Wednesday, September 3, 2014

Leverage And Operational Challenges Result In Real Risks

by Bob Evans Farms


  • Investors in Bob Evans have been disappointed, as the company posted a small first quarter GAAP loss.
  • The company remains challenged as I perceive quite some risks from the rapid built up in leverage amidst pressured earnings.
  • The valuation is rather high in my opinion, despite a correction from last year's high. The risk-reward at current levels is not attractive in my opinion.

Investors in Bob Evans Farms (NASDAQ:BOBE) were not happy after the company posted a modest loss for the first quarter of 2015, triggering a 10% sell-off.

Amidst struggling core operations, a high valuation and a leveraged balance sheet I would be very hesitant to buy into the recovery story with activist investors already onboard.

I continue to shun the shares despite a 30% sell-off from last year's highs.

Difficult Start To 2015

Bob Evans posted first quarter sales of $326.3 million which is a 0.9% drop compared to the year before. Restaurant sales were down by 1.8% to $240.2 million which was largely the result of a 2.0% decline in comparable store sales. The BEF Foods business posted a 1.5% increase in sales to $86.2 million amidst its quest to boost the number of stock-keeping units and points of sales. Adjusted for a sold production facility, sales at BEF were up by 5%.

The company posted a GAAP loss of a million, for a loss of $0.04 per share. This compares to last year's earnings of $8.4 million.

Adjusted for certain items, earnings came in at just $2.3 million, or $0.10 per share. Adjusted earnings fell sharply as well compared to the $15.2 million reported last year.

A modest positive result of the restaurant business was offset by a small loss at BEF Foods, while the profitability of both segments fell compared to the year before.

August Presentation

In accordance with the first quarter earnings release, Bob Evans presented itself to the investment community.

The company currently operates 562 restaurants in nineteen Mid-Eastern States. At the same time the company has the sausage, refrigerated sides, frozen and food service business which is sold at over 30,000 locations.

The company stresses its ambitions and goals to develop its regional brands into national brands. For the long run the restaurant business is targeted to grow sales by 3-3.5% thanks to comparable store sales growth and a planned 10 openings a year. A pro for the business, roughly a third of sales are generated for both breakfast, lunch and dinner.

The food business is expected to grow by 6-7% thanks to greater stock-keeping units and more service points anticipated in the future. All off this should be complemented with lon term margin expansion, allowing earnings per share to improve by 10-12% per annum.

Of course these are predictions and management does not have a great track record on delivering on its expectations.

2015 Outlook

For the full year of the new fiscal year the company continues to foresee 1.5-2.5% growth in comparable store sales. After falling in the first quarter, comparable sales are seen flattish in the second quarter, followed by an anticipated growth in the high-single digits for the final two quarters of the year.

All in all, sales are foreseen at $1.38 to $1.40 billion as the company anticipates adjusted earnings of $1.90 to $2.20 per share. Note that in the first quarter alone there was already a $0.14 discrepancy between GAAP and non-GAAP earnings.


With some 23.6 million shares outstanding at the end of the quarter, after repurchasing a substantial portion of the outstanding share base in recent quarters amidst activist investor pressure, the equity in the business is valued at around a billion.

Note that the company has some $463 million in debt, and holds just $3 million in cash which results in a rather sizable net debt position.

The $1 billion equity valuation values the business at roughly 0.7 times anticipated sales for the upcoming year and 21-22 times adjusted non-GAAP earnings. Given the discrepancy in the first quarter already, the valuation multiples based on GAAP metrics will be much higher.

The debt position is rather high, especially in relation to net earnings and trailing EBITDA of about $100 million. Earnings are especially on the high side if earnings continue to be under pressure.

Long Term Challenges

The company has seen a great deal of challenges in recent years with sales improving from $1.5 billion in 2005 to peak at $1.75 billion in 2009, to fall to little over $1.3 billion on a trailing basis.

Earnings have been very volatile, ranging from anything between a tiny profit and peak earnings of $70 million in 2010, although trailing earnings total just $35 million by now.

It should be noted that the business has retired a third of its shares outstanding over this time period while leverage has risen a lot. Worse, much of this debt is of a shorter term nature posing significant risks given the leverage if the business does not improve.

Takeaway For (Potential) Investors

I must say that I am not at all impressed with the company's performance. If the company can improve its margins to historical highs, the valuation might be more appealing yet there are quite a few issues.

The competitive fields for dining is very difficult and margins are very low with Bob Evan's restaurants easily being qualified as ¨old-school¨ despite the rejuvenation of its restaurants. This makes a structural improvement in comparable stores sales unlikely in my eyes while the rapid increase in debt not only poses real dangers to investors, it also limits earnings attributable to them going forwards.

As such shares continue to trade a very rich multiples in a structurally difficult situation, an already very leveraged balance sheet and amidst the presence of activist investors in the form of Sandell Asset Management.

While the near 3% dividend yield might look appealing, the high leverage and pressured earnings could already cast doubts about the viability of this payout if operations stagnate any further.

Despite shares being down by nearly a third from a peak at close to $60 in 2013, to levels in the low forties at the moment, I fail to see any appeal on a stand-alone and historical valuation basis. Also note that the company already guides for high single digit comparable sales growth as soon as two quarters from now, leaving real risks to the downside in my opinion.

While activists and Sandell Asset Management in particular cite the room for improvements, I fail to see how much value can really be created. The risks on the other hand are very much apparent given the in my eyes reckless built up in leverage.

Shares remain a no-go in my opinion.

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