For starters, as largely a franchiser (the company only operates a few stores itself), Nathan’s has been generating lots of cash for years and has low capital expenditure requirements. Back a few weeks ago, at some 12x cash flow (it’s now around 15x) it was available at a great price. Revenue has been compounding at a steady albeit low clip of around 7%, but operating margins have improved from 13% to over 18% since 2003. Debt is nonexistent, and returns on average equity using cash flow rather than earnings have been a respectable 15-20% in recent years.
That’s all great, but here’s what I really like. First, the company has plenty of room to grow. With operations in only 22 states and a tiny footprint in just 10 other countries, there’s tons of room for opportunity. That in itself is not enough to justify excitement, but what’s great about franchises with simple businesses, particularly food and retail chains, is that they generally can duplicate success to achieve growth and advantages of scale simply by copying itself in a different geographic location. Though cultural differences surely play some role in an region’s tastes for fast food, it’s unlikely, at least in America, that a great hot dog in the Northeast wouldn’t be enjoyed by folks in the Southwest. Branching abroad may be a bit harder in countries that don’t know the brand or don’t exactly enjoy hot dogs, but I give kudos to management for setting their sites internationally for growth.
The company also enjoys a unique niche in the fast food industry and can really leverage its growing popularity thanks to the Coney Island hot dog eating contest and other generally successful marketing strategies. Despite how unsexy or commonplace a hot dog may seem, I can’t seem to think of a storefront-based company with a bigger presence or more popular brand name associated with hot dogs. Companies like this often benefit from compounding popularity and success. Just like Subway, Starbucks, etc., Nathan’s should be able to enjoy growth from a feedback loop where popularity drives growth, which drives more popularity and recognizability, which drives further growth, and so on.
Of course, I’m not claiming Nathan’s is “The Next Starbucks,” but with no coverage, a tiny market cap, plenty of room for upside, and the potential for compounding success, I like it as a long-term play. I also think it’s only slightly above the low side of my pretty conservative valuation, which places the fair value of the shares at anywhere between $16 and $32 depending on growth rate assumptions. I think a “best case” valuation could place the shares as high as $42. Regardless, great business + strong growth potential + fair price = solid returns over time