Middleby, Freshii: Two Restaurant-Related Ideas Led by Missionaries

David Barr and Felix Narhi of PenderFund Management Capital presented their in-depth investment theses on Middleby (Nasdaq: MIDD) and Freshii (Toronto: FRII) at Wide-Moat Investing Summit 2018.

Thesis summaries:

Middleby: Since taking the helm in 2001, CEO Selim Bassoul and his management team have transformed the company from a small “me too” food equipment maker into one of the world’s largest commercial food equipment makers, with three synergistic platforms serving the restaurant industry, large commercial bakeries and meat producers, and consumers in search of premium kitchen appliances. The food equipment industry benefits from a number of structural shifts taking place at the consumer and restaurant operator level.

In addition to secular tailwinds, Middleby has an extraordinary track record outpacing the growth of the market through disruptive innovation and adding value via its proven M&A framework. David and Felix believe management’s enviable value creation algorithm remains intact. Proven compounders rarely trade at a discount to the market, but sporadic bumps in the road can push down stocks to compelling valuation levels.

Of late, investors have been concerned about the weak organic growth across all three core segments as well as the full price for a proposed large acquisition (Taylor), which will increase financial leverage. Due to negative investor sentiment, the stock recently traded near the same levels as four years ago, even though intrinsic value has grown much higher. Recent concerns should prove temporary and, from a long-term perspective, are more than adequately discounted in the stock.

Freshii is a founder-led restaurant concept that has delivered impressive metrics over its short history. The brand is at the forefront of the global health and wellness movement, pioneering the new “healthy fast food” category.

It has been one of the fastest-growing QSR brands in North America, both in terms of store count and same-store sales growth. The capital-light franchise model enables the company to use other people’s money to finance expansion and grab market share at a fast pace. Store growth is also driven by capital efficiency at the store level. As there is no expensive kitchen equipment, store build-out costs are modest relative to most other QSR concepts, which broadens the appeal of Freshii to franchise partners.

With modest capital intensity at the store level, partners have been able to earn attractive cash on cash returns of 30-40%. The opportunity is resonating with entrepreneurs. The brand receives more than 7,000 applications annually from franchises and opened 120 stores last year. The company went public in early 2017 with unrealistic expectations.

The stock plunged when the company reduced 2019 guidance later that year. As the underlying metrics of the business are still quite strong, the guidance miss was short-term in nature and a result of Corrin’s inexperience communicating with the capital markets rather than any meaningful business deterioration. It was a painful lesson.

Going forward, David and Felix anticipate Corrin will “underpromise and overdeliver.” Factoring in continued execution by a passionate owner-operator, a capital-light business model, and long-term growth ahead, the company is reasonably priced at less than 8x 2020E EBITDA, as compared to fast-growing U.S. comps Wing Stop and Shake Shack at over 20x. Freshii has a long runway ahead driven by the concept’s mass market appeal and founder Matthew Corrin’s ability to execute on his vision.

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About the instructors:

David Barr is the President and CEO of Pender. He is also the Portfolio Manager of several of Pender’s funds. The Pender Small Cap Opportunities Fund, managed by Mr. Barr, has won a Lipper Fund Award for Best Canadian Small/Mid Cap Fund over both three and five year performance periods for the last three consecutive years, 2015 to 2017. The Lipper awards recognize consistently strong, risk-adjusted performance relative to peers. The Fund has also received Fundata’s FundGrade® A+ Award for the last six consecutive years, 2012 to 2017. The Pender Value Fund, which he co-manages, has received Fundata’s FundGrade® A+ Award in 2016 and 2017. This award recognises funds that have maintained “an exceptional performance rating over the entire previous calendar year”. Mr. Barr began his investing career in 2000, initially working in private equity. He joined Pender in 2003, was appointed Chief Investment Officer in 2007, before becoming President and CEO of Pender in 2016. Mr. Barr holds an MBA from the Schulich School of Business and earned his Chartered Financial Analyst designation in 2003. Mr. Barr is an advocate of value investing as well as a true contrarian. He looks for value in unpopular places to find high quality businesses at a price that includes a “margin-of-safety”. Investing in a company trading below intrinsic value decreases the risk and increases the potential for generating significant long term performance.

Felix Narhi is the Chief Investment Officer of Pender and the Portfolio Manager of the Pender US All Cap Equity Fund and the Pender Strategic Growth and Income Fund, and Co-Manager of the Pender Value Fund. Prior to joining Pender in July 2013, Mr. Narhi spent over nine years at an independent and value-oriented investment firm in Vancouver. As a Director and Senior Equity Analyst, Mr. Narhi contributed thought leadership and primarily US equity ideas to the company’s Model Portfolio, a concentrated equity portfolio that has outpaced North American benchmarks since its inception in 1994. Mr. Narhi holds a Bachelor of Commerce degree from the University of British Columbia. He earned his Chartered Financial Analyst (CFA) designation in 2003 and is a member of CFA Vancouver. Mr. Narhi advocates a business-like approach to investing. Sound investing is the process of determining the value underlying a security and then buying it at a considerable discount to that value. The greatest challenge is to maintain the necessary balance between patience, emotional fortitude and discipline to only buy when prices are attractive and to sell when they are dear, while avoiding the short-term “noise” that consumes most market participants.