Fool’s “Next Great Canadian Superbrand” Revealed

What's the "hidden brand" with the "incredible growth story" being pitched by Motley Fool Canada?

By Travis Johnson, Stock Gumshoe, June 27, 2017

I’ve got a soft spot in my heart (or maybe my head, depends who you ask) for the Motley Fool’s old “Superbrand” ads — one of the very first teaser pitches I covered when I started this website in the Spring of 2007 was the Gardner brothers’ teaser for the “New American Superbrand”.

That ad was at least a few months old even back then, and the pitch was for Whole Foods (WFM, though it was WFMI back then)… a stock that they kept recommending with similar ads for years (2008, 2009 and 2013, for example). Turned out OK for them heading into Amazon’s $42 takeover bid for that “superbrand” grocer, unless you happen to be one of the folks who bought when it was loved at $40 instead of when it was feared at $20.

But anyway, that’s why my ears perked up when I heard the Motley Fool folks peddling a “superbrand” stock again… so what is it this time?

This time it’s not Dave and Tom Gardner, it’s their scions to the north at Motley Fool Canada, with the letter signed by Iain Butler and pitching us to sign up for Stock Advisor Canada and they’re pitching “The next great Canadian Superbrand.” Here’s how the ad gets us interested…

“Chances are, you’ve never heard of this stock. And we think that’s a distinct advantage for you…

“With over 5,600 locations, spread across 27 different countries, and with over a billion dollars in sales, you’d think this “Next Canadian Superbrand” would already be a household name.

“And considering this company generates over 70% of its revenue in Canada, you’d think the name of this company would be on the tip of every Canadian’s tongue… if not already in their brokerage accounts!

“Yet nobody is walking around talking about this company or its extensive suite of ‘brands.'”

They say that this brand is “hidden in plain sight”, and has already risen 170% in five years… including a 50% rise since they first recommended it to their subscribers.

So what else are we told that helps us to narrow down the list of candidates? Here are some clues…

“… the new ‘HIDDEN BRAND’ made the decision NOT to follow an industry practice of operating all of its stores itself….

“Instead, it’s aggressively buying businesses that it likes — and then franchising the opportunities to other businessmen. Then, it uses its expertise and its historical knowledge to help those businessmen succeed in exchange for a steady stream of royalty payments. The company is capital-light because of this model and harvests cash – tons and tons of cash….

“… gross margins at this company have gone from 73% in 2008… to over 82% in 2016.

“In essence – the new ‘HIDDEN BRAND’ is using – in tandem – two of the secrets that built Wal-Mart and Starbucks… serve your customers what they want, and make it convenient… and you can charge a price that will make shareholders happy. And with gross margins that high, and with the economies of scale that this company has – it’s not hard to see why it’s been one of the most successful companies in Canada (by share appreciation) in the last decade alone…”

And apparently this company is constantly growing…

“… this company made THREE strategic acquisitions thus far in 2017 alone….”

So who is it?

This is, sez the Thinkolator, Canadian quick-service restaurant conglomerate MTY Food Group (MTY in Toronto, MTYFF OTC in the US).

The Canadian Fools have liked this one for a long time — it was one of the first stocks teased by Stock Advisor Canada when that service was just a baby, back in 2014. I even said some nice things about the stock at the time, though I never ended up buying shares — it was pretty flat for a couple years following that teaser campaign, but took off in the Spring of 2016 and made a pretty quick run from $30 to $50 a share, dipping back down a bit in the past few months to 45.

So what does it look like now? Well, back in 2014 MTY was really just a Canadian company, very reliant on a handful of mostly asian-themed quick service restaurants and mall food court-type brands that were doing well but didn’t necessarily have a lot of brand power and their presence outside of Canada was fairly limited (though they had some success in the US, and pockets of strength in the Middle East). More recently, they’ve been expanding aggressively into the U.S., particularly through the acquisition last Summer of Kahala Brands, and that’s really what got the shares climbing a year ago.

Kahala gives them a real presence in the US, including US management and a foothold for investing more aggressively in growth on this side of the border for their Canadian brands like Country Style donuts and Extreme Pita… along with new Kahala brands for MTY to grow like Cold Stone Creamery, Pinkberry and, after another acquisition last Fall, Baja Fresh.

So the growth story seems a bit reinvigorated by this acquisition, and the hope is that MTY can keep its disciplined expansion going in the US by adding lots more franchise partners and building up the store count aggressively without risking a lot of capital. The stock has not been soaring in recent months, perhaps because the last quarterly report was a little bit hairy and included some foreign exchange losses and a fall in same-store sales, which they blame entirely on softness in the Alberta and Saskatchewan markets.

I’m inclined to think favorably about this one again, given the potential for growth as they bring all of these brands together under one roof — it is still priced for growth, so you’re not necessarily getting a bargain, but it is a much more diversified company now than it was a year ago… and this will be the first year ever that US sales are larger than Canadian sales, which will probably look good for Canadian shareholders of the Canadian dollar continues to be weak (it doesn’t make much difference for those of us on this side of the border, since the currency difference washes back out when we bring our money home). They do have an outsize reliance on one brand now, since Cold Stone Creamery is going to make up probably a quarter of MTY’s revenue during the summer months, so there is certainly plenty of risk to go around.

They also have been good about growing the dividend fairly aggressively, at a double digit rate, so even though the current yield is unimpressive (about 1%) the potential is there for that to grow to be a meaningful part of your return.

And, as the ad notes, it’s on the right side of the restaurant business — you want to be the owner of the brand and the franchise coordinator, not the person who actually has to sign leases and hire teenagers to scoop ice cream and mop the floors when your employees call in sick. That keeps the margins nice and high.

The real risk is whether MTY can avoid having systemwide same-store sales decline persistently — the past three quarters have all been weak, down 1%, 1.2% and 2.1%… and while that’s largely because of the weakness in Canada’s interior provinces, it’s a sign of what can easily happen if there’s persistent economic weakness in significant swathes of the US or Canada. And, of course, if Amazon really does end up killing all shopping malls, a widely parroted theme that seems a bit of an exaggeration but not an impossibility, well, the shopping mall food courts that generate about a quarter of MTY’s revenue would obviously be at risk.

Right now, MTY at C$45 is trading at just about 20 times 2017 earnings estimates, with the expectation that there will be no meaningful growth in 2017 over 2016. The analysts think earnings growth will get back to close to a 10% clip in 2018, anticipating $2.48 in earnings next year, so the stock is trading at a forward PE of 18.

That’s obviously not cheap, particularly since those analysts see single-digit earnings growth after that, but there is clearly room for them to “beat” those expectations thanks to the asset-light and high-margin nature of their business… if they’re able to do a lot of aggressive franchise growth with their new brands, and if both Canada and the US can avoid a widespread recession, I’d think that MTY has a a pretty decent chance to beat those expectations.

That’s just my take from a few minutes of reacquainting myself with the stock, though, so I’ll sleep on it and try do dig into the financials a bit more in the months to come… and I’ll hope that they have a disappointing quarter next time out that makes the shares a bit cheaper (I haven’t seen a date for the Q2 earnings release, but last year it was on July 7 so it should be coming soon).

And, of course, it’s your take that counts — it is, after all, your money… so what do you think? Interested in a pile of US and Canadian food service brands? Think their prospects are good or bad? Have any experience with their 40 or so brands that causes you to celebrate or condemn them? Let us know with a comment below.


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14 Comments on "Fool’s “Next Great Canadian Superbrand” Revealed"

avatar

Matt
Guest
0
Matt

I’m here for the candy. That’s what a Candian superbrand makes, right? 🙂

C. Egan
Guest
0
C. Egan

Travis, love your stuff.
A side-track on the MTY article: At one time there was a hassle with buying Canadian stocks in IRAs. Canada withheld some of the dividends, which were then basically impossible to recover. My question: Does the MTYFF (ADR???) sidestep that problem?
ce

RampageKy
Irregular
22

I just checked into this because I bought Fairfax (FRFHF) in my IRA and learned through my broker that Canada does not withhold taxes on dividends if you hold the Canadian security in an IRA (taxable accounts will have a 15% withholding). Here’s a link on Seeking Alpha that agrees as well, see footnote 4 at bottom: https://seekingalpha.com/article/248039-withholding-tax-rates-by-country-for-foreign-stock-dividends

vivian lewis
Guest
0

the first thing to do is visit one of their restaurants and taste the food. I hope there is one near gumshoe so he can take himself there on expenses. Bon appetit!

carbon bigfoot
Guest
0
carbon bigfoot

Hey Hoser if they serve a “Strange Brew” I’m in.

Allan
Guest
0
Allan

I did that with DNKN in Detroit. Half-time show of Johnny Rivers,(Secret Agent Man), went to a Dunkin Donut across theatre. Clean, quick service, courteous staff, nice washroom, fresh variety. The shop was EMPTY. Except for WWE events, I don’t see DNKN being pushed/marketed.

malandro
Irregular
5
malandro

Many thanks Travis! I have been besieged daily by the Fools touting this Super Stock and clamouring for me to sign up in order to have them spill the beans about it. Keep up the great work and know that your periodic visits to the great North are appreciated!

Myron Martin
Author
311
Maybe as a Canadian I had never heard of the stock because I don’t patronize junk food restaurants, (which most fast food restaurants are) but in spite of their popularity I have to ask myself WHY I would invest $45. in a stock for the meager projected profits when I can buy junior miners for .45c instead expecting a double or even TRIPLE within an average of a year. I may be a contrarian and just don’t buy the market perception of bigger established companies having less risk. It would be interesting to compare a portfolio of similar dollar size… Read more »
Foptin
Guest
0
Foptin

“even Warren Buffet agree’s his investing performance was better when he had less money to invest because it is far easier for a dollar stock to double than a $50. stock to do so!”

What Buffet did not mention was this:

It is far, far, far easier for a dollar stock to go to zero than a $50 stock to do so!

Stick with larger names. You are going to be burned bad in penny stocks (paradise of fraud, weak corporate governance, and zero competitive advantages). You might even be wiped out totally one day.

Andrew
Guest
0

Interesting article Travis, definitely an up and comer, maybe to many brands though, Canadian Royalty stocks are the best d/y plays in that arena, looking at foreign stocks ,with China opening up here is some interesting info on Chinese Movie Stocks http://eqibeat.com/top-20-chinese-entertainment-stocks-by-market-cap/

dsfawefawef
Member
3
dsfawefawef

Thanks for the article. As a Canadian I appreciate the coverage

leofreeman
Irregular
2
leofreeman

I have eaten at many of these brands here in Toronto!
Most of these brands are knock offs from successful US brands. For example, before chipotle got a foothold in Canada, mucho burrito basically got all the mall spaces and is successful.
However, overall this financial construct company over leveraged with constant acquisitions does scare me like a house of cards. All it takes is some shock (again to use chipotle scare example) and all the franchises would fall like flies.

senior111
Guest
0
senior111

Morning Star rates MTY as overvalued.

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