Nathan's Famous ($NATH)

A capital-light consumer staple in disguise deserves a higher multiple.

Ticker: NATH
Share Price: $72
Market Cap: $294m
Enterprise Value: $342m

Quick Pitch

• Nathan’s Famous is a wholesaler, licensor, and retailer of products marketed under the Nathan’s brand, most famously known for its beef hotdogs

• While Nathan’s is usually thought of as a restaurant concept, the business is more accurately described as a high-margin licensor that makes the majority of its operating income from licensing contracts with a near 100% contribution margin

• A trailing 14x earnings multiple seems cheap vs. consumer staple comps

• Strong contract in place with Smithfield Foods (licensee & main supplier) through 2032 ensures earnings durability

• Conservative balance sheet, paying down $70m of debt over the past 2 years

  • Net debt stands at $47m (1.3x Net Debt / EBITDA)

• Strong history of retuning capital to shareholders

  • Repurchased 50% of outstanding shares since the early 2000’s

  • Shifted capital allocation strategy to dividends, paying a regular dividend since 2019

  • $0.50 cent quarterly dividend (2.8% yield)

• Nathan’s is a low float (4m shares), low volume (<$1m daily volume) stock that flies under the radar despite delivering a 19% CAGR over the past 20 years

Background

Nathan’s Famous started out as a hot dog stand on Coney Island, New York in 1916 and has grown to become a household name selling beef hot dogs, crinkle-cut French fries, and other consumer favorites to retail and food-service locations. The company is perhaps most well known for hosting a fourth of July hot dog eating contest in front of the original store on the corners of Surf and Stillwell.

Reigning champ Joey Chestnut took the victory yet again in 2023 after throwing down 62 dogs and buns in 10 minutes (he set a world record of 76 dogs in 2021).

Today Nathan’s operates through 3 segments (plus a Corporate cost center):

1. Branded Products: Wholesale of Nathan’s Famous products to the food service industry. Products are sold at over 14,000 locations including restaurants, movie theaters, convenience stores, ballparks, amusement parks, etc. This segment represents ~60% of revenues but is a lower margin business than licensing.

2. Product Licensing: Largely made up of a single, high-margin license agreement with Smithfield foods to manufacture, distribute, and sell branded hot dogs and sausages to supermarkets, club stores, and mass merchandisers.

3. Restaurant Operations: Includes 4 company-owned restaurants, 232 franchised units, and 267 virtual kitchens. The company has a presence in 13 foreign countries including the UK, Germany, Brazil, and Mexico.

4. Corporate: Includes the advertisement fees charged to the franchisee network (up to 2% of sales) as revenue and deducts all additional administrative expenses not allocated to the 3 main business lines.

Smithfield Foods is also the company’s primary supplier, accounting for 95% of Nathan’s product purchases in fiscal 2023, which includes hotdogs for Branded Products and Restaurant Operation sales. Smithfield is a privately-held pork and food-processing company based in Virginia with annual sales of $14b. In 2013 the company was bought out by WH group, the largest meat producer in China (formerly known as Shuanghui Group).

Operating Results

Nathan’s reported record revenue in fiscal 2023 driven by a 19% increase in its Branded Products business. The effect of this was somewhat muted though as higher beef prices pushed down operating margins in Branded Products to 11%, down from a normalized margin of ~15% pre-COVID. The upside is that higher beef prices help the Product Licensing division as Nathan’s makes a 10.8% royalty on total hotdog sales from Smithfield. Product Licensing revenues were $33.3m (+6% YoY) which flow neatly into the bottom line.

Restaurant Operations also grew 17% (from a still depressed base) but similar to Branded Products, operating margins were 10% vs. a historical margin closer to 15%. Despite the company’s efforts to keep the Franchise concept fresh, Nathan’s has continued to close restaurants. Unit count stands at 232 today versus 276 in 2018. The company has rolled out a virtual kitchen program since 2021 but royalties from this initiative are immaterial. At the end of 2022, Nathan’s announced a 50% franchise fee reduction to struggling restaurants to convert their existing location into a Nathan’s Famous so perhaps this initiative will add restaurants over the next few quarters.

Branded Products and Restaurant Operations produced sufficient operating income to cover Corporate overhead, ending the year with $34m in total operating income and $19m profit.

The most noteworthy trend over the past few years is how Nathan’s has practically become a consumer staple deriving most of its earnings from retail sales handled by Smithfield. This has created a resilient business that saw net income fall only 10% during fiscal 2021 when the majority of its restaurants and food service partners were shut down during the pandemic.

Operating income for 1Q24 was 2% lower driven by higher corporate costs but business segments performed mostly in-line with the previous year with Product Licensing showing a decent 3% increase. The company reported that restaurant sales were affected by worse than anticipated weather conditions throughout the country. Nathan’s has its strongest earnings during its first 2 fiscal quarters (April through September).

Valuation

• Nathan’s should command a multiple higher than a trailing 10x EV/EBIT or 14x P/E given its earnings quality, predictable growth, and low debt burden

• While Smithfield Foods accounts for 90% of Licensed Product revenues (on hotdogs), the remaining 10% of product licenses continue to grow and deliver incremental earnings to the bottom line

  • French fry license agreement with Lamb Weston delivered $1.5m in 2023 revenues (+57% YoY)

  • Proprietary spice blend license agreement with Saratoga Specialties delivered $1.3m in 2023 revenue (+7% YoY)

  • 20 more SKUs sold through grocery retail channels

• I expect each business unit to continue to grow at 3-4% and for operating margins to normalize within Branded Products and Restaurant Operations. This brings 2025E operating margin up 100bps to 27.3%, in-line with its pre-covid base

• Another $50m in debt pay down of the company’s 6.625% 2025 notes over the next 2 years would save $4.5m in yearly interest expense

• I can see Nathan’s earning ~$26m in net income in fiscal 2025. An 18x P/E multiple would be a $114 implied share price or 58% upside

  

Risks

• The biggest risk is Nathan’s dependency on Smithfield Foods both as a licensee and majority supplier

  • Accounted for 90% of Nathan’s fiscal 2023 license revenues

  • The current contract was signed in 2014 and lasts through 2032, granting Smithfield the exclusive right to manufacture, distribute, market, and sell Nathan’s Famous branded hot dogs and sausages. The first licensing agreement between both companies was first signed in 2002

  • Entitles Nathan’s to a royalty of 10.8% of net sales subject to minimum annual payments with step-ups

• Sales to the largest Branded Product program customers were 76% in 2023, which concentrates in 5 major accounts

• Retailers and grocers may chose to focus on private label hot dogs and sausages

• Beef commodity prices exert pressure on both restaurant operations and branded product sales. The company has shown some limited pricing power being able to raise prices by 3-5% in the last few quarters. The upside is higher Licensing revenues which so far have more than offset margin compression in Branded Products and Restaurant Ops

• Despite some claims of hotdog and sausage sales being in a secular decline my quick research showed that sales have continued to grow 3-5% annually

Final Thoughts

• Extremely capital light (negative book value) business that has grown EPS with minimal capital invested

  • Nathan’s has reinvested less than $10m over the past 10 years

• Interesting comps would be a few of the Canadian pure royalty plays but I would argue Nathan’s is a better investment as cashflows are tied to grocery purchases and are less discretionary than QSR dining

  • Pizza Pizza - 32.0x P/E

  • The Keg - 15.9x P/E

  • A&W - 14.8x P/E

  • Boston Pizza - 9.0x P/E

• A focus on brand management while continuing to reduce operational expenses around Restaurant Operations could unlock additional value

• While capital allocation strategy continues to be focused on debt repayment current financials could easily accommodate a much higher dividend and/or re-levering of the balance sheet

• Good likelihood that the licensing agreement with Smithfield will be extended beyond 2032. The agreement will ensure durable licensing cashflows on a higher sales base even if the royalty rate is negotiated down