Rising Debt And Costs Will Threaten Margins Yet Enable Turnaround

Key Takeaways

• High debt and cost pressures constrain profitability and reinvestment, while evolving consumer preferences and operational risks threaten future growth.
  
• Ambitious expansion and digital gains are challenged by labor shortages, supply chain disruption, and franchisee vulnerabilities.
  
• Elevated debt, operational inefficiencies, regulatory risks, and shifting consumer preferences threaten profitability and expose the brand's business model to sustained financial and structural challenges.

Catalysts

A multi-brand restaurant franchising company, acquires, develops, markets, and manages quick service, fast casual, casual dining, and polished casual dining restaurant concepts in the United States, Canada, and internationally.

• While FAT Brands is positioned to capture long-term growth from global urbanization and franchise expansion, its continued high leverage and significant debt service requirements put persistent pressure on net margins and earnings, limiting the company's flexibility to reinvest for future revenue growth.
  
• Although rising digital ordering and interest in off-premise dining have driven strong digital performance in snack segments and higher loyalty-driven sales, an industry-wide shift to health-conscious eating continues to threaten the traditional core of FAT Brands' menu, putting future top-line growth at risk as consumer preferences evolve.
  
• Despite an ambitious development pipeline with franchisees committed to opening approximately 1,000 new locations over five to seven years, labor shortages and wage inflation in key North American markets may hinder franchisee profitability and slow the pace of store openings, negatively affecting royalty streams and franchise fee income.
  
• While the successful integration of new brands and expansion of manufacturing capacity offer prospects for operating leverage, ongoing supply chain disruptions and commodity price volatility expose FAT Brands to margin compression, especially as cost pressures are only being partially offset by internal efficiencies.
  
• Although international diversification and investments in technology position the company to benefit from global growth trends and modernization, FAT Brands' complex brand portfolio and heavy reliance on small-scale franchisees increase operational risk, raising the likelihood of franchise closures or underperformance that could depress overall revenue and system-wide sales growth.

FAT Brands Future Earnings and Revenue Growth

Assumptions

• This narrative explores a more pessimistic perspective on FAT Brands compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts.
• The bearish analysts are assuming FAT Brands's revenue will grow by 4.6% annually over the next 3 years.
• The bearish analysts are not forecasting that FAT Brands will become profitable in next 3 years. To represent the Analyst Price Target as a Future PE Valuation we will estimate FAT Brands's profit margin will increase from -38.2% to the average US Hospitality industry of 8.0% in 3 years.
• If FAT Brands's profit margin were to converge on the industry average, you could expect earnings to reach $53.1 million (and earnings per share of $2.66) by about August 2028, up from $-220.8 million today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 5.0x on those 2028 earnings, up from -0.2x today. This future PE is lower than the current PE for the US Hospitality industry at 23.3x.
• Analysts expect the number of shares outstanding to grow by 5.12% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 9.82%, as per the Simply Wall St company report.

FAT Brands Future Earnings Per Share Growth

Risks

• FAT Brands' relatively high debt load, combined with increasing interest expense of nearly $40 million in the quarter and the need for ongoing refinancing, exposes the company to significant financial risk if capital markets remain tight or rates rise further, negatively affecting net margins and future earnings.
  
• Persistent softness in same-store sales, closures of underperforming units, and reliance on a highly franchised, multi-brand portfolio make the company vulnerable to evolving consumer trends such as health consciousness, which could depress revenue growth as demand for indulgent, legacy menu items declines over time.
  
• Elevated general and administrative expenses, highlighted by a sharp increase in share-based compensation and potential operational inefficiencies from managing a complex, sprawling brand portfolio, could constrain the company's ability to expand net margins and impact long-term profitability.
  
• Rising labor costs, supply chain challenges, and inflationary pressures-especially as noted in food costs and wage inflation-threaten franchisee profitability across regions, which could lead to higher rates of store closures and reduce the royalty revenue stream over time.
  
• Ongoing regulatory and legal risks, including unresolved SEC investigations and potential changes in franchising rules, nutrition labeling, and environmental standards, may increase compliance costs and create further uncertainty, thus weighing on future earnings and equity valuations.

Valuation

• The assumed bearish price target for FAT Brands is $10.0, which represents the lowest price target estimate amongst analysts. This valuation is based on what can be assumed as the expectations of FAT Brands's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
  
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $15.0, and the most bearish reporting a price target of just $10.0.
  
• In order for you to agree with the bearish analysts, you'd need to believe that by 2028, revenues will be $660.9 million, earnings will come to $53.1 million, and it would be trading on a PE ratio of 5.0x, assuming you use a discount rate of 9.8%.
  
• Given the current share price of $2.01, the bearish analyst price target of $10.0 is 79.9% higher.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.