Motley Fool Hidden Gems Investing - 1 Restaurant = $51 Million

Episode Date: November 13, 2024

Cava stock is up nearly 270% since the start of the year. Does its valuation make any sense? (00:13) Tim Beyers and Mary Long discuss: - The difficulties in valuing Cava. - Why the fast casual restaurant doesn’t want to lean too far into digital channels. - How Toast is able to keep growing despite macro headwinds. Then, (17:40) Fool Contributor Rick Munarriz joins to check in on movie theater stocks, and to discuss what a $2.2 billion industry-wide renovation plan might mean for moviegoers. Learn more about the Range Rover Sport at www.landroverusa.com Companies discussed: CAVA, CMG, WING, DPZ, TOST, CMK, MKS, AMC, IMAX Host: Mary Long Guests: Tim Beyers, Rick Munarriz Engineers: Rick Engdahl Learn more about your ad choices. Visit megaphone.fm/adchoices

New from Nespresso. Blend wellness into your coffee routine with the Coffee Plus range. Infused with functional benefits. Choose the coffee you love with added B vitamins. Like Coffee Plus B12 to help support immune function. And Coffee Plus B6 to keep your day moving. Or go with the flow and choose Ginseng Delight. Our new double espresso with ginseng extract.

Whatever lies ahead, don't change your morning. Let your morning change you. Discover Coffee Plus on Nespresso.com. I hope you're hungry. You're listening to Motley Fool Money. I'm Mary Long, joined live and in person today from a co-working office in Denver, Colorado with Tim Byers. Tim, thanks for being here with me this morning. Thanks, Mary. Fully caffeinated, ready to go. Fully caffeinated, ready to go. We've got a Thanksgiving lunch prepared for us after this,

I think, and to just whet our appetites even more. We're talking about three stocks that we'll see if we get to the third, but what we've got lined up for us today are three companies, all of which I know that you're big fans of, and they're all kind of food related. So with that, we can get right to it. First up, we got Kava reported earnings yesterday. Earnings nearly doubled, churning out 15 cents per share in the third quarter. That's compared to six cents a share a year ago. Same-store sales grew 18% during the quarter. Traffic also up nearly 13%. Company now is targeting full-year adjusted EBITDA of $121 to $126 million. That's adjusted pretty far up from what they previously had. Wall Street is amped about this. Stock is up

over 10% this morning, last I checked. Any notes, sir? I mean, it's unbelievable. What I'll key on is that 18% increase in same-store sales, which is just absolutely bonkers. For those who don't know what that means, you are essentially taking the sales per square foot at every location, and then you're looking at the year-over-year difference in how they are performing. And up 18% like that is just astounding. I mean, for context here, Mary, for a fairly well-established restaurant, like 5% is awesome. 18% is outrageous. It just means that the existing locations are crushing it.

The menu must be doing great. People are coming in and enjoying Cava. So the argument here for Cava is that this is the company that is making Mediterranean eating in the United States a thing. Like, they are the concept that is taking Mediterranean mainstream. Now, whether or not you think that's real or not, I think that's up for debate. But the numbers suggest that's at least part of the conversation. Well, it's not just those existing stores. They're also rolling out new stores.

So the company opened 11 new restaurants within the quarter, 73 new restaurants within the past year. There's now 352 Cava restaurants around the U.S. Tim, I've done some back-of-the-napkin math here, and I want your take on it. This company's got a market cap of about $18.3 billion. Divide that by the total number of restaurants. each restaurant location by that is valued at about $51 million. If you do that same math for

Chipotle, obviously a massive company, a stock that's done really well for investors, each of its 3,437 locations is worth about $24 million. That feels crazy to me. What needs to happen for Kava's valuation to come back down to earth? Or is $51 million per location something that's justifiable? Well, I mean, look, I don't think you could say that. But at this stage of its life, it is going to be priced at an outrageous premium. And right now, I don't think you can make a really good numerical valuation argument for Kava. The work that I did on this is that the free cash flow yield, which is for those who don't know how to calculate that, you take the free cash flow, as you've defined it, divided by enterprise value, which an enterprise value is market cap

plus debt minus cash. So free cash flow divided by enterprise value gets you a percentage. The higher the percentage, the cheaper the stock is. The lower the percentage, the more expensive it is. In the case of Kava, it is 0.2%. In other words, the amount of required growth baked into kava is outrageous so it's a lot of freak assumed free cash flow growth via new restaurant openings expanding margins so the expectations here are very high can they meet those expectations i think there is a case for it but we could talk about that, I can tell you, you asked what needs to happen. We could start with, they need to open a lot of restaurants and those restaurants need to be profitable per square foot pretty quick.

And they've been able to deliver that. Will they continue to? During the earnings call, CEO and co-founder Brett Shulman talked about Mediterranean hospitality as quote, an increasingly powerful differentiator. And he talked about our obsession with screens. about how we've lost 24 hours a month in personal connection. For those asking, hmm, how is this relevant to Kava? Here's a quote from Brett. He goes, at Kava, we believe technology should enhance, not replace the human experience,

and we're leveraging it to create warm personal moments across our physical and digital channels and to support our team members in engaging and connecting with our guests. End quote. As someone who enjoys going to Kava and appreciates the experience part of a restaurant. That all sounds awesome to me. As an investor, everybody's talking about AI and efficiency and technology.

So how is Kava balancing those two things, technology and experience? And does anything about how they're doing that stick out to you, particularly from the investment standpoint? Well, I think it has a lot to do with the loyalty program. So they want more people coming into the restaurants and eating in the restaurants. that's a big part of the kava story right now digital ordering and you know digital as a channel for revenue for kava like you order on the app you go and you pick it up and you leave that's only about 35 of the business so this is not we're not talking about wing stop we're not talking about

dominoes which are close to 70 you order on the app they try to get you they upsell you through the app, you get some additional things, you go in, you get it, you're gone, you go eat at home. Kava wants you in the store. But what they want to do is use the digital channel and particularly the loyalty program to get you interested in the menu and engaging with the menu. So if they know, for example you are nuts for the pita chips they are experimenting now with new flavors with the pita chips and you can imagine that they will maybe make an offer or make you one of the privileged few mary you love the pita chips i do and there's only a few locations in the denver metro area that are going to try something entirely new and you are invited

because you are a CAVA loyalty member and not everybody's going to get access to this. So that's not the same thing as a coupon. That is not the same thing as giving you bonus points so you can get more free meals. That is trying to engage you, get you to a location, get you trying something that they want to find out whether or not this new thing that they're trying

actually is going to work with some of their most loyal customers. So they're going to use this loyalty program to do something interesting that may go system-wide. We don't know. So they're calling this first-party data. They call it a first-party data platform, meaning they're going to take all the data they can get

about what guests do when they show up at a Kava location and build experiences that are customized to every guest that walks through the door. Will that allow them to increase sales per square foot? We don't know, but that is their hypothesis. for it. So this is what Shulman roughly means. He's not talking about, look, we're going to get a whole bunch of orders through the digital channels. He's saying, let's use the digital channel to help us get to know our customer better and do things to engage them differently

and more deeply. And if he's right about this, if the hypothesis holds, then sure, you could see more visits, more spending per square foot, and, you know, maybe some appreciation and loyalty. You know, when you have dollars to spend on going out, maybe you'll spend a little bit more with Kava than you did previously. Why does Kava want to get people into the store so much? Because I can see another type of restaurant that would say, like, that leans into the Wingstop, the Domino's approach of, hey, we can shrink down our square footage. We can push this whole thing to digital why do what is the value for them in getting more people well i'll give you only one example of this because kava does sell some of its own branded product in grocery stores

you go into a store and you're gonna buy some of their sauces it's a little bit like this is a terrible analogy but i'm going to use it anyway because i think it makes sense okay you go into Ulta salon what are they every time I go I mean I am not even remotely the person that buys product at the barber but people do you go to the barber and you walk out not just with a haircut you walk out with some product that happens all the time you go into a kava store will you walk in there and get a meal will you also walk out with some sauces and maybe something else you might i don't know that that's going to happen all the time but there are other things you can do to enhance the amount you will spend inside the kava store because it isn't just a place where you get

cafeteria food and you're gone it is a you know a flavor mart where you can go in and buy not just your meal, but also some things you'll bring home to try when you're cooking your own food. I'm going to take advantage of having you here today and hop us in the way, way back machine to a couple of days ago when Toast, another favorite company of yours that you follow quite closely, reported earnings. This was last week. Toast, for those that don't know, is a vertically integrated restaurant software and hardware company. They had a pretty great quarter, one could say. They posted a third quarter profit of $56 million. That's after having had a loss of $31 million a year before. Not only that, but they raised their EBITDA forecast for the year

quite significantly. All of this, Tim, at a time when other data, not Kava's data, but other data would suggest that people are eating out less, feeling a bit more sensitive towards how they spend their money. How is Toast able to grow so much despite macro headwinds that, again, aren't necessarily affecting kava which we just talked about but that are that are hitting other parts of the restaurant industry yeah i mean it's a great question two things can be true i've said that so many times and two things can be true here um the fintech business which is driven by guests going to and spending dollars with restaurants that was um there was a modest sequential decline in gross payment volume so gross payment volume is the amount of spend

at restaurants that are using Toast. It's a very important metric for them. They make some money. Like this is the win-win part of the business. When Toast clients make money, guests come in, spend money at Toast restaurants, they get a piece of that. And so more traffic into more Toast restaurants

is good for Toast. But on a gross payments volume per location basis, sequentially that was down slightly. So there's your macro headwinds. wins. However, restaurateurs are spending on toast. They want it. They are signaling that they want it. And the subscription revenue, which is the steady state piece of toast business, you pay a subscription fee for how much toast you use inside your restaurants. So restaurateurs are taking on more toast product. They're adding it to more locations. And that does not change.

like that irrespective of the macro headwinds if restaurateurs are saying we need more toast we want it in more locations that is business that is not variable that is steady and growing and it is growing up and to the right so this has been true for toast for a really long time that restaurateurs see the value in what they do they bring it into their restaurants and so they pay the subscription fee to have it. The fintech fee, which is a bit more variable and is subject to macro, yeah, that's going to bounce around a bit. But the core business, that subscription business is going absolutely gangbusters, Mary, and it just shows no sign of slowing. Speaking of showing no signs of slowing, you and Tim White have a show on Motley Fool Live

called This Week in Tech. And this past Friday on that show, you said that you think Toast can bring in annualized returns of almost 19% over the next 10 years. I asked you this question earlier about another company, but I'm going to ask it again to you of Toast. What has to happen for that to be true? So in this case, there are two primary drivers of value for Toast. It is the number of locations and the average spend per location, the average that they get, revenue per location for the restaurant clients that they serve. So I think it's fair to estimate that Toast is going to grow the average spend per location from about $40,000 per location today. So that's a restaurant customer.

Spends about $40,000 per location on Toast subscription fees annually and transaction fees as well. It's about $40,000, okay? I think they can get that to $55,000. In other words, raising it at the rate of inflation, the historic rate of inflation, about 3.3% over 10 years. I think that's absolutely possible, very reasonable. 127,000 locations today, I think they can triple that. I think they can get to 350,000 locations pretty easily. That's not quite a triple. It's a little bit less than that. I think they can do that without too much problem. If I'm right about that, that gets you to that number. It might come a little bit short,

It depends on how much dilution there is in the stock price. But I think that is very, very reasonable because, again, the amount of uptake of toast in locations that are here in the United States, it has been accelerating, not decelerating. So in the most recent quarter, added about 7,000 locations. Same quarter a year ago, added about 6,000 locations. I'll give you one other super quick story here. So Tim and I were co-working yesterday in downtown Littleton. We went into a small coffee shop.

They had a non-toast point-of-sale system. And I just happened to ask. It was called Spot On, I think. So like, huh, this is interesting. What is this and do you like it? And the person behind the counter said, unprompted, said, yeah, it's not bad. It sort of works with the backend operations of places like ours, but it's not as good as Toast.

I never mentioned Toast. I didn't say anything about it. I said like, Toast is a lot better. I like it a lot more, but yeah, this thing is okay. And like, that is the sort of thing. Look, it's completely unscientific, but I love hearing that. And that happens all the time, unprompted. You know, what do you think?

Oh yeah, I think Toast is great. And that when you have somebody whose experience is using the product day to day, and they are an advocate for it, your cost to acquire new revenue goes down substantially, the amount of free cash flow you can generate goes up substantially, and you become a very interesting investment for the long term. New locations seems to be the key for not just Cava, but also for Toast. Two very different businesses that kind of play in similar hungry spaces. Tim Byers, thanks so much for joining me today. I think we've got a Thanksgiving meal prepped for us, so we should go eat. We need to eat. All right.

Thanks, Mary. A lot more may soon be coming to movie theaters near you. Up next, Fool contributor Rick Munarez joins me for a look at what a new renovation budget might mean for movie theater stocks. And right now, save up to $2,500 during our massive Labor Day event. Hurry into your local Sleep Number store today, because we have your number. Rick, earlier this fall, the other NATO, that is the National Association of Theater Owners, announced a $2.2 billion renovation plan that's set to revamp a bunch of different parts of the theater experience, from snacks to seating.

There are eight large chains that are really a part behind this deal. We're going to talk about three of them later on in the show, but basically this plan will impact nearly 70% of theaters in North America, and it's going to roll out over the course of three years. What kind of returns can movie goers, people like you and I, expect to get out of this $2.2 billion investment? Yeah, so the product is technically, they're already getting better over time. Since the pandemic, we've seen reserve seating, mobile ordering, all these things that make

the experience more friction-free and enjoyable, have popped up across the major chains. Enhanced concession stand offerings, that makes sense for the exhibitor and also for the customer to have more variety in what they can get. And this NATO that we're talking about here is basically the eight largest theater chains. So, it's basically practically two-thirds of the market. So, I'm just hoping that the $2.2 billion isn't just going to reclining seats or flavored popcorn or premium s'mores milkshakes or anything like that. It's going to go to improving projection systems, sound systems. The announcers also mentioned bowling arcades and other leisure offerings, which I think makes sense to movie theater, but it's great to

have a place where you can go to even when there's not a movie you want to see out there. So the industry, it has come back from the initial pandemic slump, and it's time to invest in keeping it that way. And I think this is a smart move right now. Yeah, this is kicking things back to last summer with the Barbenheimer release. But around that, you had so many people talking about, okay, wait, it's experiences that get people to the movies. And exactly what you just mentioned, you know, whether it's a bowling alley or something else, that's an experience that's different than the Barbenheimer variety, but could also certainly serve to get people back in person in theaters. During COVID, this will come as no surprise to most listeners,

movie theater ticket sales sharply plummeted. In 2019, the average person was buying a little less than four tickets a year. In 2020, that number sank to less than 1.7 tickets per person per year, to be kind of exact. It's up since then, but it's still far below those pre-pandemic levels. Do you think that these renovations that you just mentioned, updating the sound systems, the screen systems, et cetera, is that enough to bring people back to the movies? Yeah. So no one goes to Yankee Stadium or Dodger Stadium because the seats are comfortable or the projections are nice. They led the Major League Baseball in attendance this year because they're the winners. They went to the World Series, sorry. But content matters is what I'm saying.

Same thing with baseball, same thing with entertainment. When Wicked or Moana 2 hits theaters later this month, folks are going to go, even if they have to sit in a lightly padded bleacher seat or a bed of needles. Unfortunately, the theater chains themselves can't control the quality of the films or even the pipeline of how quickly they're made. Movie theaters also can't control uh studios that make these movies wanting to stream their movies sooner even though they have tried to negotiate longer release windows uh i think where they what they can't control and what still matters it's not necessarily renovation but innovation i like what some companies are doing like cinemark is doing with their d-box seats these are motion sensitive seats

that this has historically been sort of like a hokey flash in the pan gimmicky thing but with d-box uh they have control so you can actually control the intensity of the experience you're experiencing or shut it off completely because they're really nice padded seats to begin with And more importantly, you can just put a couple of these in each theater screen. You don't necessarily have to have the entire theater have this one platform, which sort of sabotaged previous efforts on that. So I do think there will be a renovation, but I'm more excited about the innovation that's going to happen. We're going to turn the spotlight on to a couple different specific movie theater stocks. But before we get there, how how loyal are moviegoers to a particular theater chain?

Is like convenience and location kind of the name of the game here? Are most folks going to just go to the theater that has the most convenient time for the movie that they want to see and is closest to them? Or are really loyal theater goers saying, oh, no, I exclusively go to Cinemark screens, for instance? I think your first scenario may have been true about five, ten years ago, but I think things are different now. And I know this is going to be controversial, but I think MoviePass was the best thing that ever happened to theater operators. It made theaters disrupt themselves. So, when MoviePass eventually went belly up and came back in this half-hearted effort that's probably going to fail again, you had these companies come up and say, hey, let's

do it ourselves. So, Regal Unlimited, AMC Stubbs, A-List, these are monthly subscription plans where you can see as many movies, almost as many movies as you want in a month for basically the price of two individual admissions. Cinemark and Marcus, they have a little more restrictive movie clubs, as they call them, but it's still about anchoring you to that silver screen outing to a single brand. And I think that's what people are doing, they're signing up for these plans and they're saying, hey, this is going to make a lot more sense. So I think it is a lot more effective than the loyalty rewards programs that they have been in the place for ages. The fact that they have these subscriptions where you're no longer looking at

the other theaters. You're saying, hey, I'm a member of this AMC brand. I'm a member of this Regal Unlimited. That's the theater I'm going to go to. I'll work my schedule around the times that it's showing the movie. And with so many screens, odds are they're showing the movie you want to see if it's a big movie about every 30, 40 minutes. So let's turn and focus on Cinemark specifically for a second. Of the companies that we're going to look at today, this is the largest one by market cap. It's worth about $3.8 billion. They reported third quarter earnings at the end of October, saw record high revenue for that period, about $922 million. That's up 5% year over year and up 12% from the third quarter of 2019. Operating margin nearly 18%, which is a

big improvement from the 7% that they saw in that same quarter pre-COVID. What has the key to Cinemark's successful, seemingly successful turnaround, Ben? Yeah, I think the key is simple. Again, big movies are now back in the theaters. Back in the pandemic, you were mentioned like 2020, no one was going to the theaters.

I think I finally got my way to, when Tenet came out, I said, well, I'm not going to miss this movie. And even then I was maybe like 12 people at a theater that would have been jam-packed if that movie came out a year or two earlier or a year or two later. Studios are now putting out the big movies.

You're seeing this come out. You have a third Avatar movie coming out next year. Obviously, you have a big Lion King sequel and other movies coming out just before the end of this year. So all these things are happening right now, and Cinemark has done what some of its competition hasn't. Unlike Regal, that basically went through bankruptcy reorganization, or AMC that just went lavish on all these other projects, Cinemark has basically been sticking to its

knitting, making sure it's operationally more effective, taking advantage of the fact that people are hungry for movies, willing to pay more for concessions, and it's all paying off on the bottom line and the top line. Pre-COVID, Cinemark used to have a dividend. They paused that during the pandemic. What would you like to see happen before Cinemark reinstates that dividend? Yeah, so dividends, they're cool again. Now with interest rates heading lower, it's attractive to have a little yield that may be competitive with a short-term, you know, fixed income that you can get elsewhere.

Royal Caribbean, Disney, these are some of the companies that have brought back their dividends this year for the first time since the pandemic. Cinemark's long-term debt right now is basically back down to where it was in 2019, and its profitability is actually higher. So I think I've seen enough. I think this is a good time for it to bring back its dividend. And if it doesn't, I think maybe they're just looking at maybe a potential acquisition or two that maybe their money is better spent that way. I think that they know what they're doing. When they announce a dividend, it's because it's the best use of their money. A company that plays in this theater space but also kind of plays in different segments as well is Marcus.

They're a bit unique out of the companies that we're looking at today because, again, they're not just a theater company. They also have a hotel portfolio. Does that diversification make Marcus a more compelling investment opportunity than its other publicly traded competitors? Yeah, I'm not so sure about that. Again, to me, the movie theaters at Marcus are still 63% of the revenue it was last year. And multiplex concessions is its highest margin segment. So if you're investing in Marcus, the hotels are nice, but you better believe in Tinseltown

if you're buying in Marcus. It does diversify the business in an interesting manner, but it also opens Marcus up more to the economic cycle. If money's tight, you're still going to go see that movie you've been dying to see for weeks at the local theater. But you're probably going to scale back and cancel that weekend getaway. So corporate travel and related lodging is also going to take a hit in a recession. This isn't Monopoly where you need hotels to win the game. Another thing that separates Marcus apart is that unlike a lot of its peers, this company owns a lot of the underlying real estate for the majority of its theaters.

If this is an advantage, why is Marcus kind of unique among its cohorts in following this path? Yeah, it's probably for the same reason why a lot of us rent instead of owning our own homes and properties and apartments. It's cheaper in the near term. And when you're a chain looking to expand as quickly and as cheaply as possible, especially in the scalable business, it's what works. And Marcus is essentially a real estate company. The others are in the movie business. And one last point on this is that movie theater chains, they need foot traffic. And you'll often find that these theater chains happen to be in shopping malls or strip malls that are owned by landlords where you have to pay if you want to play movies.

We can't talk about movie theaters without talking about AMC. This is the biggest theater company by footprint, and yet it posted a net loss of nearly $21 million for the quarter. By comparison, Cinemark and Marcus, which we've talked about earlier on, were both profitable over the same quarter. What's going on? Yeah. AMC, they have great ideas, but unfortunately lousy execution. So AMC stubs A-list. It's the best of the movie subscription plans. It's the only brand that can get away with selling its popcorn prepackaged in retail stores the way it did a couple of quarters ago. It's the only movie theater and chain that gets lampooned in SNL. However, its share count has been exploding.

Cinemark's share count in the last five years has grown by 32%. Marcus, just 2%. For AMC, it's exploded 24-fold since 2019. And that's adjusted for the reverse split it did. It's insane. This doesn't explain the net loss, but again, it gets divided into so many shares. But there's an arrogance to the shareholder dilution here that reflects in a lack of cost controls and prioritizing spending initiatives. I'm not sure Nicole Kidman walking into an empty movie theater is as strong a selling point as AMC thinks it is. Are you buying any of these companies? Or are Are there other entertainment plays out there that you like a bit more than Marcus, Cinemark, AMC, or other movie theater plays that we haven't talked about today?

Yeah. So I don't own any of the theaters right now. Cinemark is the one that I find the most interesting of the ones we've talked about today. It's making smart moves and it's trading at a forwards earnings multiple in the mid-teens. Very attractive on that front. And yeah, the dividend is going to come back if that matters for you. One sort of related, the most theater adjacent movie stock that I like is IMAX. To me, IMAX is a company – it's more expensive, trading at higher multiples than Cinemark, but this is a company that cashes in on the one part of the movie business that's actually working right now.

IMAX is basically – if you're probably familiar with IMAX, you go into a theater, you pay a premium to see an IMAX screening of this movie that's a supersized screen, supersized sound, with sometimes additional footage shot for these IMAX screenings from these directors that love IMAX. and right now if you're going to movie theater you're going because it's that big action movie big superhero movie big horror movie big animated film for kids you're not going to see the indie film uh on imax and again if you're putting out indie films you're probably not distributing through theaters effectively now because those are the movies that people are willing to wait to watch at home uh you know two or three months later so i really like imax here rick we're recording this in early november we're heading into what some might consider like peak movie season are there any movies on the slate like the release slate this fall slash winter

that you are especially excited to go see in theaters yeah there's a lot of big movies coming out uh obviously uh wicked uh just by the end of this month you'll have wicked uh the the the screen adaptation of the wicked musical uh getting a lot of hype uh moana 2 is also coming out right before thanksgiving a week after wicked and that movie is uh as far as disney goes uh it's their the most views that they've seen for a trailer that they put out within the 24 hours of putting out. So there's a lot of anticipation for that movie. Gladiator 2, in December, you have Mufasa, another Lion King entry. So there's going to be a lot of exciting big movies coming out. Again, there's a lot of movies coming out because studios are comfortable and they trust the movie

theaters to amplify their voice in the future. So yeah, I'm excited. There's a lot of great movies. I'll be in the theater a lot. I live two blocks from an AMC, so I will be there for many of these films I just mentioned. There we go. Making good use of your loyalty pass. Rick, thanks so much for chatting with me today and for giving us some insight into what the movie theater industry looks like now and could look like in the years to come. As always, people on the program may have interests in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. All personal finance content follows Motley Fool editorial standards and are not approved by advertisers.

The Motley Fool only picks products that it would personally recommend to friends like you. I'm Mary Long. Thanks for listening. We'll see you tomorrow.