The Oliver’s Turnaround Story
DMX Capital Partners recently held a stock picking competition where you could enter your best stock idea for the next 12 (?) months and win $2000 worth of units in their fund if you made the best pick. A tip of the hat to DMX for coming up with such a cost effective way of collecting great stock ideas.
I entered Oliver’s Real Foods (ASX: OLI) as my idea. Oliver’s is not my highest conviction idea, but it is the only company in my public portfolio that could conceivably have a big re-rate within in the next 12 months. I had already almost completed this post at the time the competition was announced, so the DMX entry was a convenient way of piggybacking on work I’d already done.
Here is the post:
I’ve written more than any man with $500 invested in Oliver’s Real Foods (ASX: OLI) should be able to justify, but such is your writer’s cross to bear.
I think Oliver’s has substantial potential as a turnaround:
- Oliver’s has a lot of low hanging fruit in the business and room to optimise. I’ve touched on this here.
- Forecast earnings post-downgrade (EBITDA of ~$1.5m for an EV/EBITDA of 24x ish) are artificially low because they include the cost of store closures and ~5 store openings that will be occurring in the next few months.
- The economics of Oliver’s stores should improve substantially with a modest increase in sales. More on this below.
- There’s a new CEO and I perceive (/ hope) that there is a newfound will to do hard things to generate the right lifetime outcomes for the business. That is a key reason that I recently bought back into OLI, and why I created my recent presentation for management.
In rough numbers, Oliver’s will get around $1.3 million in revenue and $55k in EBITDA per store this year. KFC stores, as measured by Collins Foods (ASX: CKF) Australian stores, earned around $2.5m revenue and $400k in EBITDA per store in FY17.
There are flaws with this methodology – KFC is a franchise, KFC has much lower gross margins (50% vs 75% at OLI), many KFCs are not at highway rest stops, OLI’s per-store results are skewed by new/immature stores and a couple of flagship stores, KFC has much better brand recognition and pricing power, KFC is a true QSR whereas Oliver’s may not be, etc. Those things are relevant, but I think the case can be summed up in two axioms:
- Oliver’s restaurants are not achieving the performance that they should/could, and;
- A successful chain, beloved of customers, with 75% gross margins, should not be 1/4 as profitable in EBITDA terms as a KFC restaurant. An alternative measure of chain restaurants is their FCF yield, 15% reportedly being typical in the USA. Oliver’s is not getting anywhere near that either. Another measure would be ROCE, with KFC getting around 15% and Oliver’s again falling well short.
Oliver’s earnings show me that the business is essentially just breaking even at the moment. Current sales are basically just covering the costs of rent, wages, etc plus all of the corporate costs. That sounds bad, but the flip side is that if sales can grow say 10% without a corresponding increase in costs (other than COGS), per-store earnings could double.
Oliver’s has 75% gross margins. It has $1.3m revenue per store on which it will earn $55k per store this year. If Oliver’s can add say $100k (7.6% increase) to sales without increasing costs, $75k (ish) of that should come out as EBITDA. Store and administration/corporate expenses are already largely fixed. The only variables should be marketing expense (how much marketing $ to add how much $ to sales) and restaurant related expenses (e.g. potentially more staff hours, etc). Adding $75k of EBITDA per restaurant to the existing $55k will do great things for earnings, if achieved.
It’s likely that a turnaround won’t be that straightforward, as some mix of lower prices to drive higher volumes could lead to a different EBITDA performance, for example, but I think you see my point.
How can you add $100k to sales without increasing costs?
- Higher foot traffic*
- Higher spend per customer
- Higher prices, but that is not an option in this case & management has stated this.
*if achieved without a large marketing expense, which is why I think social media is important.
I wrote about the first two options extensively in my recent presentation. Oliver’s has a lot of low hanging fruit when it comes to social media, upselling to customers, and promoting its products. This business has substantial room to improve and I think the economics should improve if they can deliver on it. Several possible fixes, while far from a complete solution, are intuitive and should work.
That’s my thesis, and I think there is a good case to be made that Oliver’s is undervalued at 13 cents.
The crucial question to my mind is:
Does this brand/product delight ALL of its customers?
There is evidence both ways but I submit that the answer cannot be proved with a high degree of confidence. And that is the key risk. If Oliver’s cannot delight its customers – and I have written this before – it is my belief that it does not have a bright long term future. Possibly it won’t go bankrupt, but nor will it spread across Australia. That’s fine, but that is the risk you run.
Second, Oliver’s is in a tricky place, and it is lucky that it does not have more debt. It would be relatively easy to for things to spiral out of control from here. Even excluding the core question of delighting customers, Oliver’s might have to close a couple more underperforming stores, which would spread the corporate burden (a heavy one) across a smaller number of stores, resulting in a higher fixed cost base and largely eroding any benefits from higher sales or lower costs. You can insert your own risks in there – maybe the new CEO brings in a corporate culture that doesn’t work, or whatever.
There is a saying in sport – “slow is smooth and smooth is fast”. It reflects the fact that trying to go fast generally leads to underperformance, because muscles tense up and do not ‘whip’ or ‘flow’ as well as they could. Thus, the athlete trying to go faster actually needs to focus on relaxing and moving smoothly & with good technique, not on raw speed. By using this counterintuitive approach, performance improves markedly.
It is my view that Oliver’s needs to go ‘slower and smoother’ and get the core premise right, which will ultimately result in it moving ‘faster’ (generating more value) in the long term.
If the business gets on track, there is a substantial opportunity ahead. While the risks are real, I think there is a good case to be made for a turnaround, albeit with a cautious position size.
I own shares in Oliver’s Real Foods. This is a disclosure and not a recommendation.