Rev = 12.04/32.92 = 36.57% (5th Favorable)
EV/MC = 12.04/11.24 = 1.07 (4th Favorable)
OI/EV = 3.08/12.04 = 25.58% (1st Favorable)
GP/EV = 12.36/12.04 = 1.0266 (2nd Favorable)
FCF/EV = .94/12.04 = 7.81%
EBITDA/EV = 3.69/12.04 = 30.65% (1st Favorable)
NI/EV = 2.16/12.04 =17.94% (2nd Favorable)
EV/NI = 12.04/2.16 = 5.57 (2nd Favorable)
52 week change = -65.16%
52 low = 7.92
52 High = 34.59
Disclosure: I have a long position in ARKR.

6 comments:

Anonymous said...

Thanks for fixing your feeds! Everything is working great...cheers!

Anonymous said...

FYI, Just saw that Joel Greenblatt opened a positon in ARKR.

ShadowStock said...

Interesting and surprised given the method Greenblatt proposed in his book “ the little book that beats the market”. ARKR is more of a special situation and a wait and hold because of the poor performance of their Retail operations. It seems the only way we will realize value is when then do something with their real estate holdings.

Thanks for the reponse! Can you let us know where you found the information about Greenblatt and his recent opened position in ARKR.

Thanks for any help.

John

ShadowStock said...

Sorry about the previous response I thought you were referring to SYMS. ARKR is a classic Greenblatt stock, Sorry.

John

Jae Jun said...

There was an article on ARK in last months Forbes which said similar things to what you have written. Good management that is realistic with its business as well as good numbers for a restaurant business. Will have to revisit this company.

Anonymous said...

This looks like a really interesting company. I love what the CEO says about not knowing how to build a brand. That's perfect for the restaurant business since the sophisticated urbanite customer sneers at the concept of "chain restuarants." This is at the top of my list for further research. -W