Covenants and expected EBITDAThese are just my back-of-the envelope numbers. Please, feel free to give your own comments.
The long term debt to TTM EBITDA for 20Q2 should be about 3.6x. The covenants for the next quarters are 4.5, 4.5, 4.25, 4.25, 3.5 onwards. I assume the lending syndicate worked with MTY and set these up so that they would not be exceeded. This should, therefore, give us the worst case scenario the banks and management think are plausible for the nearby future. At 4.5, this would mean at least 117M in EBITDA for a whole year for 2020 and at least 151M TTM by Q3 2021 (assuming the same debt at 519M). In 2020, MTY has already earned 59M in EBITDA, meaning for the second half of the year, they will need to generate at least 58M. The management expect the 2020 results to be worse than 2019, but for comparison the 2019 Q3 EBITDA was 42M and Q4 was 43M. Therefore, as long as we have less than 30% drop in EBITDA in Q3 and Q4, the company should be OK. For Q2, however, there was a 47% drop (56% from Q1). It is also noteworthy that at the end of Q2, MTY still had over 38% of locations closed. At 38% drop in EBITDA in Q3, MTY would need to go back to business-as-usual with same EBITDA as before COVID from Q4 onwards in order to reach the 3.5x convenant. This is not realistic. By 21Q3, the covenants require a smoothed drop in EBITDA of no more than 10% from pre-COVID numbers (or comparabe debt repayment). I do not know how to interpret this but it does not seem to leave too much wiggle room in my humble opinion.
We have 38% of locations shut down at the end of Q2; there was 40% discount to royalty payments if they were made on time (not sure if this franchisee assistance program was discontinued); the company has reduced salaries and headcount to unsustainable levels (ie expenses will have to go up soon); there are 23M in 30d+ overdue accounts receivables (or about 20% of covenant EBITDA threshold which were still recognized as earned on the books); and 17M of net leases payable by the company (from 134M in total for next year and more of this might fall on MTY's shoulders if any more franchisees go bankrupt). On a positive side, the company still managed to pay about 25M of debt (mostly thanks to one-time asset sales) and they have still managed to open some new locations and are down only about 1.5% of pre-COVID locations for the quarter. The bank covenants also forbid any dividend payment or share buybacks until the debt to EBITDA is below 3.5, so all excess free cash flow will essentially have to be directed towards debt repayment.
My conclusion from the relaxed bank covenants is that they are either cautiosly optimistic about recovering profitability (which is hopefully the case) or that they will necessitate either further asset sales, issuance of new equity, and/or significant belt-tightening and agressive debt repayment for the foreseeable future.
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Now, how do these numbers translate to MTY's valuation?
We should be fairly conservative in assuming medium term smoothed out EBITDA in the lower range of 117M to 151M, based on the covenants. In the upper range, at pre-COVID post-Pappa Murphy's acquisition levels we would be at about 168M (I do not foresee additional growth beyound these levels but this is more than overall 2019 levels at over 42M per quarter). Fully dilute, there are also about 25.1M outstanding shares (including the recently issued 400k options).
Per share, this means we have EBITDA of somewhere at 4.67 to 6.00 according to the bank covenant assumption and 6.70 at the optimistic pre-COVID levels. We also have about 21 of long term debt per share and 60 in total debt minus cash. Currently, the shares are trading at bout 31. So the EV/EBITDA on MTY is at 15.13x to 19.46x using the bank covenants and at 13.57 using the optimistic pre-COVID numbers. MTY has made large acquisitions at around 10x EBITDA in the past (Pappa Murphy's was acquired at proforma of about 8.5x). MTY's historical EV/EBITDA range has also been 14.17 (5-year average) and ranged from 9.66 to 22.56 in the past 10 years (Morningstar data).
Each person has different thresholds for their investment. To me, however, the current valuation appears as quite fair and not very deeply discounted considering MTY's historical multiples and potential risks in its business model. Given other comparable stocks are trading at more compelling multiples, I will not be buying more shares unless there is a more substantial decline in share price. If the price goes up, I will be happy because I am about 1/2 underwater on a 4% portfolio position (and if you do some adjustments, a fair price could still be justified even at 46-63 dollars, especially given the rock bottom interest rates and the new IFRS rent liabilities). If it goes down, I will try to average down. A fair purchase price for me would be somewhere in the low 20s per share (or about 12x pre-COVID EV/EBITDA and at about fair book value and well within the MTY's recent trading range).
I am at work so I was not able to listen to the conference call. I will read the transcript once it will come out in a few days. What were your key take aways? If I made any mistakes in my back-of-the-envelope calculations, please, do correct me.
Have a nice day everyone!