A Member of Pat McKeough’s Inner Circle recently asked for his advice on Canada’s oldest restaurant company, which recently returned to the Toronto Stock Exchange.

Pat feels that the company’s overall size and well-known brands add to its appeal. In the recent quarter that expanding number of restaurant chains led to a 24.8% revenue increase. However, Pat cautions that a growth-by-acquisition strategy comes with considerable risks.

Q: Hi Pat. What can you tell me about Recipe Unlimited? Thanks.

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Recipe Unlimited Corp., $26.55, symbol RECP on Toronto, (www.cara.com), changed its name from Cara Operations (symbol CAO) in May 2018. The company has a long history in Canada. It was founded in 1883 and is the country’s oldest restaurant company. Its shares traded on the Toronto Exchange from 1968 until 2004, when the business was taken private. In April 2015, it returned to the Toronto Exchange and began trading, after selling shares to the public at $23 a share.

Recipe Unlimited both franchises and operates restaurants, mostly in Canada. Of the current 1,382 restaurants, 82% (1,133) are held by franchisees and 18% (249) are company-run.

These operations are divided into restaurant chains: Harvey’s (with 292 locations), Swiss Chalet (212), New York Fries (159), St-Hubert (123), Montana’s (107), The Keg (105), East Side Mario’s (76), Kelsey’s (68), Original Joe’s (64), Milestones (46), Prime Pubs (44), State & Main (26), Burger’s Priest (17), Pickle Barrel (13), Elephant & Castle (11), Landing (9), Bier Markt (7), 1909 Taverne Moderne (2) and Casey’s (1).

Fairfax Financial (symbol FFH on Toronto) holds 43.5% of the shares outstanding. That stake translates into 56.9% voting control.

Inner Circle: Growth by acquisition drives an expansion to 1,382 locations

Since the end of 2014, the company has expanded from 837 restaurants to today’s 1,382.

On October 31, 2015, Recipe Unlimited purchased New York Fries for $40.6 million. That business is a quick-service restaurant chain that sells premium fresh-cut french fries.

On September 2, 2016, the company completed the $537.0 million purchase of Groupe St-Hubert—a full-service chain of chicken restaurants in Quebec.

On November 28, 2016, Recipe Unlimited bought majority ownership of Original Joe’s for $93.0 million. Original Joe’s operates and franchises full-service restaurants in Canada and the U.S. across three brands—Original Joe’s Restaurant & Bar, State & Main Kitchen Bar and Elephant & Castle Pub and Restaurant.

On June 1, 2017, the company bought a majority interest in The Burger’s Priest, a fast-casual premium burger restaurant chain with locations in Ontario and Alberta. On November 30, 2017, Recipe Unlimited completed the acquisition of Pickle Barrel Restaurants, a leading full-service restaurant operator in the Greater Toronto Area. That deal included The Pickle Barrel catering. At the same time, the company paid $18 million for a 50% interest in Rose Reisman Catering.

In February 2018, Recipe Unlimited completed its acquisition of Keg Restaurants Ltd. for $105.0 million in cash and 3.8 million subordinate voting shares. That makes for a total value of roughly $200.0 million. The company may be required to pay as much as $30.0 million more in cash if Keg Restaurants achieves certain financial milestones.

As a result of its acquisitions, Recipe Unlimited’s total revenue jumped 37.2%, from $373.3 million in 2015 to $512.2 million in 2016. It climbed another 62.6%, to $832.7 million, in 2017. In 2018, it rose a further 43.1%, to $1.2 billion.

Earnings, excluding one-time items, jumped 50.9%, from $64.3 million ($1.58 per share) in 2015 to $97.0 million ($1.86 per share) in 2016; profit then climbed 20.7%, to $117.1 million ($1.96 per share) in 2017. In 2018, profit rose a further 5.2%, to $123.2 million ($2.00 per share).

In the latest quarter, ended March 31, 2019, revenue rose 24.8%, to $304.6 million from $244.1 million a year earlier. The gains came mostly from the acquisitions of Pickle Barrel and The Keg. Same-restaurant sales fell 1.6% and earnings, excluding one-time items, dropped 14.1%, to $17.7 million, or $0.20 a share, from $20.6 million, or $0.34. The drop came mostly from higher costs, including restructuring expenses.

On March 31, 2019, the company held $41.3 million in cash. Its total debt of $445.8 million is a manageable 27.7% of its market cap.

Recipe Unlimited’s well-known brands add to its appeal. As well, its size lets it centralize purchasing and administration for all of its restaurants. However, acquisitions as big as St. Hubert and The Keg add risk.

The stock trades at 14.6 times the company’s 2019 full-year earnings forecast of $1.80 per share. Recipe Unlimited raised its quarterly dividend by 5.0% with the April 2019 payment, to $0.1121 from $0.1068. The shares yield 1.7%.

It’s generally a good idea to be skeptical of companies relying on a growth-by-acquisition strategy. Recipe Unlimited exposes you to that source of risk. The company hopes to restore same-restaurant sales by spending more on marketing and renovating locations to attract customers. That will cost money, and Recipe Unlimited faces an increasingly competitive restaurant market.

However, the company has a number of moderately successful restaurant brands. Any one of them has the potential to expand in the steady economic growth that’s likely in the next few years.

Recommendation in Pat’s Inner Circle: Recipe Unlimited is a hold.