MTY Food Group – A Case Study of a 100-Bagger

Chip Maloney Blog, Educational, Intelligent Fanatics 38 Comments

In late 2003, I had been investing in microcaps for about 3 years when I came across a small microcap company called MTY Food Group that was trading on the TSX Venture Exchange.  At the time, MTY had a market cap of under $5 million.  Incredibly, $1 invested in MTY stock in 2003 would go on to be worth $100 by 2013.

MTY Chart

So how did MTY management achieve this, and could an investor have foreseen this multi-bagger potential at the start of the run?

With some hindsight bias, let’s go back to 2003 and look at the circumstances that led to this incredible investment opportunity.  In early 2003, MTY Food Group was then known as iNsu Innovations. INsu consisted of two divisions – a profitable fast food restaurant franchisor, as well as an unprofitable technology business.   On April 10, 2003, MTY announced they would be divesting their unprofitable technology business to focus on the fast food restaurant franchising business, and they announced the name change to MTY Food Group to symbolize their focus on the franchising business.  The annual results from 2002 had just been released and buried in the footnotes to the financial statements were the segment results, and the fast food franchising division had earned $.07 in the previous year, doubling earnings over the previous two years.  Since the collapse of the tech bubble, the unprofitable technology division had been masking the profitable fast food franchise business.  So from now on, the profitable franchising business would start to show through in the financial statements.

On April 17, 2003, Stanley Ma was appointed President of MTY.  Ma was the entrepreneur who started the company’s very first restaurant concept Tiki Ming – Chinese Cuisine in 1987 as a recent immigrant to Canada.  Ma was a fanatic about the fast food franchising business.  He had  previously been the Chairman of the company with it’s unsuccessful foray into the tech business, but now he was stepping in to lead the company in it’s expansion of the fast food franchising business.  He had guided the accretive acquisition of four fast food franchise concepts over the previous three years.

On Sept 25, 2003, Stanley Ma purchased 3.1 m shares or 20% of shares outstanding for $.25 per share from two large shareholders.  The total cost was $.8 million (to be paid over 5 years in installments) to bring his shareholdings to 4.3 million shares or 29% of the total outstanding shares.  Ma was now heavily incentivized to make this business a success.

On Oct. 24, 2003, MTY announced they had earned 3.5 cents per share for the third quarter.  Revenues were up 20% year on year, but without the unprofitable technology division, earnings had rocketed up 178%.  The restaurant franchising business had very little seasonality, and so an astute investor could annualize this quarter’s results to come up with an approximate forward EPS number of 14 cents EPS.

Throughout the summer and fall of 2003, there was a fair amount of liquidity in the stock, and a small investor could have acquired a decent sized position between 25 and 35 cents.

At this point in 2003, the stars were lining up for this to be a very good investment.  Here were the key reasons why:

1). Q3 2003 had just shown massive growth in revenues and earnings per share quarter on quarter and year on year.  In relation to run-rate EPS, the shares at 30 cents were trading at an absurd valuation of 2X forward earnings, not even factoring in the 30 cents per share of excess cash.

2). MTY was a cash cow with high gross margins in the 70% range, EBITDA margins in the 35% range, and was growing organically with a capital light business model.

3) The franchise business had very high returns on invested capital (greater than 60%) with the ability to reinvest incremental capital at similar high rates.  In other words, MTY was generating substantial cash flows, and because it didn’t have to reinvest that cash back into the business, it was plowing it into acquiring more fast food franchising concepts at similar high returns, which would lead to rapid earnings growth if continued.

4). MTY was run by an owner operator who was incentivized to run the business to maximize growth and profitability over the long term, and who was a fanatic about the business.

5). The business had a durable competitive advantage.  There were two sources to the competitive advantage.  First, MTY owned regional fast food restaurant brands that were very strong in Eastern Canada.   In a mall setting, eating decisions are made in a few seconds, so brand recognition is important. Secondly, and more importantly, MTY’s customers (the franchisees) had large switching costs.  The initial franchise fee to start an MTY location is $25,000 to $40,000.  In addition, the capital investment to build out a location for a new MTY franchise is between $150,000 and $450,000.  If a franchisee wants to switch restaurant brands, they would need to rip out all the signage and equipment, and pay another franchisor another franchise fee as well as make another capital investment into equipment and signage. So unless the customer went bankrupt, they would probably continue to pay MTY a monthly royalty.

6). The business had a long runway of growth.  In 2003, MTY’s market share was a fraction of the total quick service restaurant franchise market in Canada, not even considering the U.S.

7). There was little risk of obsolescence.  Unless shoppers and office workers abandoned food courts, this business would be around for many years.

8). The restaurant franchise royalty business was a very stable business with recurring revenues that would grow throughout the economic cycle and MTY had a perpetual option on any growth in a franchisee’s revenues.  Because MTY was paid, depending on the brand, 4.5-6% of a franchisee’s revenues, any growth in the franchisee’s same store sales resulted in growth in MTY’s royalty stream.

9) MTY had a very tight share structure with around 15 million shares outstanding, and the company had bought back 5% of shares outstanding in the previous year. In other words, they treated their shares like gold.

So in essence, at 30 cents, you were buying a great business at 2X forward earnings, with a Fort Knox balance sheet.

Here’s what happened to MTY from 2003 to 2013:

MTYchart

Between 2003 and 2013, MTY launched 5 new restaurant concepts, and acquired another 19 restaurant franchise concepts, which added 2029 locations to it’s franchise network. Except for a small sale of shares, all these acquisitions were financed out of cash flow.

As you can see in the above table, over 10 years, MTY increased it’s share price by one-hundred fold.

Earnings per share grew by a factor of 12.4X.  But if the company only grew earnings by 12.4X, how did the stock grow 100X? The answer lies in the price to earnings (P/E) multiple expansion.  Investors in MTY went from paying roughly 3.5X earnings when it was left for dead in 2003 to a more optimistic 26X earnings in 2013.

So how did I do on this investment you may ask?  The answer is I didn’t make a single dollar of profit on it.  I was paralyzed by two behavioral biases that prevented me from buying shares.  The first was that I had anchored onto the price of 25 cents that Stanley Ma had paid for his 3.1 million shares, and was unwilling to up my bid to the $.30 ask.  The other bias that paralyzed me was recency bias.  I had just read Kathryn Staley’s excellent book The Art of Short Selling, and there was a chapter on the Jiffy Lube franchise failure, and I saw that MTY was on the hook for leases if it’s franchisees failed, so I was hesitant to pay up for the shares.  Short story is I never bought any shares, even though there were multiple opportunities along the way to make 2X, 5X, or 10 X my money all the way up.

The painful lessons I learned from this experience were:

  1. A large part of the return on a multi-bagger will come from performance of the business and earnings per share growth. However, if you pay a very low multiple for a great business, you can really juice your returns because you get a double whammy from earnings growth and the P/E multiple expansion.
  2. When all the stars line up, swing for the fences. Make these rare opportunities a significant part of your portfolio because they don’t come around very often.
  3. Buy right and sit tight. When you own a great company with great management, hold on for the ride.
  4. Be cognizant of behavioral biases. They can cost you a lot of money in missed opportunities.
  5. At least I don’t feel as stupid for missing this 100 bagger as the two large shareholders who sold Stanley Ma 20% of the company for 25 cents a share, to be paid back in installments over five years.

The moral of this story is that the investor who has the ability to find great stocks but does not buy them has no advantage over the investor who has no idea how to find them. The next time you find a stock like MTY Food Group, back up the truck and load up.

If you liked this article, you would enjoy this book: 100-Baggers by Chris Mayer

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About the MicroCap Expert Author

Chip Maloney

Chip Maloney is a Canadian-based private investor and has been investing primarily in non-resource Canadian microcaps for 15 years. His investment style could be summed up as GULP (Growth at an Ultra Low Price). When he is not doing investment-related reading, you can find him running, biking, skiing or spending time with his wife and daughter.

Comments 38

    1. Thanks Burzian. I hope so too. We just need some patience and curiosity to keep searching, and the discipline to pounce when they do come around.. Who knows, you may already have a future 100 bagger in your portfolio already.

  1. Chip, great job at summing the story behind MTY and thanks for sharing your experience. I had the pleasure to hold the stock for 2 years (although almost a decade after you found it lol!). Unfortunately, it was already a good way into becoming a smallcap when I bought it. Really wish I found it and bought a boat load earlier!

    But as Peter Lynch already said, “You don’t have to “kiss all the girls.” I’ve missed my share of tenbaggers and it hasn’t kept me from beating the market.”

    1. Thanks Seb and congratulations. You profited a whole lot more than I did on MTY. I’ve since improved my process so that I am not quite as anchored to previous stock prices, so that I am more willing to buy at higher prices, but I am still fighting that bias.

  2. Chip, thank you for taking the time to share MTY’s history and your experience. I think doing such exercises of studying history is extremely valuable and can help investors build the appropriate mental models for identifying opportunities in the present.

    1. Thanks Uncap. Even though I’ve followed MTY for 13 years, it was a great exercise to read back over 15 years worth of reg filings and to write the story. It was painful to rub my nose in it again, but hopefully the lessons will sink in better.

    1. Jonathan, at the time I came across MTY, I was half way through looking at every single public company in Canada on Sedar.com. I got the idea from Warren Buffett who suggested in an interview starting at the letter A and looking at every single public company looking for little mispricings. It is a great exercise, and if I were to do it again, I would do it like Aaron Lanni does it
      https://espacemc.com/en/general-en/how-to-find-a-microcap-investment-idea

  3. Fascinating story. What I didn’t know and found particularly interesting is the fact that MTY had a mediocre technology business that obscured their small but successful food operation. It seems like small microcaps which venture into a new direction (from insecticide to iron pills!) can be real sources of undervaluation if the company’s “other business” shows promise.

    Great stuff!

    1. Thanks ET. and I agree, these microcaps with two divisions where one is obscuring the profitability of another are great areas to search for mispricings. In my experience, the low risk way to play these is to wait for the divestment or closure of the crappy business, or signs that they will now focus on the good business, because I have been burnt on a few investments like this where management kept the crappy business and the value in the good business never materialized. Although nowhere near as attractive as MTY in 2003, a real time example is NXJ-T, where the decent CRM software business is being masked by the healthcare division which is bleeding cash. Management has announced that they are looking at ways to stem the cash drain by finding a partner to fund the development of the unprofitable division. I have a small position, but would look to make it a bigger position once they announce the signing of a strategic partner to fund the unprofitable healthcare division.

    2. ET,

      I thought of a name for this category of companies. Tapeworm companies would aptly describe these types of companies where a parasitic money sucking division is stunting the growth of an otherwise healthy entity. Once the company acknowledges that they have a parasite, only then can they kill it off, and the company begins to thrive. Maybe Biosyent could formulate a specialty pharmaceutical to treat this type of company. Maybe a large suppository for the CEO of such a corporation?

  4. Fantastic real life perspective. Chip great job in conveying the details in your write up. What I found fascinating was that the stock price was reflective of the fundamentals. Top line growth thru the years. Very nice job Chip and Ian.

    1. Gary, thanks for the comment. It is fascinating isn’t it that the stock price followed the fundamentals. The biggest part of the gain came in the first year when EPS improved by 90%, but the stock price advanced 635% due to P/E multiple expansion. Evidence for finding them cheap and letting them run.

  5. This was interesting. I knew some of the history but not all of it. I’ve been invested in MTY for the past few years. It’s only been a 2x for me, but I still like the story. They initiated a dividend a few years back and have increased it every year. I’ve thought of buying more, although the stock has looked expensive for a long time now and I like bargains.

    1. Great job on the 2X on MTY John. I don’t really have a strong opinion either way on MTY currently. The low hanging fruit for acquisitions is probably already picked over, and the law of large numbers probably comes into play at some point. But it has never paid to bet against Stanley Ma. Who knows, maybe 3G will come in and acquire MTY at a 100% premium, and will eliminate 95% of MTY’s operating costs by combining with Burger King/Tim Horton’s. MTY head office can probably get by sharing 1 phone for every 100 employees, no?

  6. Thank you for your write-up.

    Did you look at all at book value? I imagine the book value per share growth was similarly fantastic.

    And in this case it seems the evidence of good management came quickly. So many microcaps are “pre-revenue” and are thus more speculative in nature. Here the sales & revenue were there.

    1. A in P, I didn’t do a detailed analysis of book value growth, but you are right, it looks like the trend was similar. BV went from $.51 in 2003 to $6.86 in 2013. That is actually better than I thought it would be because they amortize intangibles (franchise rights) from acquisitions, which lowers book value. I agree on the evidence for good management being there early. If you looked at the segmented results prior to 2003, the trend had already started. From 1997 to 2002, revenues more than doubled in the restaurant franchise division and were the following in millions $4.1 $5.5 $6.1 $6.5 $6.6 and $8.9. Pre-tax income nearly quadrupled from 1997 to 2002, and saw the following trend in millions $0.5. $ .7 $0.5 $.95 $1.35 and $1.9

  7. Great article, I agree. I especially agree with the observation that the best returns were from around 2003 to 2007, due to P/E multiple expansion, as well as to the increase in the earnings of the business.

    As for the two “behavioral biases that prevented me from buying shares”…..it seems to me that only the FIRST one was really a mistake;

    “The first was that I had anchored onto the price of 25 cents that Stanley Ma had paid for his 3.1 million shares, and was unwilling to up my bid to the $.30 ask”

    I agree that that “anchoring” was not a valid reason to avoid purchaising shares…..but the second reason given, it seems to me, may very well have been a valid reason for not buying shares – I would have liked to have seen an analysis of how likely it was that the franchises would have failed;

    “The other bias that paralyzed me was recency bias. I had just read Kathryn Staley’s excellent book The Art of Short Selling, and there was a chapter on the Jiffy Lube franchise failure, and I saw that MTY was on the hook for leases if it’s franchisees failed, so I was hesitant to pay up for the shares.”

  8. Paul,

    Thanks for the comment. That 2003 to 2007 period was an extraordinary time to be a microcap investor wasn’t it.

    You may be right on the second reason not being a mistake. Franchisee failure and MTY being on the hook for the lease was certainly a risk, but where I think I made the mistake was oveweighting that risk / potential liability of franchisees failing. if I were to approach a similar scenario today, I would definitely want to explore that risk with the CEO, and I would look at the historical failure rate, and stress that under more difficult economic circumstances. I would probably speak to a few franchisees to get their perspective on the probabilities of failure. I think MTY’s historical rate of franchisee failure was low In 2003. Since that time, as the number of brands under the MTY banner has increased, and because MTY owns the lease, more often than not, I think MTY has been able to put a different brand in the space whenever another brand doesn’t work out. In addition, MTY has focused on selling franchises to well financed owners of multiple rataurants, although that could increase the risk if a few large franchisees failed.

  9. Hey Chip, May I ask, along the journey did ever get the chance to meet with senior management of MTY, or was it something you studied from a distance? Thanks for taking the time on the write-up. Rgds, Graham

    1. Graham,
      No, I never have met with senior management in person. Obviously hindsight is 20/20, but had I met with Stanley Ma in the modest company digs back in 2003, that may have gotten me over the goal line to invest in MTY.
      Chip

  10. Thank you Chip for sharing this valuable learning experience with the forum. This is gold to me! Please keep up the good work, and I look forward to be reading stories of you making 100x!

  11. Thanks for sharing chip . It would be really great if you share the PE expansion for the company with time.

    One question on capital allocation , Do you allocate the money at initial stage itself or you increase allocation as the story unfolds .

    Thanks
    Vishal

    1. Vishal,

      I think it’s both. Sometimes I will take a larger initial position if I don’t think the attractive opportunity will stick around for long, however more often I will take a smaller initial position and add to it over many months or even years as management continues to execute.

  12. Excellent article Chip. I re-read it often as I view one of my positions in a very similar situation as an early MTY. I should only be so lucky! Thanks again.

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