RE:RE:Case study #1 - MTY Food Group Inc.You know Cpeczek, I have seen a lot of bad outcomes wth companies that do frequest acquisitions. One of the most eggregious examples is probably the Lowen Group that filed for bankruptcy back in 1999 (at least that is my recollection). I had just made my first stock purchase ever that year (not in Loewen fortunately).
The odds of being successful with this type of strategy are much worse than you think unless you have a real good management team. For starters we have to keep in mind that 2 out of every 3 acquisitions lose money. So right from the start the odds are against you. Then as you keep making acquisitions, they get bigger and bigger to move the needle and over time the odds are failry high that you will mess up at some point. Now it doesn't always lead to bankruptcy. Of course not but it can produce mediocre results if you have bad management.
MTY has been very successful for a number of reasons. The most important is that they really know their industry well and are incredibly disciplined.
It is the same as in investing. The real way you reduce risk is by really, really, knowing the company you invest in, its competition and the industry it operates in. This is how you reduce risk. Diversification does not reduce risk if you have a collection of businesses that you don't understand.
MTY are incredibly talented operators and they have one of the best capital allocation skills that I have ever seen.
Most companies that do roll ups use way too much debt - dangerous levels. Of those that issue shares, the majority produce very poor results because the percentage of shares issued is greater than the percentage incrase in free cash flow from the acquisition.
MTY's free cash flow always grew at a much faster pace than the shares issued. In other words MTY was gaining more in intrinsic value that it was giving up in dilution.
While MTY never used much debt, they only used it for their first time ever in 2013, they were able to increase free cash flow from $178,000 to $25,992,000 between 1998 and 2012. This is a 14,502% growth if free cash flow while not using any debt and having issued only 28% more stock and so free cash flow on a per share basis, and this does take into account any dilution, increased from $0.01 to $1.36 between 1998 - 2012.
These are spectacular results to say the least.
The six year period from 2007 to 2012 saw MTY increase its free cash flow from $6,762000 to $25,992,000 without the use of any debt and without ths issuance of any shares. They just used cash that they generated internally from operations. This is a 284% increase in free cash flow without debt or share issuance. Unreal!
Stanley Ma and Eric Lefebvre are the real deal. Ecellent operators and fantastic capital allocators. They both have tremendous knowledge and discipline and work all the time except for Sundays.
I have an interesting story for you:
MTY started to use more debt in 2016 as they were looking once again to transform the company. The first vision was to dominate the food courts in Canada. Mission accomplished. The second vision was to get Canadian street front and to become the number one or numbe two player in Canada. Mission accomplished. The third vision was to get a big foothold in the U.S. and learn that market and then once they understood the local markets to begin their quest to become one of the biggest players in the U.S. As Stanley told me in 2015, he did not want small U.S. acquisitions to start. He wanted to come in big to have a better base for expansion. This was accomplished with the larege Kahala Brands acquisition and they are looking to become a big player over time in the U.S.
I became concerned about debt for the first time ever in 2019 after MTY bought Papa Murphy's. Net debt peaked out at $490M which was 6X trailing 12-month free cash flow due to the large price paid. I called Eric and I expressed my concern over debt levels. I told him that I like to see a company not have more debt than what could be paid for with 3 years of free cash flow and thought 6X was excessive. I could say things like this because I have a good relationship with Eric going back to 2010 and with Stanley going back to 2004.
Eric told me 2 things:
1) We decided this was too good of an acquisition to pass up. This acquisition will be a superstar for MTY in the not too distant future and is extremely important to our long-term growth in the U.S. market. It is a game changer for MTY that will only get better with time. We could not let this incredible opportunity pass us by
2) Within 2 years we will have our debt levels that not only meet your standards but well below your rule of 3X free cash flow. I assure you we have not lost our discipline.
This is the actual outcome Cpeczek:
Two weeks after my discussion Eric the pandemic hit. What a time for us to be having a high debt load. This is what was going through my mind.
MTY had restaurant closures. Different rules and regulations were imposed by the governent and there was exteme uncertainty world wide.
Well all bets are off - who could have predicted COVID. Bad news!
This is the result that MTY produced in these incredible uncertain times:
1) Papa Murphy's became an instant superstar and their sales went through the roof. Yes it was good to be in pizza in the pandemic. Even now it is doing just incredibly well.
2) 2 years after my discussion with Eric and even though we have been in a pandemic for this whole time, MTY has lowered its net debt to from $490M to $299M. That is total debt repayment of $191M over two years, in a global pandemic which saw our restaurants under full or partial lock down for a very large part of those 2 years. Total net debt can now be repaid with 2.7 years using trailing free cash flow. We are at conservative debt levels now and have dry powder for acquisitions when the right target is available at the right price.
Not only did MTY pay down $191M of debt in the two years of the pandemic but they have also repurchased over 400,000 shares in this same time span.
One last stat for you Cpeczek:
The year befor the pandemic, 2019, MTY had its best year ever. It had $4.10 in free cash flow per share.
Two years later, 2021, and still in a pandemic, MTY made $4.45 in free cash flow per share. This is a 9% increase over their pre pandemic record of $4.10. All while having paid off $191M in debt and repurchasing more than 400,000 shares and all in a global pandemic with lockdowns and uncertainty.
MTY is truly a great company and now you know why it is my largest holding.