Accounting for Real Estate

 | Mar 23, 2012 | 1:00 PM EDT
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Readers sometimes ask me about my fascination with real estate and frequent references to acreage and buildings owned by some of the companies I've written about, most typically restaurants and retailers. For me, it's all just part of the asset package, and assets are an important component of value investing.  Since many of the companies I research and/or own have a value flavor, a bit of distress or are trying to work their way back to health, it's important to know what is supporting book value. What is it that they own that might have some real value, could be of interest to potential acquirers, or could backstop the company in case of bankruptcy (à la Syms Corp)?

Owning real estate is not necessarily a recipe for success. There are plenty of restaurants and retailers that own little or no real estate and are extremely successful. But remember, I'm typically looking at companies that have struggled, may have a flea or two or are simply underappreciated. I'm trying to determine whether the market is undervaluing a business and ignoring potential value.

One of the calculations that I use in these situations is enterprise value (EV) to owned location (OL). Big disclaimer here, this will not provide you with an apples-to-apples comparison across companies, because all real estate is different. The value depends on quality, location and other factors. I simply use this as an indicator, a way of measuring the current value of a company solely on what might be its most valuable assets. Keep in mind that the calculation of EV includes company debt, which is important because many names that own a lot of real estate do have significant debt.

Take Bob Evans (BOBE), for instance. While not in distress, it is not a top-tier brand and tends to fly under the radar in the extremely competitive restaurant landscape. With a current enterprise value of $1.18 billion, the company owns 493 locations (486 Bob Evans, seven Mimi's Cafe). That equates to an EV/OL of $2.39 million. This calculation places no value on the business itself, future cash flow or any other assets beyond real estate.

Below, I utilize the same formula for some other restaurant names that own a significant amount of real estate. (Note: This is by no means an exhaustive list of every chain.)

  • Wendy's (WEN)
    EV: $2.83 billion
    OL: 640
    EV/OL: $4.42 million
    Note: Wendy's also owns the building only for another 474 locations; EV/OL does not account for this.
  • Denny's (DENN)
    EV: $603.4 million
    OL: 89
    EV/OL: $6.78 million
  • Ruby Tuesday (RT)
    EV: $873.2 million
    OL: 368
    EV/OL: $2.37 million
    Note: Ruby Tuesday also owns the building only for another 250 locations.
  • Cracker Barrel (CBRL)
    EV: $1.76 billion
    OL: 400
    EV/OL: $4.4 million
  • Sonic (SONC)
    EV: $957.5 million
    OL: 247
    EV/OL: $3.88 million
  • Luby's (LUB)
    EV: $178.4 million
    OL: 81
    EV/OL: $2.2 million
  • Frisch's Restaurants (FRS)
    EV: $155.3 million
    OL: 108
    EV/OL: $1.44 million
    Note: Frisch's also owns building only for 22 locations.
  • Jack In The Box (JACK)
    EV: $1.51 billion
    OL: 231
    EV/OL: $6.53 million
    Note: Jack In The Box also owns building only for 643 locations.

While I'd never buy a restaurant name solely based on real estate, it certainly can be a sweetener. Take Denny's, for instance. There's no way that the company's real estate is worth anywhere near the $6.78 million EV/OL calculation, but it can still be sold and it still gives Denny's some options as the company continues to pay down debt and rebuild the brand. In Cracker Barrel's case, we know that back in 2009, the company did a sale/leaseback transaction for 15 stores for $45.2 million, or just over $3 million per store, not all that far removed from the current $4.4 million EV/OL calculation. Keep in mind, this calculation considers nothing other than real estate.

If nothing else, the EV/OL calculation can give you an idea of how the market values a name based solely on real estate. It is far from a perfect measure, by any means. It's just another tool in the arsenal.

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