Franchise Group Stock: Diversified Portfolio To Support Finances – Seeking Alpha


The Vitamin Shoppe shop store sign in South Carolina selling health supplements


Investment Thesis

Since the beginning of the year, the franchise conglomerate Franchise Group ( NASDAQ: FRG ) has lost about half its market capitalization, due to the macroeconomic environment and headwinds in the furniture business, which occupies a significant share of the company’s operations. However , we expect the growth of Vitamin Shoppe, Pet Supplies Plus, and Sylvan Learning to support FRG’s financial performance. The management is demonstrating a masterclass within the M& As, expanding the potential toolbox for creating shareholder value. The company provides its shareholders with a high dividend yield, and an authorized buyback program can significantly reduce the number of shares outstanding and lead to a revaluation of stock. According to our valuation, Business Group trades at a discount to fair market value. We rate shares as a Buy .

Company Profile

Founded out of the combination of Liberty Tax and Buddy’s Home Furnishings in 2019, the Franchise Group owns franchised and franchisable businesses. Today the company’s portfolio consists of seven franchises:

  • The Vitamin Shoppe is a multi-channel retailer of vitamins, minerals, specialty supplements, and other wellness products.
  • Pet Supplies Plus operates a pet supply retail chain and provides a wide range of services including grooming and pet washing.
  • Badcock Furniture is a retailer of furniture, appliances, bedding, electronics, home office equipment, accessories, and seasonal merchandise in a showroom format.
  • American Freight operates a retail chain of furniture stores, new and used home appliances, and home accessories.
  • Buddy’s Home Furnishings specializes in rent-to-own furniture, home appliances, electronics, and accessories retail.
  • Sylvan Learning manages centers of additional education for Pre-K-12 students in the US and Canada.

The structure of financial results by segment is presented below:

Structure of financial results

Company Presentation

Diversified Franchise Portfolio

The largest franchise in the company’s portfolio is The Vitamin Shoppe, which accounts for 27. 7% associated with Franchise Group’s total revenue. In the first half of 2022, the segment’s revenue increased by 3. 4% year-over-year to $617. 85 million, while operating income improved by 5. 3% to $66. 37 million. The company’s management notes the growing demand for the franchise, the particular backlog is 20 shops. In addition , Vitamin Shoppe will be expected to improve its operating leverage by growing direct-to-consumer sales and increasing the share of higher-margin private brands in its revenue structure.

The Vitamin Shoppe

Company Presentation

The second largest section is Pet Supplies In addition. Franchise Group acquired a pet supplies retailer in March 2021 for $1. 3 billion, equal to 1 . 4x 2021 revenue. Pet Supplies Plus is one of the top three pet care market leaders and is the fastest-growing business in Franchise Group’s portfolio.

In H1 FY 2022, the segment’s revenue grew by 84. 7% year-over-year. While last year’s results are reflected from the acquisition date, the adjusted figure would still be in the tens of percent. Operating income was $35. 7 million compared to $6. 4 million a year earlier. Backlog – 230 stores, or 58% of the current number of franchised stores (392 units) and 38. 2% of their total number (602 units). Management has set a goal of opening 1, 650 stores over time. It is worth noting that more than ten states are still not covered by the company, which represents a good expansion opportunity.

Pet Supplies Plus

Company Presentation

Badcock is one of the largest home improvement retailers in the country with 384 showroom stores. Franchise Group acquired Badcock in November 2021 for $575 million. At the end of 2021, Badcock generated $901. 9 million in income and $22. 7 mil in operating income. In the first half of 2022, revenue was $489. 6 million and operating income was $101. 1 million.

Badcock has significant growth potential. Firstly, Badcock is one of the frontrunners in its market with over 100 years of history. Secondly, the company has a presence in only 8 states in the southeastern United States, and additional markets are currently being discussed for expansion.


Company Presentation

However , due to the decline in excess demand driven by the pandemic stimulus, FRG furniture franchises have faced headwinds. United states Freight’s revenue was down 11. 3% YoY, Buddy’s was down 8. 3% and Badcock’s like-for-like sales were down 11. 4%. American Freight’s revenue is usually expected to be $200 mil less than forecast, resulting in a 30% decline in Adjusted EBITDA.

In 2021, the furnishings business provided the company with 35% of total revenue and 48% of total Adjusted EBITDA, and the decline in the segment will significantly affect the finances of Business Group. However , the current challenges in the segment present an opportunity for investors because:

  • Headwinds in the furniture business have been a major driver of Franchise Team share price decline in recent months. Probably, all possible risks of the segment are already priced in.
  • It looks like the particular peak of inflation has already passed, and the average duration of recessions is 17 months, which should not be a problem for long-term investors.
  • The particular management notes the developing interest in their furniture franchises. American Freight’s backlog is definitely 26 stores, up from 17 stores last quarter. The backlog of Buddy’s is 98 units or 30% of the current open stores.
  • Although this factor is highly subjective and should not be the basis for an investment thesis, we nevertheless like the management’s rhetoric regarding American Freight, FRG’s main furniture company:

“The American Shipping in my mind is, still it’s the best unit economics of all the brands that we have, right now. There’s a ton of demand from franchisees, we’re limited by finding real estate and being able to get stores open. And as I think, it’s the only brand that we have, where we are as eager as we can be to even open up company-owned stores. And part of our plan is open company owned stores every year whether we end up ultimately refranchising those or not, but whether it’s two years, three years, five years, 10 years from now, American Freight is eventually likely to be the most valuable business that we own contributing the most free cash flow of any business that we own today, that is of course. And it really is a fantastic business. It’s just been hit with quite a storm that makes it very deep value products, not so heavy value in the customer’s eyes, and our main customer can’t afford the product. ” – CEO Brian Kahn, Q2 2022 Earnings Call

M& A Deals

Brian R. Kahn, you can actually CEO and Managing Partner of Vintage Capital Management has invested most of his own assets in Franchise Group and made FRG his main investment vehicle. You can actually PE background has been reflected in a number of extremely successful M& A deals.

In December 2019, Franchise Group bought Vitamin Shoppe for $208 million. Franchise Group did a quality job on Vitamin Shoppe, which was perceived as a stagnant company. FRG cut costs, launched online sales and introduced its own brands, which have higher margins. By the end of 2021, Vitamin Shoppe had $1. 17 billion in income and $137. 2 mil in EBITDA.

The $575 million Badcock acquisition in November 2021 is also a case in point. Following the closing of the transaction, Franchise Group sold the Badcock receivables portfolio for $400 million and leased the acquired firm’s real estate for $667. 5 million. In the second quarter of 2022, the company closed the particular sale of retail and distribution centers Badcock for $94 million and $150 mil, respectively. The Badcock headquarters was also sold for $23. 5 million. Thus, Franchise Team has generated more than the initial price of Badcock through the implementation of these strategic initiatives alone.

The M& As’ success has enabled the company to secure support from major capital providers. Oak Street Real Estate partnered with Franchise Group in a Badcock real estate deal. Oak Street Real Estate was also expected to become a partner in a failed Kohl’s deal this summer.

Thus, thanks to the PE background, Franchise Group is able to create shareholder value not only through both the organic growth of its businesses and M& A deals.

Capital Allocation

By the end of 2021, the company paid out ~$67 million in dividends, which amounted to about 18. 5% of net income and 16. 4% associated with Adjusted EBITDA. Today Franchise Group provides shareholders with a ~10% dividend yield. In addition , the company authorized a $500 million buyback over the next few years, which is about 40% of the market capitalization.

In our view, the company can maintain payouts and repurchase shares because:

  • Despite headwinds in the furniture company, Vitamin Shoppe, Pet Materials Plus, and Sylvan (not considered separately as Sylvan’s contribution is negligible) are supporting Franchise Group’s financials. Revenue for 2022 is expected to be $4. 30 billion versus $4. 29 billion dollars a year earlier, and Adjusted EBITDA of $350-390 million, which implies a 5-15% year-over-year decline.
  • Reaching the estimated Adjusted EBITDA for the year, the net debt/EBITDA ratio will be 2 . 85x, which is within the target values of 2x-3x.
Cash and Net debt

Company Presentation

FRG Stock Valuation

The DCF model is built on several assumptions. Revenue is expected to be $4. 30 billion by the end associated with 2022. We assume that revenue will grow at an average annual rate of 2% from 2022 until the end of the forecast period, in line with the Fed’s inflation target.

All of us assume that the gross margin will be 44% by the end from the year, which corresponds to the indicator for H1 FY 2022 – 44. 1%. 2022 Operating margin can be projected based on management’s expected Adjusted EBITDA of $350 million and the assumption that adjustments will be in line with last year. Thus, the operating margin is 6% until the finish of the forecast period.

In late 2021, DD& A expenses as a percentage of income amounted to 5. 2%, we expect this figure to remain until the end of the forecast period. CapEx as a percentage of revenue is certainly equal to the average of the last three years.

The assumptions are presented below:


Created by the author

With the cost of equity equal to 12. 8%, the Weighted Average Cost of Capital [WACC] is 12. 0%.


Created by the author

With a Terminal EV/EBITDA of 6. 13x, the particular model projects a fair market value of $1. 52 billion, or $37. 7 per share. The upside potential we see is about 51%.

You can see the model here .

The minimum price target from investment banks set by Stephens is $38 per share (30. 3% upside potential). In turn, D. A. Davidson estimates FRG at $55 (88. 6% upside potential). According to the Wall Street consensus, the company’s fair market value is $46, which usually implies 57. 7% upside potential.

Target price


Thesis Risks

  • Management attributed the decline in financial performance in the furniture segment towards the macroeconomic environment. Indeed, some companies such as Wayfair ( W ) and Bed Bath & Beyond ( BBBY ) are also showing sales declines, however , companies such as Williams-Sonoma ( WSM ) plus Arhaus ( ARHS ) are increasing despite headwinds. In other words, there is a risk that the decline within furniture franchises is due to a change in consumer preferences. If consumers turn down American Freight offers, Franchise Group’s financials will decline substantially and stocks will drop.
  • A significant concentration on mergers and acquisitions creates risks to shareholder value. There is a possibility that will Franchise Group will overpay for a particular business, or even that the fundamental qualities from the acquired companies will turn out to be worse than the initial estimates.


Despite headwinds in the home furniture business, Franchise Group has a diversified portfolio of franchises, most of which are showing development in financial performance and have a significant backlog of new stores, the launch of which will support revenue. Thanks to the PE background, the organization can create shareholder value not only through the organic growth of portfolio companies but also via M& A transactions. Business Group provides shareholders having a high dividend yield, plus an authorized buyback program can reduce the number of shares outstanding by 40%. According to our estimations, Franchise Group trades at a discount to fair their market value. We are bullish on FRG.

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