Despite its turnaround efforts, this restaurant stock isn’t worth biting into — yet

Benj Gallander, Ben Stadelmann, and Philip MacKellar
Wednesday July 10, 2019

At Contra the Heard, our modus operandi is to find unpopular stocks that are showing signs of regaining their lustre. We want to be early to a great party and then leave when enough delectable canapés have been enjoyed.

Of course, we can also acquire some distasteful morsels, and then we must decide whether to give them a chance to revive or perhaps slink out the back door via a tax loss sale.

When it comes to investing, managing to avoid buying a loser can come down to sheer luck. But it can also be the product of to rigorous analysis combined with a well-developed market instinct. We use screens, watch lists, a point system, and then technical and portfolio analysis before placing a buy order.

Some restaurant stocks appear attractive from a value standpoint. Canadian value investor Prem Watsa holds a 57 percent interest in Recipe Unlimited (formerly Cara Operations) through Fairfax Financial Holdings. Evidently, he is keen on this sector.

One stock in the restaurant business that scored high on the Contra point system, but fortunately never made it to the order stage was Luby’s, which has been churning out meals since 1947. Unfortunately, it has given investors a bad case of indigestion.

Luby’s is based in Houston and owns the Luby’, Fuddruckers (pardon the name), Cheeseburger in Paradise and Koo Koo Roo brands. The Pappas brothers, who made their fortune starting with a family-run restaurant chain, own 36.8 percent of the stock.

The company has been in official turnaround mode since early 2018, closing out-of-favour restaurants, trimming costs and selling real estate to pay down net debt of $30 million (figures in USD). The plan was to sell enough properties to generate $45 million, and thus far $34.7 million in assets have been hawked.

Since first being considered for the Contra portfolio in 2016, Luby’s has underperformed. In fiscal 2018, total sales were down 3 percent to $365.2 million and same-store sales fell 0.5 percent.

The net loss was $33.57 million, compared with $23.26 million in 2017. For the second quarter, same-store sales declined 3.3 per cent and total restaurant sales dropped 12 percent to $65 million. Net income for the quarter was a $6 million loss, not including $12.7 million in gains on property sales.

In response to the pitiful results, activist investors Bandera Partners commenced a proxy fight. They felt the corporate strategy was a case of too little, too late. Owning about 9 percent of the stock, Bandera pushed for four board seats. They didn’t get any.

Some change is happening, though. Luby s will add two independent directors, and chief executive Chris Pappas has reduced his salary to $1.00.

Luby’s has traded publicly since 1980, and the price has been in a steady decline for six years. It recently hit a record low of 99 cents. Is receivership beckoning? It is not out of the question. Fortunately, we can watch from the sidelines while kicking the tires, just in case it becomes an appetizing buy.

The business of operating mature brands in a highly competitive restaurant market is a hard one. Just ask Jamie Oliver, Zane Caplansky and Michael Bregman. Mississauga-based Second Cup, of which Bregman is the chairman, is on our watch list, but the shares have been too bitter for our taste for eight years. Black ink has been spotty, but they have no debt and are buying back shares. Their alliance with National Access Cannabis to convert coffee shops into cannabis retail is a smoky question mark.

We’re frequently asked about Toronto-based Freshii, but it clearly doesn t fit our methodology. It is one of the gold standards for overpromising and underdelivering. That said, it is tapping into a trendy health-and-wellness space that appeals to the converted, including a hip millennial demographic.

Avoiding losses by being extremely selective and staying on the sidelines when buys are questionable boosts financial returns. Doing nothing is often better than being active. It may not satisfy itchy trigger fingers, but the money saved will allow for scrumptious summer vacations.