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Cara Foods Acquires Original Joe’s

*This post was delivered to readers of The Stock Analysis Waiting List on September 1, 2016.  Join if you would like to receive early releases of posts such as this here.

Back in August I wrote a post titled, Allocation of Capital – New Positions & Purchases in 2016, in which I included a short synopsis of one of my recent buys; Cara Operations (CAO).

Cara has been a stock I owned in the past and added to my watchlist in April of 2015 after its IPO. I had originally planned on watching the operations for 2-6 quarters, but when it dropped below $25 in February 2016 I was able to fill out a position completely. I have initially been happy with their quarterly results and most recently their acquisition of Groupe St-Hubert Inc. in March for $537 million. My intention is to hold Cara shares for the long-term due to an open position in my sector allocation for consumer and this stock fits a model I’ve developed of investing in similar companies. I wrote that I do want to see sales growth improve, but I’m willing to be patient considering some of the headwinds the Canadian economy has faced in 2015-2016.

What I didn’t publicly state, but privately was researching, were the quality of the hard assets and brands they purchased from St-Hubert.

Like many investors I knew St-Hubert was focused on restaurants (franchised and owned), but what I didn’t know was the quality of their assets in food manufacturing and distribution. St-Hubert’s sells products under the brands (in Quebec) of Allan, Andros, àtable!, Bonne Maman, Chef Lelarge, Loney’s, Major Gourmet, Pasta Fiesta, S-Sens, St-Hubert & SUWONG that include marinades, seasonings, desserts and BBQ sauce. Some brands have a history dating back to 1965.

The real gem in my opinion aside from the restaurants is the food manufacturing business they will acquire from Group St-Hubert. Cara may be able to organize their distribution network and potentially control much more of their food costs, quality and logistics for their 1,219 restaurants nationwide. Some products will be dropped, expanded, sold or leveraged/trialed in restaurants under existing banners with complete quality control.

But wait, did I say 1,219 restaurants? Yes, because today Cara announced that it has signed a deal to acquire a majority stake in Original Joe’s Franchise Group Inc., for $93-million. Those include 99 restaurants under the names of Original Joe’s, State & Main and 10 Elephant & Castle.

$90-million of the $93-million will be used to re-acquire trademarks and royalty rights from Diversified Royalty Corp (DIV) for Original Joe’s Franchise Group. This allows them to retain over $12-million in royalty payments that were previously paid to Diversified.

The plan is starting to emerge quite nicely; Cara will possess geographic distribution across the restaurant landscape of Canada. It can choose to keep the prized Blainville & Boisbriand plants from the St-Hubert acquisition or possibly sell them for a premium (both plants are HACCP facilities, recognized by the Canadian Food Inspection Agency and accredited according to SQF international quality standards) as they would be attractive to a food manufacturer. The distribution centre, also in Boisbriand, could be an individual asset, be bundled together with the two plants or all three utilized by Cara and its operations. Moves such as these can strengthen margins; increasing profitability by reducing costs.

The only warning would be that expanding East to West tends to be a difficult task in North America which is why companies often look towards acquisitions. Empire (EMP.A) has had difficulty with their integration of Safeway in Western Canada, but that doesn’t mean that Cara will fall into the same issues as their business models are completely different and Cara has already made what I consider to be some strategic moves to mitigate those risks.

As with Maple Leaf Foods (MFI) these are small incremental moves that add long-term value. I would expect same store sales to improve into 2017 and margins to improve along with them. Increased cashflow could be moved to investors (higher dividends) or into more accretive acquisitions. Management has clearly demonstrated to me that they are as sharp as they were prior to Cara being privatized, but we will wait to see if they can now execute on the performance and financial side.

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