Food from company's website!

Whopper is a deep value investor and the founder of whopperinvestments.com. He can be reached at [email protected]

I recently stumbled upon this great write up on SYMS, a retailer whose real estate is likely worth more than the current market cap. That write up got me thinking about another company I ran upon that has significant real estate assets- J. Alexander Corp (JAX).I first stumbled upon JAX when I went digging through the microcap restaurant sector (same way I found MHGU and STRZ). JAX operates the J. Alexander’s line of restaurants, a chain of 33 restaurants in 13 states in the Southeast. These restaurants are pretty classy- they aren’t quite Morton’s, Ruth Chris, or other steakhouses level, but they are definitely more expensive than chains like Applebees, Chilis, etc. The average check is just under $25 per customer. This is a bit above Outback ($20) which is at the high end of the casual chain dining sector, but Outback is only open for dinner (which is more expensive than lunch) while JAX is open for lunch and dinner, so the number is a bit skewed (for comparison sake, average dinner check at a steakhouse is $60+, with RUTH coming in at $70).

As you’d expect, JAX’s higher end dining experience was absolutely CRUSHED during the great recession. However, there is a lot to like about the business model going forward. JAX focuses on creating an incredible customer service experience. Instead of spending money on advertising, they hire more waiters/waitresses and have more servers per table. This creates a better experience, and the company relies on the word of mouth from this experience to increase traffic. Before the recession, this had created a pretty resilient and consistently profitable business model- the company was consistently earning $6m+ in operating income before the recession with returns on equity around 10%. Op. Income this year will come in a little lower ($2.2m), but sales and earnings continue to gain momentum as the economy recovers.

What really made the company interesting to me, however, was that they actively tried to own their stores. Most restaurants (and retailers) choose to lease their locations, for several reasons- for the most part, you can’t earn good returns on real estate without significantly leveraging it, they’d rather invest their capital in opening more locations than tying it up in real estate, it makes it easier to move and/or close under performing stores, etc. In contrast, JAX “generally preferred to own its sites because of the long-term value of real estate ownership” (from their 2010 10-K). Beginning in 1997, the company had trouble finding suitable locations to open stores that they could buy and thus began leasing the locations (only 2 of their 15 stores opened since 1997 were on company owned land). Finally, the company notes the land acquisition costs for its restaurants is generally $1.5 to 2.5m and the cost to build a restaurant, excluding land cost, is $4 to $4.9m.

So let’s do some quick math. The company owns the land to 15 of their locations. Using the mid-point of their land valuation for the sites ($2m), their land alone would be worth $30m. They then own the building to 27 of their locations. I’m sure the locations have depreciated since they were built, and the $4m number above included equipment, inventory, training, etc. However, I don’t think it’s a stretch to say the building are worth at least $750k a piece. This would give them total property value of just over $50m. Compare this to their current EV of under $46m (they haven’t filed their 10-K yet; I’m going off number derived from their earnings release). On another metric, BV per share stands just over $8 per share versus current share price of $5.91.

Of course, both of those metrics are pretty crude. Investors who want to truly get a feel for the company’s land valuation can use google maps and loopnet to locate the company’s owned real estate and estimate it’s value based on comparable sales (this is actually what I was in the process of doing when I stumbled upon the stock… the stock ran up from $4 to $6 (50%) basically before I could even get started. Damn you, value standards! Funny story- I even had a limit order in for around $3.80 and missed it by about 2 cents. Lesson- don’t let pennies keep you from making investments at huge discounts if they’re within your circle of competence).

Anyway, I honestly think the company is worth more dead than alive. Rent expense is currently $4m and would AT LEAST double if the company leased all of their properties. Add that expense back and the company would be earning about $2m in operating income pre-recession and will still have negative income this year. Margins would be razor thin even in good times with that added back. If they tomorrow announced they were going to engage in sales of all of their properties, leaseback the strong performers, and just shut down all of the poor performers, I bet they stock would be worth at least $9 per share.

My take

Anyway, at today’s price of $6, I feel like the stock’s still cheap but not really in value territory anymore. At a lower price (say, low $4) you get a heads I win, tails I win more investment- either the core business turned around and the stock belonged higher (in which case, you have a company worth at least $8 per share) or the restaurant business continues to lose money and you’re protected by the value of the real estate. This is another one of those cases where I really couldn’t argue with an investment at today’s prices, especially if you were an activist with enough buying power to get elected to the board and force the sale/leaseback/store closure plan through, but I’d personally rather be in RSH (for people who want exposure to the consumer) orRDI (for people looking for real estate).

Disclosure: Long RSH, MHGU, and RDI, and I’d be a richer man if I was long JAX!!!!