The Tex Mex burrito and Lemon Grass soup are seen at Freshii at 444 Spadina Rd. in Toronto on Monday June 17, 2013. (Pawel Dwulit For the Globe and Mail)

Ryan Modesto, CFA, is Managing Partner at 5i Research, a conflict-free investment research provider for retail investors offering research reports, model portfolios and investor Q&A. 5i Research provides content under an agreement with The Globe and Mail, which receives royalty compensation. Try it.

After discovering Freshii stores just a few months ago, a lot of the 5i Research team, including myself, quickly became hooked on their food. A unique format, along with healthy food options that don’t sacrifice taste or skimp on the serving sizes is more than welcome in the fast food landscape.

While enjoying a wrap with the team recently, we commented how quickly the company seems to be expanding and the potential it could have with access to the capital markets. Fast-forward a bit, and here we are, with Freshii preparing a Canadian IPO. With the company filing its amended preliminary prospectus on January 9, 2017, we wanted to distill the 226-page document into a bite-size piece that all investors are able to digest.

The business

In 2005, at the age of 23, founder and CEO Matthew Corrin opened the first Freshii location. The business has now grown to 244 stores across 15 countries. Freshii is a limited-service restaurant that offers healthy menu options that revolve around fresh produce and lean proteins for on-the-go individuals, particularly millennials. The restaurant balances taste and affordability, with an average item price of $7.50. The menu is developed in a way that allows it to evolve and adapt to emerging food trends.

Freshii is concerned with the "triple bottom line," which comprises People, Planet and Profit. The company wants to ensure that they have franchisees that believe in the brand and will be brand ambassadors, while also helping their customers live healthier lives. The CEO intends to directly or indirectly own roughly 20 per cent of the outstanding shares after the IPO.

The franchise model is noteworthy, as it is considered to be "asset light." The way the stores have been developed is such that there is no need for large kitchen equipment like microwaves and ovens. This helps keep start-up and energy costs low and makes it easier to find potential store locations in varying sizes. This is attractive to franchisees, as it helps reduce any upfront costs and support profit margins. Store sizes can range from 300 square feet to 2,500 square feet.

Strategy, growth and outlook

Freshii outlines its strategy as growing the franchise partner store base, growing same-store-sales (SSS) and enhancing profitability and free cash flow. It has some test partnerships with companies such as Walgreens, operating Freshii restaurants within its stores. If these partnerships prove successful, this could be one avenue to quickly grow the store base.

Freshii has also been seeing a great deal of unsolicited demand from potential franchisees to open new stores. The company feels that it faces a few key market drivers that will allow it to continue to maintain its growth trajectory: Health and wellness trends, millennial demographics embracing the brand, and a trend of individuals looking for affordable entrepreneurial opportunities.

Freshii has grown its store count by just under 60 per cent and EBITDA by nearly 59 per cent since 2013, with adjusted EBITDA over the last twelve months amounting to $9.4 million. Freshii plans to open 150 to 160 new franchised stores in 2017 and have a total of 810 to 840 stores by the end of 2019. Freshii is targeting a SSS growth rate of 3 to 4 per cent, an average royalty rate of 6 to 7 per cent of franchise store revenues and adjusted EBITDA in the range of $20-million to $22-million by the end of 2019.

Finally, Freshii is not afraid to try more innovative ways to generate revenues. Freshii is also exploring a meal delivery service through Meal Boxes. These are built during off-peak hours within the restaurant and harness an already built-out distribution network. It is in early stages, but sales at some stores already comprise 5 per cent of revenues. The company also has an app that allows users to skip the line when ordering.

Risks

Aside from the usual risks involved with equities, there are a few we think are worth highlighting. First, Class A shares get one vote while the Class B shares are entitled to 10 votes per share. The class A shares represent around 82 per cent of outstanding shares but only 32 per cent of votes. The subordinate structure may turn some potential buyers away from the offering.

Another risk worth considering is the key-person risk with the founder. Maintaining a sizable position in the company is reassuring, but if the founder were to leave, it could cause issues at a company that prides itself on a unique culture. The final risk is outstanding litigation for amounts of up to $10-million brought on by a competitor. This is certainly not an amount that would end the company, but also a risk worth being aware of.

Valuation

Freshii is looking to issue 10.9 million shares under the ticker FRII at a price in the range of $8.50 and $10.00 per share, for total proceeds of roughly $92 million to $109 million. The shares are subordinate shares — which will keep some investors away — but they have a decent track record in Canada and are becoming the trend amongst founder-led companies. With 2015 revenue being $11.1-million, and assuming the company can deliver at least 20 per cent growth, which would be below historical averages, the valuation for the IPO actually doesn’t look too bad.

Based on EBITDA, the shares will likely be trading at a premium in the 15 to 18 times EBITDA range. This is still lower than companies such as Chipotle, which has been hit with weak guidance and past concerns over food handling practices. While unlikely to be a value investor’s top choice, the growth at the company looks impressive, and the potential global market is large. If Freshii is able to hit their 2019 targets, the premium will likely be well justified.

Given the lack of IPO supply over the last year, there is potential that Freshii not only performs over the longer-term, but also breaks the spell of Canadian IPOs that typically fare poorly right after the shares hit the market. This is in contrast to U.S. shares, which often see a near-immediate gain once going public. In general, we do prefer to allow shares to trade for a while and have a bit of a history before jumping in, but we have little doubt that Canadian investors will be very happy to see a fresh face trading on the TSX.

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Please perform your own due diligence before making investment decisions.

In order to remain truly conflict-free, the writer and employees of 5i Research cannot take a position in individual Canadian equities.