Case Study #1 - MTY Food Group Inc.
In the name of full disclosure I’ll point out that I have been a shareholder of MTY since 2004.
Company MTY Food Group Inc. is a Quick Service, Fast Casual and Casual Dining restaurant franchisor. The Company has 6,719 restaurants under 80 banners, mainly in Canada and the U.S.
MTY also sells its frozen meals under various banners in grocery stores and big box outlets.
In 2021, MTY had $3.6B in system wide sales and generated $109.8M in free cash flow (ex-working capital items) on $552M in revenues.
Founder - Stanley Ma Stanley Ma has been the CEO of MTY Food Group from 2003 – 2018 and is the current Chairman.
Over the years, I have had discussions with Stanley many times. Initially, it was only at the annual meetings but over time it turned into a quarterly discussion. Here is a brief history of Stanley from my talks with him over the years.
In 1968, Stanley was 21 years old and he left Hong Kong to come to Montreal to discover new opportunities. He chose Canada because it was a pacifist country and Montreal in particular because it was a vibrant city, that at the time, was the business capital of Canada and that the whole world was talking about because of the World’s Fair, Expo ’67.
He only had $100 in his pocket and was not the type to ask for help, not even from his parents who were successful business people back in Hong Kong that owned manufacturing, real estate and retailing businesses and were prosperous enough to have a chauffeur. In Montreal, Stanley found work as a dishwasher in a restaurant in Chinatown.
Being tall, and the sink being very low to the ground, he would be soaked from the waist down from washing the dishes. He would arrive home humiliated and vowed to make something of himself in his new country. Stanley held different odd jobs - dishwasher, waiter, cook - but his goal was to open a restaurant and so he worked very long hours and 7 days a week. On a trip to Calgary he visited the Beachcomber, an iconic Calgary landmark that served Polynesian food. Stanley says he loved the concept and wanted to create a small version of that restaurant. So in 1979, 32 year old Stanley Ma opened his first restaurant.
It was a 7,000 square foot restaurant that was located in what he describes as the middle of the cornfields in Laval, Quebec and served Chinese and Polynesian cuisine. Within 2 years of opening, he had about 40 employees. The restaurant was profitable but Stanley realized that fast food restaurants might provide an even better return. He never set out to own a vast chain of franchised restaurants. No, the original idea was to make a living and be able to support his family.
In 1983 Stanley Ma opened a restaurant in the Rockland shopping mall food court in the Town of Mount-Royal, Quebec called Tiki-Ming. His objective was to learn the quick service restaurant industry.
A few years later in 1986 he sold his first Tiki-Ming franchise. He then realized there was real demand for a variety of food court choices. In the mid 90’s he had 50 restaurants (franchised and corporate owned) and was still working in the kitchens. In all Stanley said he worked for 30 years in restaurants.
The Company went public in 1995 through a reverse takeover of a shell company named Golden Sky Ventures International Inc. and was listed on the Vancouver Stock Exchange, which today is called the Venture Exchange. Back then, in addition to restaurants, the Company had a strange brew of operations: selling parking equipment in China, selling computers and fax machines in Canada along with IT services and in July 2000 changed its name to iNsu Innovations Group Inc. to reflect their operations.
The restaurants were doing well but the other operations were dragging down iNsu Innovations and so in March and April 2003, the Company divested all non-restaurant operations and Stanley Ma was appointed CEO. In July of that same year, the Company changed its name to MTY Food Group Inc. to better reflect operations and to focus the Company on industry domination. The Company changed its ticker symbol from INU to MTY.
Stanley still works 6 days a week, 12 hours per day. He always eats lunch, even on weekends, at one of his franchisees, preferring to give them the business and to see for himself how things are going: the taste of the food and the service.
Stanley has accumulated a tremendous amount of knowledge in the industry. He started as a dishwasher, then became a waiter and then a cook. He then owned his own restaurant and learned how to run a whole kitchen, handle employees, purchasing, menu development and pricing. He then learned about franchising and this would become his business model of choice. The decades that he spent in kitchens served him well as he had very detailed knowledge of how kitchens should be designed for maximum speed and efficiency and used this in rolling out his franchise model.
Stanley realized very quickly that the more restaurants he had, the more food he sold and the greater the discount he could receive from suppliers for buying in bulk.
He also realized at the time that almost all restaurants in food courts were mom and pop owned. The competition was very small and had no competitive advantage.
His entire focus would be to grow by acquisition by buying up these mom and pop restaurants and to get cheaper prices on food and supplies due to the large volume he would buy from suppliers. This would allow the company to be more profitable than its competitors and provide him with the cash needed to fund his acquisitions. His goal would be to become the biggest and most profitable player in Canada. Initially his competitive advantage would be economies of scale and being the dominant player in the small food court market. In time he would come to dominate the space and set his sights on other food markets.
This case study will cover the 20 year period from 2002 – 2021 in 5 year increments.
2002 – 2006 Please not that per share values may not always add up to due rounding of dollar amounts. Example: if free cash flow is $1,550,412 I will show it as $1.6M and this will make small differences on a per share basis.
End of 2001 End of 2006 Restaurants: 154 784
Number of banners: 9 19
System wide sales: $44M $160M
Revenues: $15.8M $22.4M
Free cash flow: $1.4M $6.8M
Free cash flow/share: $0.09 $0.36
Shares: 15,723,534 18,688,350
Stock price: $0.36 $6.55
Debt: $0 $0
Cash: $4.1M $7.5M
Dividends: $0 $0
In this five year period, the Company was implementing its growth by acquisition strategy in the food court sector of the restaurant industry.
They key piece of data to focus on in this industry is system wide sales (SWS). Same restaurant sales are also important but to a much lesser degree. You want to focus on SWS because the Company receives a royalty on all sales from its franchisees. If SWS are increasing then so are your sales and free cash flow as the Company is asset light and so revenues get turned into free cash flow at a greater rate than in other industries.
MTY increased its number of shares outstanding by 18.9% which created dilution but this was more than acceptable because its free cash flow on a per share, which takes into account the dilution, increased by 300%.
In this five year period, MTY’s stock price increased by 1,719%. This is not a typo.
All of this was achieved without the use of any debt and the Company had $7.5M of dry powder at the end of 2006.
This was achieved because the Company did not pay a dividend and instead allocated all of its capital to growth and grew by acquisition. Shareholders were very handsomely rewarded for not receiving a dividend. The stock price would not have grown to the level it did if all funds were paid out as a dividend.
End of 2006 End of 2011 Restaurants: 784 2,263
Number of banners: 19 28
System wide sales: $160M $528M
Revenues: $22.4M $78M
Free cash flow: $6.8M $19.6M
Free cash flow/share: $0.36 $1.03
Shares: 18,688,350 19,120,567
Stock price: $6.55 $15.21
Debt: $0 $0
Cash: $7.5M $1.3M
Dividends: $0 $0.225 per share cumulatively since end of 2011
In the five year period of 2007 - 2011, the Company continued to implement its growth by acquisition strategy in the food court sector of the restaurant industry.
MTY increased its number of shares outstanding by only 2.3% which again created dilution but once again this was more than acceptable because its free cash flow on a per share, which takes into account the dilution, increased by 186%.
In this five year period, MTY’s stock price increased by 132% and an increase of 4,125% since the end of 2001.
All of this was achieved once again without the use of any debt and the Company had $1.3M of dry powder at the end of 2006.
Once again, this was achieved because the Company did not pay a dividend until 2011 and it was only $0.045 per share/quarter. This was an insignificant as it was only an 18% payout ratio and so MTY had a lot of money left for growth.
Shareholders were very handsomely rewarded for receiving only a small dividend. The stock price would not have grown to the level it did if a higher dividend were paid out.
End of 2011 End of 2016 Restaurants: 2,263 5,681
Number of banners: 28 52
System wide sales: $528M $1.5B
Revenues: $78M $191M
Free cash flow: $19.6M $51M
Free cash flow/share: $1.03 $2.38
Shares: 19,120,567 21,374,497
Stock price: $15.21 $50.16
Debt: $0 $289M
Cash: $1.3M $0
Dividends: $0.225 cumulative $1.70 per share cumulative from 2012 - 2016
In the five year period of 2012 - 2016, the Company continued to implement its growth by acquisition strategy but now expanded its focus to street front. It also made its first acquisition in the U.S and it was its biggest acquisition ever: $394M for Kahala Brands, a U.S. franchisor with 2,879 restaurants under 18 banners and that had system wide sales of $1B. MTY, that had become very big in Canada, was now shifting its focus to the U.S.
Kahala brands has good exposure to markets outside of North America and so this would be the beginning of two new growth markets for MTY. This was a transformative and strategic acquisition for the Company that would help to drive growth for decades to come. The initial vision of dominating the food courts in Canada was achieved and now the vision was expanding.
MTY increased its number of shares outstanding by only 2.3% which again created dilution but once again this was more than acceptable because its free cash flow on a per share, which takes into account the dilution, increased by 186%.
In this five year period, MTY’s stock price increased by 132% and an increase of 4,125% since the end of 2001.
This is the first time in MTY’s history that it used debt. The high level of free cash flow generation would allow the Company to pay down debt very rapidly if it chose to do so.
All of this growth was achieved because of the low dividend payout ratio. Their policy is to pay out 15% - 20% of the prior years’ free cash flow in the form of a dividend and to keep the rest for acquisitions and some debt repayment.
End of 2016 End of 2021 Restaurants: 5,681 6,719
Number of banners: 52 80
System wide sales: $1.5B $3.6B
Revenues: $191M $552M
Free cash flow: $51M $110M
Free cash flow/share: $2.38 $4.45
Shares: 21,374,497 24,669,861
Stock price: $50.16 $55.19
Debt: $0 $299M
Cash: $1.3M $0
Dividends: $0.225 cumulative $2.46 per share cumulative from 2017 -2021
In the five year period of 2017 - 2021, the Company continued to implement its growth by acquisition strategy but now its focus was on the U.S. It also made its second acquisition in the U.S and it was its second biggest acquisition for the fifth largest pizza chain in the U.S. and one with a different operating model than the other chains for $253M in 2019: Papa Murphy’s.
For the first time ever, MTY now has more restaurants in the United States than in Canada and their U.S. acquisition strategy has been highly successful. Not many Canadian companies are successful in making U.S. acquisitions. Statistics show that about 67% of all acquisitions fail to create shareholder value. In other words they lose money. MTY has made 45 acquisitions and all have been successful. This is more incredible than you can imagine. Management is very disciplined and does very deep research. It’s not just about the numbers. Yes, they do not overpay but it is the knowledge that they bring that is the real differentiator.
Pizza in the U.S. was something they were looking at since their acquisition of Kahala Brands in 2016. When the pandemic hit, Papa Murphy’s became a superstar and was one of the big factors behind the following fact:
Since the start of the pandemic the Company has been able to repay close to $200M in debt.
MTY increased its number of shares outstanding by 15% which again created dilution but once again this was more than acceptable because its free cash flow on a per share basis, which takes into account the dilution, increased by 87%.
In this five year period, MTY’s stock price increased by 10% and an increase of 15,231% since the end of 2001.
In 2019, Eric Lefebvre has been appointed CEO and Stanley who is now 74 years old remains as Chairman. Eric is 43 years old and is a workaholic. Like Stanley, he works 6 days a week. When I asked him if he has any hobbies like sports or movies he told me that work is his hobby. Impressive!
He has been with the Company since 2010. He was comptroller and then CFO. Eric has the same mentality as Stanley with the exception that he has an accounting major and an MBA. The MTY culture remains and as Eric told me: acquisitions are in MTY’s DNA. They will always grow by acquisition but now he wants to add organic growth to the mix.
Once again, all of this growth was achieved because of the low dividend payout ratio. Their policy is to pay out 15% - 20% of the prior years’ free cash flow in the form of a dividend and to keep the rest for acquisitions and some debt repayment.
Today MTY's food court operations are a very small part of its business. They represent only about 15% of revenues.
Back in 2012, they started to sell frozen foods to the grocery stores under some of their more popular banners. This business was started from scratch: $0 in revenues. Today they sell for over $100M dollars of frozen foods and most of this is only from the province of Quebec. More growth to come.
Conclusion There are only 5 places a CEO can allocate capital:
- Reinvest in operations
- Pay down debt
- Acquisitions
- Buy back stock
- Dividend
How the CEO goes about allocating capital is the major factor behind how much free cash flow, on a per share basis can be generated.
Free cash flow per share is directly correlated to how your stock price performs and the higher the free cash flow per share, the higher the stock price. It is that simple.
Paying a dividend takes capital out of a company and prevents the company from growing its free cash flow per share.
Shareholders may like receiving dividends but it makes them poorer over time.
Had MTY paid out virtually all of its capital to shareholders over the years in the form of a big juicy dividend, they would not have seen their stock rise from $0.09 to $55.19 (and down from a high of $72.10 due to the pandemic).
$10,000 invested in MTY at the end of 2001 would have been worth $6,132,222 at the end of 2021. This is a 37.9% yearly compounded return for 20 years.
Excluding dividends received along the way.
Dividends are the enemy of wealth creation.
They may be the right decision from a capital allocation perspective if the company has no growth left it in. But if that is the case, why own the stock?
MTY achieved this incredible record due to its logic in employing capital and its skill at identifying and integrating acquisitions successfully while not paying too much for those businesses.
Let us hope that GH does not increase its dividend. I for one would like GH to retain its earnings and plow those dollars into growth initiatives.
We need a separate infrastructure to house the type of restaurants that will attract a different type of customer. One that is not interested in going to casinos. This would be a good step towards growth. A new addressable market.
A friend of mine pointed out that expanding casino operations into BC would make sense. I agree.
Build a casino. The casino would have nice sit-down restaurants inside. Build a separate restaurant structure next to the casino using the Fast Casual model to attract a different type of customer. One that would not think of eating at a casino.
Offer a loyalty program inside the Fast Casual restaurants that gives you points for every dollar you spend. Those points are converted to free money to play the slot machines.
New customers. New addressable market.
It is time for GH to start growing.
Capital must be allocated to growth and not only to dividends. Those dividends have held GH back for far too long.