MTY Food Group Inc. (TSX: MTY) is a leading Canada-based company franchisor and operator of restaurants in North America, which provides quick-service and casual dining restaurants. The company operates in two segments, namely Canada and US & International. The company operates through a wide network of 7,236 locations including 137 corporates, 7,077 franchises and 22 joint ventures.

Q2FY20 Financial Highlights: For the second quarter of FY20, MTY posted revenue of CAD 97.808 million, as compared to CAD 125.57 million, primarily attributable to a lower system sale on account of store closures due to COVID 19 pandemic. EBITDA plunged to CAD 18.213 million, down from CAD 34.145 million in Q2FY19, due to a lower income. The Group reported EBITDA margin at 18.6% against 27.2%, a year ago. Free cash flows improved to CAD 28.926 million from CAD 21.767 million in the previous corresponding period, driven by the refranchising of two groups of Papa Murphy's corporate locations. The company reported a net loss of CAD 99.126 million, as compared to a net profit of CAD 19.337 million in Q2FY19 due to inclusion of an impairment charge amounting CAD 120.3 million related to property, plant and equipment, intangible assets and goodwill. Cash on hand stood at CAD 49.9 million, followed by a long-term debt of CAD 536 million at the end of Q2FY20.

Q2FY20 Financial Snapshots (Source: Company Reports)

Risk:  Prolonged restriction measures or second wave of the novel virus might result in extended closure of restaurants. Any such scenario would dampen the system sales for the Company, which would hurt the income and cash flows. Change in customer’s preference and lower acceptability of the existing products might lead to a challenging demand scenario. 

Valuation Methodology: EV/EBITDA Based Relative Valuation (Illustrative)

Note: All the forecasted figures are taken from Thomson Reuters, NTM: Next Twelve Months

Stock Recommendation: The stock of MTY corrected ~49% so far this year due to a weak investors’ sentiment coupled with a demand destruction on account of COVID 19 pandemic. The Company will observe the customer’s buying pattern and will emphasize on the innovation, product quality and customer service across the outlets in order to improve the sales volume. Currently, the restaurant segment is witnessing several challenges due to closure of the outlets, while on a long-term perspective, we assume that the demand will pick up as the Government eases out the restrictions and the situation normalizes. The group has started opening the restaurants gradually, which is likely to drive sales.

Further, to enhance the liquidity, MTY negotiated an amendment to its credit agreement with its syndicate of lenders for flexible financial covenants for the next four quarters, which is a prudent move. The Company has ample liquidity to mitigate the current situation while the business has delivered stable cash flows from operations, augurs well for the funding requirements.  Further, to support the near-term cash flows, the Company suspended its dividend payment program. The stock of MTY gained ~23% in the last three months and we believe, most of the negatives has been priced in. We have valued the stock using EV/EBITDA based relative valuation approach and considered industry (Consumer Cyclicals) median and arrived at a target price offering double-digit upside potential (in % terms). Hence, considering the aforesaid facts and risk, we recommend a ‘Speculative Buy’ on the stock at the current market price of CAD 28.05 as on July 14, 2020.

MTY Daily Technical Chart (Source: Refinitiv, Thomson Reuters)

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