Motley Fool Hidden Gems Investing - The Public Company Hiding In Plain Sight

Episode Date: April 12, 2023

You might be familiar with some of the brands, but the company's name is probably not on your radar. (00:21) Jim Gillies discusses: - MTY Food Group's 1st-quarter results and why the restaurant franchisor is one of his long-term holdings - The math behind MTY's success - Why he's most curious about Medpace Holdings reporting earnings in late April (17:45) Most businesses are paying their rent on time, but what happens when they want to renegotiate their leases? Ricky Mulvey talks with Deidre Woollard about the "Wall Of Debt" that's coming due and some more promising sectors in real estate for investors to keep an eye on. Companies discussed: MTY, MTYFF, MEDP, SBNY Host: Chris Hill Guests: Jim Gillies, Deidre Woollard Producer: Ricky Mulvey Engineer: Dan Boyd Learn more about your ad choices. Visit megaphone.fm/adchoices

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I'm Chris Hill. Joining me today from the Great White North, Motley Fool Senior Analyst Jim Gillies. Good to see you. Good to be seen, Chris. Longtime listeners will know that when Jim Gillies shows up on Motley Fool Money to talk about a stock, you can expect a couple of things out of the business. One is, it's probably a business that most American investors have never heard of. And two, there's a reason Jim is a fan of that business that most Americans have never heard of. And no exception today with a company called MTY Food Group, which reported first quarter earnings. There must have been something positive because the stock is up about 4%. But this is an interesting one

to me because you and I, I hadn't heard of the parent company, but I have heard of the brands, or at least some of the brands, because this is basically, if you've ever been to a food court in Canada or the United States, you've probably seen these fast food slash fast casual businesses and dozens of them are under the MTY food group umbrella. Yeah, they've got somewhere north, I believe now, of 85 banners. It wasn't uncommon, say, five or seven years ago, if you went to a mall food court, which, you know, I try to avoid the plague. But you would go to a mall food court, and half of the stores in that mall food court are all owned by MTY, and you wouldn't know it. But they are a restaurant

franchisor, Chris, which I've always found interesting. I love the MTY story. MTY, just quickly for American types, they are MTY on the TSX, the Toronto Stock Exchange. There is a pink sheet listing, it's MTYFF or MTY Fast Food, if you want to get your kicks on the pink sheets. I've always held that they were a very foolish story. They had a very foolish founder leader. He's in his 70s now, so he's largely stepped back from the business, but he's still the largest shareholder and is Chairman of the Board. His name is Ming Shea. Pull up a two-decade stock chart of this company, and you can see how Mr. Shea and anyone who's followed him has done pretty well. They're a restaurant franchisor, again,

for about 85 banners, I'm going to say roughly. It was about 80, and then they made a couple of big acquisitions at the very tail end of 2022. But some of the brands that the Americans in the audience will have heard of. Wetzel's Pretzels, they recently bought that. Famous Dave's Barbecue, they bought Barbecue Holdings, which owned them, among several other things. Cold Stone Creamery, Taco Time, Blimpies. Baja Fresh. Baja Fresh. There's a great story in the Baja Fresh acquisition. Some people may remember Baja Fresh as one-third or one of the three brands that Wendy's, back in an old prior

day was the Wendy's brand was going to use to take over the world. It was Wendy's, Tim Hortons, and Baja Fresh. Wendy's paid $300 million for Baja Fresh back in the day, kind of fast Mexican casual, I guess before Chipotle was hip. And at some point, I guess they didn't really execute with Baja Fresh and they sold it off for pennies. And then MTY picked it up a couple of years later for like $30 million, 90% off. Who doesn't like a 90% off sale? Wendy's probably overpaid, MTY probably underpaid. But the idea of a franchisor, I really like franchising businesses because I sell you a concept, I hand you all the capital risk, I hand you all the operating risk, risk. And I just take 6% of your top-line sales. So, before you've paid anybody a penny,

I take my 6%. Oh, and by the way, I'm going to probably also hit you for 2%, 3%, 4% for an advertising fund as well, which you're going to pay. And so, it's a very high-margin business. They have good margins, EBITDA margins, or they now call it adjusted EBITDA because you know, we couldn't stick with them at all. And what MTY does is, basically, they will recycle the capital that comes from those royalty payments, and they'll go out and buy additional concepts. And again, I'm a quirky kind of investor guy. I like strange things when I see them, just because I find them interesting. Maybe no one else does. But when I see a company like MTY, They'll make a $300 million, Canadian dollars, near enough, acquisition of, say, Wetzel's Pretzels.

And it gets the same fanfare in terms of the write-up as a few years ago, MTY bought, I don't think they bought the whole thing. I think they bought 60% of this little company called La Dipperie, which is a French ice cream. It's in Quebec. It's a French ice cream chain. I think they had less than 10 outlets. I mean, it's a rounding error. It's a who-cares acquisition. Why would you even bother? But you got the same press releases for La Tipperie as you did for Wetzel's Pretzels or

for Barbecue Holdings. I don't know. I find that quirky. I find that endearing. So, I like that. But as I mentioned, they did report this morning. Numbers look good. I'm going to give a little qualified good. Reported EBITDA, or again, adjusted EBITDA, or Lord, now they're calling it normalized adjusted EBITDA, because we've always got to have more superlatives. What they're doing, Fools, is they're taking out the one-time costs associated with acquisitions, which is actually reasonable, but I just hate this progression of increasingly strange terms for non-GAAP metrics. But they announced their earnings this morning. Their EBITDA numbers look very good. They might actually look better than I was thinking, and I'm going to explain

why in a minute. The cash backstop of that is not great, actually. I would have liked more cash rather than EBITDA. But I think this might just be a quarterly thing. Numbers look generally good. But Chris, you wanted to ask a question? Chris Hill I wanted to immediately jump to the future, Jim. I wanted you to look into your crystal ball and tell me, where is this business three years from now? Is the path forward? Because one of the things you said to me earlier today was, this is a stock that I think is undervalued. This is a straightforward business. Even if people haven't heard of the parent company, they're probably familiar with at least some of the

brands. I think it's a business model in part because of the way you laid it out that people can wrap their heads around. Do you think the next three to five years look similar to, let's just say, 2015 to 2020? We'll remove the pandemic for a moment. But is this just, in your mind, is the future of this business a pretty steady, like, this is just how it's going to go? It's not the most exciting business in the world, but if you like steady cash flow, this is one to put on your radar. That is exactly what I think it is. And I do think it is undervalued today, and I'll explain why. Franchisors, because they offload most of the operational day-to-day costs

and what have you to the franchise level. Now, that means pick good franchisees. Don't pick franchisees who are $50 away from going bankrupt themselves all the time. And MTY is a very good track record. But I'm just saying, there is know-how at the parent company level, that specialized know-how that they need to have, and they do. But because the costs are moved to the franchisee level, at the franchisor level, which is MTY, they produce a very high margin stream of EBITDA and free cash flow. Historically, because of that higher margin, I've always, I won't get into the boring math behind it, but I've always felt that if I can pay under 12X EBITDA for this higher margin stream, I'm generally happy. Because they're

usually making a lot of acquisitions, and a lot of acquisitions, again, the two most recent ones, you don't have a full year in the rearview mirror with those yet, so you have to run rate these things and figure it out. But I figure at this point in time, what we have now is we have a company capable of doing about $250 million to $260 million a year in EBITDA. I've been willing to pay up to about 12X EBITDA for that. I know it sounds funny when we might have talked about paying 20X sales, but I'm cheap and I'm the value guy. With today's results, I think they're good. I've marginally increased my estimate of what I think this current business can produce on a run rate business, which is actually about $260 million, but if you want to keep me at $250

million, that's fine. It's based on where the stock price, even with the 5% rise today, and there is some debt on the balance sheet because they're very protective of their equity, they don't hose out shares easily. The business today on enterprise value, so that is the market capitalization plus the net debt, is trading at about 8.9, just shy of nine times EBITDA. Again, I've historically been willing to pay up to $12,000 whenever I've recommended it, whenever I've bought it personally, because they have this history of increasing that EBITDA over time, increasing revenue, increasing cash flows. I am willing to do that. Then you also realize that they pay a dividend. It's a fairly modest yield today, but the important

thing is they raise their dividend every year practically. It's not so much during the pandemic, but I think we can all agree that was a weird time. They have a large shareholder in Ming She, as I mentioned, the founder, and he's now a chairman of the board. He's out of the day-to-day stuff. I think he's got like 20% of the business, so he takes 20% of the dividend. So, he probably wants to keep that dividend flowing. And importantly, they can afford it. The dividend doesn't use very much of their cash flow, frankly. They could double it tomorrow, it'd be fine. If you're looking for the next 10-bagger in six months or whatever, are we looking for those anymore, this is not your huckleberry. However, I do believe that the combination of dividend

plus appreciation of just in general as results come in, appreciation of the equity, particularly as they pay down debt from their more recent large acquisitions, I think you're going to get a low to mid-teens total return here, which perhaps at my advanced age of investing, I'm perfectly fine with, because I think it's going to be fairly consistent. Consistent results over a long enough period of time generates some really spectacular returns for investors. Real quick, let me hit you with the question I gave to Jason Moser and Bill Mann earlier this week. Earnings season starts on Friday. What are you going to be watching this earnings season?

I'm going to argue it started today with MTY, but they're on a November fiscal year. No disrespect to MTY, but as far as I'm concerned, earnings season starts on Friday. Sure. Let's run with that. I'm going to give you a company that I'm watching, because it's a favorite company of mine, as is MTY, I guess. It's a company that I spent most of the first three quarters of 2022 going, this one's a powder keg, this one's a powder keg, watch, this one's going to bump, you watch. When they reported their Q3 earnings, stock went up 38% in a day. It was tea and metals all around. That company is Medpace Holdings, which is MEDP on, I believe, the NASDAQ. Medpace is another one that I categorize as very

foolish in the best sense of the word. The founding CEO, Dr. August Trendle, started the company in 1992. He's still CEO today, still the largest shareholder. Put $155 million of his own money into the stock last year ahead of that third quarter. The company itself bought back close to 13%, 14% of their shares because, again, it's looking really good. The Q4 numbers came out and the stock sold off. Now, why did the stock sell off? Well, the stock sold off because Dr. Trundle, who is, I will say, if you ever listen to him on the conference calls, Guy is a very straight shooter. Guy is not afraid to say negative things about his industry or his business, which is rare, I will argue, in the world of executives talking about businesses.

He's very blunt, and I like blunt. MedPace is a contract research organization. They do various tests for drugs and medical devices. They basically allow the outsourcing for the drug companies and medical devices. They outsource, much like MTY does with the operational risk of running restaurants, drug companies, medical device companies outsource the actual day-to-day testing and clinical trials, outpace it to CROs like MedPace. MedPace is taking on a task that those other companies don't want to do. Traditionally, they've been very good at it, they've been very cash-generative at it. But you then should wonder about the health of the companies that are farming out to MedPace, you worry about the health of those companies. Those companies coming into 2023

looked a little strange, particularly in the biotech space as interest rates went high and the cost of financing with those companies might have got a little dodgy. It went into overdrive, frankly, when Silicon Bank went down. People construed that a lot of MedPace's customers would have had money with Silicon Valley Bank and, oh, my God, what's going to happen? Of course, we all know that the government stepped in and Silicon Valley depositors have been made whole or made fully whole, so this should alleviate some concern. But the issues potentially at MedPace, and I should underline, all of this is basically coming from exterior, it's external questions. MedPace themselves haven't said anything. And the other thing about MedPace

that you should know is they are traditionally very, I'm going to say, under-promise and over-deliver. The last three years, I think, their initial guidance for the fiscal year, every single time, it disappoints investors. Then every single time, they blow past it. I'm not too sure why investors react negatively to it when they initially, but that's what happened again. When the fourth quarter numbers came out, they gave initial guidance that basically, investors puked all over them and we're out. The price is a little higher than right now. I've recommended this company a couple of times in Hidden Gems Canada, where I hang my hat most of the time, and it's been a great performer for us. The last time I featured it in that service,

I featured in our Best Buys Now column, and I pointed out that the valuation, this was end of February, and at a slightly higher stock price than we have today, the valuation was essentially better. The valuation had gotten better vis-à-vis where we had recommended it in the middle of 2022, and more importantly, much better than after that 38% stock price reaction after the Q3 numbers. Those valuation numbers are today marginally better. Again, I've followed this company for a lot of years. The management team, as manifested in Dr. Trundle, again, Founded the company in 1992. He remains CEO today. He's been CEO the entire time. I'm going to suggest he's probably seen one or two things like what we're featuring in the

market before. That experience and that ignoring the market and focusing on your business is exactly what I think investors should be looking for. If they're going to invest in individual stocks, that's what you should be looking for. It's not a sexy story, I get that. But then again, I never go for the sexy stories, I just go for the cash flow and good valuation stories, and it seems to work pretty well. MedPace Holdings is scheduled to report on April 25th, so I know what you're going to be doing that day. Jim Gillies, thanks for being here. Thank you. When it comes to office space, most businesses are still paying their rent on time.

time. But what happens when it's time to renegotiate the lease? Ricky Mulvey caught up with Deidre Woollard to discuss the wall of debt that's coming due and some more promising sectors in real estate that investors should keep an eye on. do not like it when their loans are worth less than what they paid for them, and many commercial real estate loans are going to take a haircut. Deidre Willard is a real estate expert at The Motley Fool and has been following this story closely. Deidre, these stats got my attention. According to Bloomberg, $1.5 trillion of U.S. commercial real estate debt is coming due before the end of 2025. Morgan Stanley estimates that office and retail property valuations are going

to fall by about 40% from peak to trough. This is a big deal, right? Yeah, this is a big deal. And there's really about $5.6 trillion of commercial real estate debt total. So, even beyond 2025, there's other things to look at. But it's also, it's not as much the debt. I mean, the debt is huge. It's the timing, right? Because right now, so much of this is in office real estate. And we've all seen the impact of work from home. So, you've got those kind of systemic concerns about office not being desirable. And about 25% of office real estate is due to be refinanced in 2023. So debt's coming due. You either have to repay it or refinancing it. You're refinancing it in an environment where you've got nervous banks, stricter lending,

higher rates, uncertain valuations for so much of the real estate that's backing these loans. And that's part of the concern here. Yeah. Another stat I want to get your reaction to is that 70% of other commercial real estate loans that are maturing in the next five years are held by banks. I feel like I'm looking into a black hole trying to describe what I see. I have no idea. Yeah, that part is worrying me as well. I was recently reading Bill Ackman's shareholder letter for Pershing Square, and he pointed out the role of the smaller regional banks in this. And that's the part that is particularly important because it makes sense, right? Smaller regional banks would own this kind of debt. It's highly localized. You want local banks because they

understand the local market. But it creates this real problem if we start to see a lot of foreclosures, because these smaller banks, they're already under stress. They're seeing deposit flight. They don't want these buildings on their books any more than anybody wanted to own houses. Banks did not want to own houses during the great financial crisis. It just, unfortunately, it worked out that way. So all of that is worrying me. It's just this kind of recipe for disaster. I feel like sometimes people don't understand how important commercial real estate is to the U.S. economy. It contributed $2.3 trillion last year. We tend to obsess over the housing market, myself included, but commercial real estate, it's part of our daily lives.

As we start to think about this, and now it's getting covered by the media, it makes people start thinking about their local banks and the risk there. Then I'm also thinking about the impact on institutional investors because that's where a lot of this is being financed, things like pension plans like CalPERS, which is the California pension plan. To the point of regional banks, I keep seeing this argument that many of the commercial real estate loans are in good standing, they haven't been delinquent on it. But I don't think that's necessarily an accurate picture of what's to come if a lot of those loans are getting repriced or a lot of businesses just exit out of their office space and office buildings.

It's not bad debt for the most part and they're not bad buildings. This is Class A and Class B real estate. These are good buildings, but they are seeing significant vacancy rates and that may continue. Let's dive into the ripple effect. Let's say that the Morgan Stanley scenario plays out. Banks want a higher interest rate for their office building debt. That seems like a reasonable prediction and the value of those loans are written down. What are the ripple effects? There's just a lot of ripple effects. As I said, the money is going to be tight, so there's that squeeze right there. The other thing I think about a lot is that we don't necessarily know the value of the underlying real estate because there hasn't been a lot of

activity in the last year in terms of commercial real estate transactions. There's this expectation gap. We've seen it in residential real estate where there's a six months, maybe even up to a year of lag between what people saw six months ago and sellers expecting to get that when the market shifts and that creates a real problem. I think the owners are going to have to make some hard decisions. I've already seen some high-profile loans go into special servicing, which opens up the ability to negotiate. But then what's next? What happens to these buildings? I'm thinking about other uses. There's been a lot of talk about multifamily conversion. Multifamily conversion, very small part of the market, it's expensive, it's really hard to convert a building.

Then you start thinking about other uses, maybe vertical warehouses, maybe data centers, but then you've got zoning concerns, you've got energy usage. What's next for all of this real estate is the big question. The leases for these office buildings and commercial real estate are different from the leases and mortgages you might interact with for getting an apartment or your home. Oh, yeah, sure. They're longer, first of all. A lot of times the tenant is reconfiguring the floor plan based on their needs. When they move out, there's going to have to be some money spent to get it up to for the next tenant. You've also got insurance, you've got common area maintenance. You think about those big lobbies in

office buildings. Someone has to pay for that to look so pretty when you walk in. The other thing I'm watching is subleases. Subleases are becoming a bigger and bigger part of the CRE market. I've seen a lot of sublease activity. We've seen some high-profile once. Salesforce, they've put up subleases in multiple markets, Verizon, Amazon, Meta, lot of subleasing activity, which is putting additional strain on it. You mentioned that the commercial real estate market has been slow. There might be a window into what's going on with Signature Bank. Signature Bank shut down by regulators earlier in March. It was the third largest commercial real estate bank in New York City.

A lot that went wrong, but one thing to focus on is that Signature had about $36 billion in real estate loans. Now, the FDIC have been taking over those loans or getting some investment bankers together to sell Signature's loan book. That might sound boring, but why should investors care about this sale? What are you watching? It's not boring for me at all. As a commercial real estate watcher, it's something I'm watching avidly, and I think the whole market is watching to see what's going to happen next. So, you've got these loans. They're going to be divided up into pools. They're good loans. They're high-performing loans. Interest rates may be a couple of points lower than the current market, but who wants these loans? So, are banks going

to want to take on these loans? Where are these loans going to go? And the fact that the FDIC brought in Newmark already means that nobody was exactly chomping at the bit to pick these loans up. So, what we're looking for is, are they going to get sold at a discount? Is that going to set into normal, are we going to see something that makes us feel pessimistic or are they going to find a buyer relatively quickly? That would be a sign of health and make us feel really optimistic. Yeah. I can easily imagine the end of this story from a pessimistic angle. Maybe I lean towards that too much, but there's also a version of this story with the commercial real estate market where fears were overblown and it wasn't that big of a deal. What's the version where that ending plays

out? And do you think it's credible? You know, I think when we make predictions and everybody wants to look at the worst case scenario, but there are some ways in which it plays out and it's not a big deal. You know, it's so much depends on the Fed. I mean, I hate talking about the Fed. I think we focus too much on it, but we get that normalization of interest rates. Maybe even, you know, it starts at the interest rates start to go down. Maybe it gets easier to refinance. These loans get more attractive. The other thing, the big, like magic eight ball, who knows what's going to happen is remote work. Maybe we'll get more remote work. Maybe we'll get less. We don't seem to know. I think the numbers have stabilized, but

then I'm looking at productivity. I'm looking at layoffs and people wanting to have that visibility in the office and employers wanting to have that. So maybe that's the way this works out. I appreciate you're not looking into the crystal ball too deeply. I was reading this article in CNBC. It was a commercial real estate analyst for Moody's Analytics. And he said, quote, 2025 is where we really see that pivot toward recovery for office, end quote. And I kept thinking, like my guy, a lot of real estate experts have been making predictions on back to office. And we're still doing that three years from now. I think we're going to be doing that for a while. I think things can change very quickly. So I want to talk. Let's end with

some optimism, some silver linings, because there are parts of the real estate market showing some promise. What are the sectors that you find compelling or silver linings for investors to watch? I think there's always silver linings. The fun part about real estate is different sectors come into fashion. It just happens. For the last couple of years, industrial and multifamily have been the darlings of the sector, and they're both still doing well. Industrial, maybe we saw a little bit of a drop-off with Amazon giving up some space. With multifamily, there's a lot of supply at the high end, so you've got a little bit of rent compression happening. Retail has been doing great. People

were saying a few years ago, retail is dead. The same way they're saying office is dead now, they're saying retail, it's never coming back. That turned out to be very not true. It's been going up as office has been going down. I love those grocery-anchored retail, that essential business thing that we saw so much during the pandemic. Looking at hospitality, too, and the impact of remote work has led to this rise of medium-term rentals, like a month or so. So those are the areas that I'm looking at. Deidre Rollard, appreciate your time and your insight. Thank you. As always, people on the program may have interest 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. I'm Chris Hill, thanks for listening. We'll see you tomorrow.