Hitting a home-run with a micro cap stock really isn’t all that difficult. All that’s required is decisive action and a willingness to take a calculated risk when the right idea comes along. Most timid investors find themselves missing out on huge winners because they take a swing too late – the peak opportunity is gone. Instead, they chase a stock after the fact for a much smaller gain. The lesson in all this comes in the form of a question…do you have the foresight and risk tolerance to take a swing before the biggest gains have been made and the company becomes a household name, or have you learned to live with the regret of missed opportunities? If you’re truly an opportunity seeker, read on. We informed everyone last week we’d be bringing our readers an idea we’re ecstatic about. Well, today’s the day. The name you’ve been waiting over a week for is ….Spicy Pickle Franchising Inc. (OTCBB: SPKL).
Simply put, this restaurant franchise is experiencing significant growth in a booming sector of the restaurant industry – fast casual dining. Why? Because it has it all …a highly profitable business model, nearly-unlimited expansion potential, and constantly-renewed consumer demand.
As of right now there are 26 of these franchised ‘quick and casual’ restaurants in operation, but 14 more are under construction. The company thinks they could add 40 more in 2008, and even more on an annual basis after that. Folks, that’s about a 100% annual growth rate.
What I like best right now about the stock is this – most other investors aren’t yet familiar with it even though it’s already got a major growth trend in place. This means you actually have a chance to get in now at a reasonable trading level before any unbridled demand drives shares much higher.
If you know anything about restaurant chains, then you know there are two basic ways to make money with them – by franchising them, or by operating corporately-owned stores.
At the end of this year Spicy Pickle will only have one company owned store. The guys at Spicy Pickle have focused much of their attention on franchising, so they can focus on building and expanding the brand. And, the numbers behind the franchise model look really good (i.e. fruitful for shareholders).
Within their franchise model, there are two basic revenue streams. Spicy Pickle collects a one-time $35,000 fee from each new franchisee (and/or $17,000 for subsequent stores owned by the same person). And, they collect 5% of each store’s monthly sales in perpetuity. On top of that, they receive about a 2% rebate from each store’s suppliers (soft drinks, meat, etc.). With the average Spicy Pickle storefront doing about $700,000 a year, each unit adds about $50,000 per year to the corporation’s annual revenue. How long do they get to collect that revenue? Forever. Let me repeat that – forever.
So how many stores can they really open? Does 80 seem aggressive? Eighty franchises have been committed to already. How about 500? It may seem like a lot, but how many restaurants do you think there are in this country? Try 935,000. So, I feel squeezing in the first 80 or so should be a piece of cake. Frankly, I think 500 seems like a low number too, but I’ll stay tempered for now.
The next question is, will consumer demand be able to support 500 (or more) restaurants? I think the answer to that question is another resounding ‘yes’.
Like I said last weekend, the National Restaurant Association expects the ‘quick and casual’ restaurant segment (which is Spicy Pickle’s category) to see double-digit growth in 2007. There’s a reason this is one of the fastest-growing restaurants in the business. There’s a reason Spicy Pickle does more sales per square foot than comparable restaurants. You don’t need me to tell you the average consumer just can’t take another hamburger joint.
I could go on an on with the list, but I’m happy to say we can let technology do that work for both of us. As promised, we’ve got a short web video for you to watch. It tells the whole Spicy Pickle story a lot better than I ever could. Take a look by clicking here. Just be sure to come back and read the rest of our report,because we have some details the video didn’t.
Like I mentioned, with the average Spicy Pickle storefront doing about $700,000 a year, each unit adds about $50,000 per year to the corporation’s annual revenue. So, when the remaining stores currently under construction are completed and the total number of storefronts is 40, we’re looking at about $2.0 million per year in revenue royalties. The one-time franchise fees are added to that total.
Not a big number? It’s all perspective. Remember, those are flat-out royalties…100% gross margin. The restaurant operators pay the expenses associated with running the store.
The other thing to keep in mind about the revenue model is something I already mentioned. There are 26 up and running, 14 units under construction, and there are 40 more waiting to start construction. Let’s just call it 80 stores by the end of 2008. At that point, we’re talking about $4.0 million in recurring annual royalties and rebates – with huge margins. As same store sales improve, so too will the royalties. (And again let’s not forget the one-time franchise fee is also booked as revenue.)
By the way – and this is the exciting part – the current burn rate is about $200K per month. I estimate when they get about 45 stores up and running, they’ll be able to cover all their overhead, and start generating positive cash flow. This is likely to happen sometime in 2008…just around the corner.
As far as capitalization is concerned, this is one of the most investor-friendly I’ve ever seen (and I’ve seen a lot). There are about 12.2 million shares in the float, and 45 million outstanding. The current market cap is right at $31.3 million when shares are at 69 cents. There’s no debt. Potential dilution? Don’t worry about it ….there are no warrants or convertibles, and only a few employee options. What a breath of fresh air!
Now, let’s put some of the numbers together and see what the stock could likely be worth in the not- too-distant future.
(Granted, this is my rough math, but you’ll get the idea. Also bear in mind the franchise model – this one in particular – doesn’t lend itself to normal valuation modes. In this case, I’d equate Spicy Pickle’s revenue stream more to an annuity than anything else.)
At 80 or so stores, we’re looking at $4.0 million in annual sales. Take out about $200K per month for overhead. In fact, let’s raise the overhead to $250K per month when there are 80 stores to run (a decent guess). That still leaves a nice profit margin. Now, at 500 stores, the company could be pulling in more than $25 million in annual royalties and rebates. At that point, let’s hypothesize that monthly overhead is $400K. That still leaves a net margin of $20.0 million.
A company the market values at $31 million could be annually bearing nearly $20 million (net) when there are 500 stores? A true P/E ratio doesn’t apply to a franchise model like this, but if it did, we’re looking at a ratio of somewhere around 2.
Like I said though, I think the real value of Spicy Pickle’s lies in its recurring income and strong margins. You know what the annual payment would be on a $30 million annuity paid out over a span of thirty years? At an average return of 12% per year, the annuity would only pay $3.3 million per year. That’s a far cry from the kind of numbers SPKL could be producing in just a few short years, and they’d be doing it forever.
Obviously this is an equity and not an annuity, and includes all the risks involved. But, the rewards built into the model seem to be incredibly enticing.
I trust that you’ve watched the video by now. If not, I urge you to go back and do it. Remember, if you agree with us about The Spicy Pickle’s potential evident in the video, a small investment of time today could mean potentially blockbuster returns later.
As for a suggested target, based on the math we did above, we think SPKL could get to $1.40 by sometime in 2008. That’s about a double from current trading levels.
An aggressive target? I don’t think so. The market cap would be around $60 million when shares are at $1.40. But, as discussed in my calculations, the company could back that valuation up pretty nicely. Actually, between the real estate, property, branding, and a reliable revenue stream (even with only a handful of operating stores), I feel an enterprise value of $60 million may actually still be too low.
As for a protective stop, I think 48 cents leaves ample room for SPKL to move.
One final thought …a question, really. Would you rather become an owner when there are 26 restaurants, or 80? When there are 80, or 500? When there are 500, or 1000? Ray Kroc started an empire known as McDonald’s when he essentially replicated one fast-service restaurant he was so impressed by in 1954. Now there are more than 30,000 golden arches all over the world. The stock has returned more than 15,000% since 1970.
Is the Spicy Pickle the new McDonald’s? Nobody can say for sure, but I do know the growth has already been superb, and appears as if it will actually accelerate over the next few years. I also know that waiting for any company to hit its peak is also a recipe for missing out on the best periods of growth for the stock…it’s just too late then – the market has doled out the lion’s share of the rewards.
To really take advantage of an opportunity, true risk-tolerant investors have to be willing to take action early on, when things are just getting started. The alternative is to just continue to hold onto other stocks that may be past their explosive growth phases, and suffer from mediocrity.
I think the window of opportunity for SPKL will still be open early this coming week, but not much longer than that. If you’re going to stake your claim, I believe the best time to do it is now.