I ran across BWLD a couple weeks ago when I was skimming through 10-ks. I think the best strategy to find undervalued businesses is to just read 10-ks, determine what I think the business is worth, and THEN check to see what the company is selling for. Let’s look at BWLD’s financials:

**Owner Earnings:**

A quick glance at morningstar’s free cash flow data (which many use as a substitute for owner earnings) shows that BWLD has earned $5.5 million in 2009, used $1.3 million in 2008, earned $2.2 million in 2007, and earned $9.3 million in 2006. For a company with over $200 million in equity, these are anemic cash flows to say the least. However, when we convert the free cash flow numbers to owner earnings (OE), we can see the true earnings of BWLD.

Owner earnings are defined as (Net Income)+(Depreciation/Amortization)+(Other Non-cash Charges)-(Maintenance Capital Expenditures)-(Any Working Capital Requirements). The largest difference between free cash flow and owner earnings is a result of the maintenance capex category. In the 2004 10-k, BWLD estimates that each restaurant opened in 2005 will cost $1 million a piece. In 05 they estimated ’06 costs at $1.1 million; ’07 costs were estimated at $1.2 million; 08 costs were estimated at $1.4 million, and the 09 costs were estimated to be $1.5 million per new restaurant. Since the company opened 19, 17, 22, 36, and 35 stores in 2005, 2006, 2007, 2008, and 2009 respectively. This means that 19 million was spent on new restaurants for 2005, $18.7 million in 2006, $26.4 million in 2007, $50.4 million in 2008, and $52.5 million in 2009. Subtracting this “growth capex” from the reported cap ex, we get a maintenance expenditures of $3 million, $5.1 million, $15 million, $17 million, and $21.3 million for 2007, 2008, 2009 respectively.

To check the validity of these numbers, we can divide each maintenance capex by the number of existing restaurants and see if the the per restaurant capex is relatively consistent. In 2005 we get $25,000 spent per existing restaurant; in 2006 we get $37,000 spent per existing restaurant; in 2007 we get $93,000 spent per existing restaurant; in 2008 we get $86,000 per existing restaurant; in 2009 we get $91,000 spent per existing restaurant. It’s clear that maintenance capex greatly increased in 2007 and has stayed relatively constant in per restaurant terms. Remember that these capex estimates are just that- they’re estimates based upon the company’s estimates. In other words, they could be way off. The 2009 10-k says that BWLD estimates 2010 expenditures of “approximately $20 million for the upgrades and remodels of existing restaurants.” Thus, our estimations are in the ball park. As Buffet once quoted Keynes:

“It is better to be roughly right than precisely wrong.”

Subtracting our maintenance capex from the cash from operations gives us 2005 OE of $21.7 million, 2006 OE of $27.9 million OE, 2007 OE of $28.6 million, 2008 OE of $49.1 million, and 2009 OE of $58 million. Not too shabby. BWLD grew its owner earnings from $21.7 million to $58 million in the last four years of operations–that’s a 28% growth rate! Keep in mind that this was through a recession.

**The Balance Sheet**

From the latest quarter 10-Q, BWLD has $15 million in cash, $113 million in current assets, $324 million in total assets, $104 million in total liabilities, and $221 million in equity. They could pay off all of their liabilities with their current assets only! But how are they employing those assets?

**Some Ratios (Using Owner Earnings)
**

CROE for 2007: 22%; CROE for 2008: 31%; CROE for 2009: 30%

CROIC for 2007: 19%; CROIC for 2008: 27%; CROIC for 2009: 26%

These are great numbers.

**Intrinsic Value
**

Using the average between 2008 and 2009’s owner earnings as my initial cash flow, a growth rate of 10 percent for the first 5 years (admittedly arbitrary, although significantly less than what I think BWLD is capable of achieving), a growth rate of 8 percent for the second five years, and a growth rate of 3% for the second 10 years, I arrive at an intrinsic value calculation of $1.14 billion for the business. Whenever I calculate an intrinsic value, I like to look at the value of the infinitely projected cash flow and see what impact that has upon the valuation. This final cash flow is often a source of controversy and is cited as a reason that projected cash flows are imprecise. In this case, the intrinsic value would have been 1.05 billion without that final cash flow– an 8% difference. Right now, BWLD is selling for a little less than $700 million or a 40% discount to our estimated intrinsic value.

Disclosure: Author is long BWLD.

Ziv(08:46:44) :Hey adam,

how are you?

I did a follow-up calculation and arrived at 702mil worth. Just because I didn’t do that many evaluations I’d love if you’d review this:

I used the 2007-2009 (three years) average OE – 45.23 as a starting point.

same growth numbers as you (10%, 8%, 3%) and just for comparison, at the end of the 20 years time I got 132.59 OE for 2029.

discounted everything back at 15% discount rate (you didn’t mention which you used) and got a total discounted value of future OE of 492.84.

Here I added the 2009 SE (ponzio’s method, I believe) – 209.8 and got 702.64 value for the company.

where did we differ? maybe your discount rate is much lower? (or maybe I’m just wrong o.O )

thanks, cheers =)

p.s.

just to be clear – did the growth by multiplying by 1.1, 1.08, did the discounting by X/1.15^y.

Adam(16:38:19) :Hey Ziv,

I should have mentioned it, but I used a 9% discount rate. I think I might have written a post on this before, but Buffett uses the long term treasury rate for his discount rate. When the treasury rate is really low, he uses a higher rate (it’s only 4% right now). That’s why I chose 9%.

But just looking at your calculations, I’m getting something different. If you use 45.23 as the initial cash flow (i used 53), 10% for the first 5 years, 8% for the second 5, and 3% for the second 10, I get my 2029 cash flow to be $143.84 instead of $132.53. Are you using a spreadsheet? I used the same method as you (multiplying by 1.1,1.08,1.03) and entered in the rates cell by cell. Even though I have larger cash flows, I still get intrinsic value to be 423 (without adding equity) using the 15% discount rate.

Here’s my spreadsheet if you want to check where our differences are,

Adam(16:40:29) :PS. The market definitely doesn’t agree with me. The Dow is up 4% and BWLD is down 1%!

Ziv(22:59:33) :ok – hi again =)

After looking at our calculations over and over I found out where we differ:

– I had a small mistake on my spreadshit – fixed it and got the same future OE numbers as you did.

– my initial OE was the median for the last 3 years, yours for the last 2 (~45 vs ~53)

– we actually discount differently – I divide by 1.15^t (t=years) and you do minus 15%, which is a huge difference. Also, from what I understand, if you want to discount for today, you have to do it by what I said, because in order to get 115$ in a year you have to have 100$ today, rather than 97.75.

– if I use 9% discount (using a modified version of ponzio’s evaluation spreadshit – attached below) I arrive at 958mil worth for the entire company. which is 22% MOS. Personally I don’t think it’s enough.

p.s.

the numbers in the ponzio’s spreadshit are a little bit different, as he uses excel based functions (FV, NPV) and I don’t know if they act the same as the calculations we did.

and btw, I’m sure you don’t care that much about mr. market these days, just remember – it took him (mr. market) 2 long years to realise washington’s post real value after buffett purchased his shares (only for the price to jump ~500%) =)

Ziv.

ben(02:05:54) :Australian guy here, just trawling the web for free cash flow analysis and dcfs. This is an impressive blog you have here. Its a shame you aren’t updating the blog.. and wow what a great CALL this came out to be.

Adam(02:40:19) :Haha thanks, I can’t believe anyone visits this anymore! I probably won’t be updating this but I’m Facebook friends with a few other old visitors and we still talk some times so you should add me too! Adam Gaglio from Michigan