Part I: Flanigan's Enterprises, Ticker: BDL

South Florida's favorite nano-cap restaurant chain

This was my first ever write up on a business and am posting in it to show you where I started my research journey from. What is shown below was what I submitted to Value Investor’s Club in June of 2020 as an application for entry in to the site and before I found out the company had been covered for years on MicroCapClub. This submission was not good enough to make it in to VIC, but it is my first ever write up so it has sentimental value. While that was a little crushing that I didn’t make it, I realized that VIC was (and most likely is) serious about their admission standards and took it as a sign that I needed to do better. In Part II I will do a self critique of this write up, talk about how Flanigan’s has done since my writeup and why I don’t ultimately see myself buying the stock. Thanks again for taking the time to read this and anything else I post. May the markets be in your favor.

Description

Flanigan’s Enterprises (BDL): A pebble in the rough?

You could say that value investors are always looking for diamonds in the rough. In today’s market good value is hard to come by and a lot of the diamonds just aren’t there. However, I think there may be at least a few pebbles and Flanigan’s Enterprises (NYSEAMERICAN: BDL) may just be one of them. I use the term pebble because the market cap as of the close on 06/18/20 is a staggering $29.74 million dollars. At best, it only trades a few thousand shares a day and is covered by exactly zero analysts. Weirdly enough, at least one Fidelity fund and Renaissance Technologies own positions in the company.

A quick breakdown of Flanigan’s: It is a restaurant and package liquor store chain located in southeastern Florida. Per the most recent 10-K, “Our package liquor stores emphasize high volume business by providing customers with a wide variety of brand name and private label merchandise at discount prices. Our restaurants offer alcoholic beverages and full food service with abundant portions and reasonable prices, served in a relaxed, friendly and casual atmosphere.” The restaurants bring in over 80% of revenues while the liquor stores bring in the remaining amount.

Pros:

Lots of insider ownership - As of the most recent 10-K, 54.5% of the stock is owned or beneficially owned by the Flanigan family. This large holding further cements their control of the business. I like lots of insider ownership personally because the management has lots of skin in the game. I know this can raise a lot of eyebrows (which I will discuss later about related transactions) in regards to self-dealing, but I do not think this is a negative concern with Flanigan’s management.

Family run business - The business was started by Joe Flanigan, the family patriarch, in 1959. Initially, Flanigan’s consisted of lounges and package liquor stores, but this changed in the late 1980’s to restaurants and package liquor stores as the company had fallen on hard times via bad luck and even worse loan agreements. The company filed for bankruptcy in late 1985 and emerged from it in late 1987. Ever since, management has taken a more conservative approach to running the business. Joe passed away in 2005 and his son James has been CEO ever since.

A beloved chain - If you type “Flanigan’s Bar and Grill” into Google Maps you will see all of their locations and you will see a glimpse of how well liked the business is. All of the ratings are above 4 and pushing 4.5 stars. On top of being a family friendly restaurant, the establishments also double as a sports bar. Lastly, the company has a rabid fan base on Twitter. The level of admiration is similar to the one’s I’ve seen for Sheetz or Buc-ee’s While these factors are mostly qualitative they do point towards Flanigan’s management executing on their business plan and they make me think that the business isn’t in danger of being taken out. Simply put, Flanigan’s seems to get it and knows how to treat their adoring customer base.

Simplicity and consistency - While the margins are small, the business just keeps growing. This goes back to my belief that management is really good at running the business as evidenced by the slow, but steady increases in total assets, revenues, net income, EPS, and equity since 2006. The company has also stuck to what they know and operate inside of its circle of competence.

Survival - I alluded to this above in the “Family Run Business” section, but Flanigan’s went through a very hard time in the 1970’s and 1980’s. The fact that the business has been able to survive for as long as it has is a real testament to management and the Flanigan family. I wondered where this mentality came from and did some digging. I found a history of the company on enclyclopedia.com. This information matched three other business/research sites, but I haven’t been able to corroborate this with the company. From what I gathered the company was going through an incredibly hard time in the 1980’s due to a very painful financial arrangement that the founder, Joe Flanigan, orchestrated in the 1970’s. He was having a hard time finding financing to expand the company so he came up with his own plan. He sold the existing real estate the company owned and immediately leased it back from the new owners for long term periods. However, the lease rates were linked to inflation rates and not revenue generated by each location. The spike in inflation in the 1970’s was detrimental to the company and caused Chapter 11 Bankruptcy in 1985. The company and its founder emerged renewed, steadier, and a bit more conservative in their outlook. It seems that the near destruction of his business was the kick in the tuchus that the company needed to turn things around and the results since then have been much improved. Why am I telling you this? I believe this experience, while incredibly painful, was a very good learning lesson. That pain is what made Flanigan’s into the business it is today and that this steadiness and conservative approach is fundamental to how the business/management operates.

Risks:

Restaurant industry - We all know that the restaurant industry that Flanigan's operates in is brutal and the margins are low. Most restaurants are lucky to have net income of mid to high single digit percentages. Flanigan’s is no exception. I’ve analyzed the 10-K’s since 2006 and the net profit margin has averaged 3.49% before accounting for minority interests. After accounting interests the average net profit margin has been only 2.55%. With that being said, this low margin approach is the company’s business model. As the Chief Operating Officer, August Bucci said in a 2017 Miami Herald article, “What was Flanigan’s secret to winning? The same thing that has been their restaurant's formula to success: They offer quality ingredients at affordable prices, making small margins, but making it up with the crowds they draw…”

Macro-Economic Factor - This is essentially the risk of recession in the United States and the lack of disposable income for their customers to spend on eating out and COVID-19. While the United States hasn’t had a recession in over a decade, we’re due for one sooner or later and this will absolutely affect Flanigan’s. Being a chain restaurant, they rely on how much disposable income a person or family has to eat out. The company will be negatively affected by a recession, but their customer base isn’t going to run away and never come back. While Flanigan’s is absolutely going to have a negative quarter or year when a recession happens, I believe it will only be temporary. With that being said, I think the company’s management will be able to navigate those waters as they have in the past and come out ahead. COVID-19 will also undoubtedly affect the company in the short term (say over the next six months to a year). With that being said, Florida is moving ahead with opening the state and it is undetermined at this point how much more damage the virus will cause. Unsurprisingly, Floridians don’t seem to be too concerned about it.

A Further Macro-Economic Factor - I think we’re at the peak of the bull market given several factors such as the amount outstanding corporate debt, credit card debt levels, incredibly low interest rates, very high unemployment, the rise of day traders, COVID-19, stratospheric valuations of companies, etc. I can sum this up by saying that I think we’re all picking up pennies in front of a massive steam roller. I refer to this section in more detail in the conclusion of this write up.

Growth - This is a particular risk to Flanigan’s. The company has only added five locations total since 2006. Why so few additions? I reached out to the company and asked about it. Management follows a “pick and choose” strategy and seems to be very particular about where it will even consider, let alone build a new restaurant. Management is not out looking to expand aggressively.

Related party transactions – There’s no sugarcoating this. There are a lot of related party transactions. The transactions revolve around mortgages and affiliated franchises and partnerships. The three related party mortgages currently outstanding for Flanigan’s are described below:

The largest is for $1,000,000 at 5% interest due April 2021. The company borrowed the money in fiscal 2010. Jeffrey Kastner, Flanigan’s CFO, is a principal of the company that provided the mortgage to Flanigan’s.

The second largest mortgage was for $850,000 began during the first quarter of fiscal 2011. Annual interest rate was 10% per annum, however, the mortgage was modified to earn interest at 5% per annum . The mortgage is due April 2021 with a balloon payment of $476,000. Jeffrey Kastner, Flanigan’s CFO, is also a managing member of the mortgagee. August Bucci, the Chief Operating Officer of Flanigan’s, also owns 11.8% of the mortgagee.

The smallest remaining mortgage was also for $850,000 and began During the first quarter of fiscal year 2010. Annual interest was 8.5% per year. In 2014 the payment was modified and now earns a rate of 5% per year with a balloon payment of $392,000 due in April of 2021.

I asked the company about these related mortgages and the response I got was, “Management made the decision under the circumstances at that time.” That’s all I got and it raised an eyebrow. However, given how closely held everything is at the company and the amounts of the mortgages, I don’t think these are too suspicious. The mortgages happened just after the financial crisis when the outlook on the economy still wasn’t great, so essentially financing the mortgages from insiders or those related to insiders isn’t a huge problem in my opinion. Additionally, there are a total of four (4) affiliated franchises and a total of eight (8) affiliated limited partnerships.

Adult Entertainment Club - Yes, Flanigan’s owned, but did not operate an adult entertainment club. As of September 10, 2018, the club is closed to what looks like a constant back and forth between the club owners/operators and residents of the town that the club was in. To be clear, Flanigan’s owned the club, but did not operate it. They simply leased the space out and collected rent.

Geography – All of Flanigan’s locations are in southeast Florida. They are all located in a part of the world that is damaged by hurricanes nearly every year. The severity of the storms varies by year, but in general storms have proven to be more costly over the last few decades. I believe the company is at a greater risk of hurricane damage than nearly any publicly traded restaurant chain and this must be taken into account. They do have insurance, however it only covers damage up to $7,000,000 and above that the company is liable.

My own foolishness - I could be a complete fool and miss out on something obvious that I haven’t paid attention to.

Valuation

Numbers - EPS has increased from $0.31 a share in 2006 to $1.96 a share in 2019 (a CAGR of 8.08% - 14.08%/year depending on how EPS is measured; I discuss this more in the following paragraph). Earnings didn’t increase over 2018 due to one of their locations being destroyed. It is currently being rebuilt, but there isn’t guidance about when it will reopen. As of the most recent 10-K, the company has total assets of $68.77 million against $24.22 million of total liabilities for a book value of $20.62 per share. FCF (defined as OCF- CapEx) for 2019 was $4.29 million meaning that the company currently trades at just under 7x FCF valuation. There are two additional points I’d like to add about the company’s FCF and why I’m not using it as the primary valuation metric. First, the company doesn’t want to rapidly grow the company so the FCF isn’t going to increase by large amounts on a yearly basis. Second, FCF, as it is, fluctuates wildly and isn’t really consistent (due to reinvestment in stores, combining certain liquor stores and restaurants, renovations, expansions, etc.) so I don’t think it’s prudent to assume it’s going to increase at a steady rate over the next 5-10 years. It’s just too hard to pin down.

I think the business should be traded on a book value and earnings basis due to it being relatively stable and not in a period of rapid growth (think franchising). As of the close today the price is $16.10 per share, the book value is $20.62, meaning it trades at an immediate 22.5% discount. Throwing a 15x P/E multiple which I feel is warranted to due how consistent and well run the business is gets a price of $29.40 which is a 46% discount. On simple metrics the company trades at a P/E ratio of 8.2x last year’s earnings, 13.42x Owner Earnings (calculated as NI + D&A +/- other non cash charges - CapEx +/- changes in NWC), 0.78x Book Value of Stockholders Equity (if you do total equity which includes non-controlling interests the stock trades at a 40% discount to book) and just under 7x 2019 FCF. As noted earlier, EPS has a CAGR of 8.08% or 14.08%, depending on how I measure EPS, since 2006. This difference is due to insurance recovery in 2006 due to Hurricane Wilma and a gain on the sale of real estate in 2007 that were one time payments and increased earnings in each reported year. Taking the recoveries out of net income reduced it by over 50% in 2006 and ~32% in 2007; I took them out to see what the earnings of the business were without these one off additions to income. The lower earnings then makes up the spread between the two CAGR figures. If we assume that holds for the next 10 years we get an NPV of $18.28 - $23.63 (fairly close to book value) per share by using a discount rate of 10% (I use 10% as it is somehow the “standard” discount rate for whatever reason). If you want to use Buffett’s 10 year treasury note as the discount rate (it’s currently 0.74% in case you’re wondering) then the value pops to $31.82 - $42.91 per share. Something tells me an under 1% 10 year treasury rate won’t last forever so let's meet in the middle and call it 5% for now. At a 5% discount rate the valuation is $24.28 - $32.10 That is an upside of anywhere from 22% (using current book value) immediately to 266% (NPV of projected earnings compounding at 14.08%) over 10 years (an intrinsic value CAGR of 10.29%). Don’t forget the $0.28 dividend! The valuation of Flanigan’s Enterprises assumes growth of the company’s earnings with no additional restaurants added. Valuation also assumes no change in number of shares outstanding, and assumes that the business will keep going in a more or less constant manner which most likely isn’t going to happen exactly as predicted by my figures. I’m assuming consistency due to how steady the business has been since 2006. I just think that Flanigan’s will more or less just keep chugging along as it has in the past minus the occasional recession, depression, or Macroeconomic event (such as COVID-19) that I can’t think of.

So, about that pebble in the rough?

I’m still going to look for a diamond in the rough and increasingly they’re hard to find. However, Flanigan’s might be a pebble of some value in a market full of lofty valuations. This is a very conservatively and well run family business. Management has learned their lesson after the hard times of the 1970’s and 1980’s and that lesson, in my opinion, has been taught to current management which continues to run the business effectively. The stock is hard to get as it doesn’t trade often, but I think there’s an immediate 22.5% upside given the current valuation and steadiness of the business. The numbers don’t exactly scream huge value for today, but do consider the industry, what the company is, what the company has done, and is doing for the future. Flanigan’s is simply a well run restaurant chain. The industry is low margin and brutally competitive. Management also has skin in the game and knows how to run their business. What the company is doing now and is going to do in the future is simple. Combine this past history with the conservative outlook the business and management have along with managing their finances as well as they have over the last 15 years and I think there is at least some value here, but I would ultimately wait for prices to come down due to the macro-risks that I talked about above. I am not comfortable with how lofty market valuations are, the sixth month to a year impact of COVID-19, the general state of the economy and ultimately how hard the stock would get hit by a downturn in the market. I will again state that I think we’re picking up pennies in front of a steamroller. Using book value as an approximation for intrinsic value, I think prices like those we saw in mid-March 2020 would be better to buy at. Prices then were under $10 per share and went as low as $8.90 on March 20, 2020 implying a margin of safety of over 100%. I would start to look at the company again anytime the share price drops to 80% of book value. I think the risk of losing money at a price of under 10$ per share is very small in any kind of medium to long term time frame. My ultimate verdict is to keep your eye on this one and patiently wait for better prices.

Catalyst

Value is its own catalyst. Solid business with a great balance and management with skin in the game.

P.S. - I will provide any links to sources about the company's history upon request.
I do not personally own shares in the company, but a family member did a few years ago.