RAVE Badly Oversold After Takedown By Erroneous Article
An article was published last week entitled “Rave Restaurant Group: Deep Analysis Of Supply Chain Reveals A Rotten Apple”, a title which would lead us to believe that there are some kind of Valeant Pharmaceuticals (NYSE: VRX) type shenanigans going on with Rave’s (Nasdaq: RAVE) supply chain or some other aspect of the company’s operations. Rave’s stock has fallen close to 15% in the trading sessions since the article was published, adding to what had already been a very severe selloff in the shares that had fallen nearly 40% over the last two months ($11.15 on Sept. 9 to as low as $6.85 on November 9). However, the article itself revealed no such rotten apple and the author’s faulty due diligence process apparently failed to “uncover” Pie Five’s expansion from 54 stores open to 74 over the last few months.
The entire gist of the article is that the author can not comprehend why the company’s cost of sales is as high as it has reported. In the article, he includes the statements from Rave’s most recent 10K that directly explains the specific components of cost of sales. He still has trouble understanding why the cost of sales would increase so much over prior periods despite admitting that Rave repeatedly gives us “… the fact that it added so many stores this year.” It seems the author believes there may be some other reason, perhaps something nefarious – the “rotten apple” indicated in the title of the article, but there is no mention of anything like a rotten apple in the body of the article or anything negative at all except that the author simply cannot fathom why cost of sales for RAVE would have increased so much.
The simple reason that the cost of sales increased much more than the author would expect given his review of the company’s financials is that his expectations were apparently not impacted by a due diligence process that included considerations of the new restaurants that would be opening in the days weeks and months after the end of the last reported quarter and/or he fails to comprehend that store openings require considerable expenditures in the months, weeks and days before a new restaurant opens and begins generating revenue. We presume this to be true because the author gives the number of open Pie Five restaurants to be 54 and he appears to be completely unaware that the number of operating Pie Five restaurants was actually 74 when his article was published. This glaring error explains much and it appears that RAVE stock has been selling off due to an article that drew negative conclusions simply because of a failure in the due diligence process of the author.
Pre-opening expenses for a new Pie Five restaurant include licensing, permitting, design, construction, marketing, staff training, etc. that are incurred BEFORE the restaurant actually opens and begins generating revenue. Most of these costs are one time expenses associated with entering new markets as RAVE did in the months that made up the quarterly filing the author pulled financial data from, a period that included expanding from three markets with corporate owned restaurants to seven as the company entered Arizona, Atlanta, Chicago, and Minnesota. Investors should realize that Pie Five’s open restaurant count has increased by close to 50% over the number the author lists as the open store count and that there are many more to open in the days and weeks ahead. The company appears to be accelerating its growth due to the success of the restaurants it has already opened (with 10 new company owned restaurants in Chicago, Minnesota and Atlanta) and while these additional expenses may have increased RAVE’s last reported quarterly cost of sales, that will result in a significant increase in revenue in future reported quarters and eventually this pushes the company closer to the scale needed for profitability. This is a very positive thing for long-term shareholders and while it may have depressed the June quarter’s earnings for RAVE, we believe the new corporate markets will benefit tremendously from the synergy of having multiple stores in each of these larger markets and this will cause the top and bottom lines to be impacted very big positive way starting with the current quarter.
The bottom line for investors is this – RAVE’s stock has been taken down by an article that drew negative conclusions about the direction of the company due to faulty due diligence. The stock has now fallen over 40% over a short period that has also seen the number of shares sold short increase to near record levels and that short interest is up over 10% in the last two weeks alone. Just under half a million shares are now sold short and at yesterday’s trading volume (25,517 shares traded), it would take 19 days where 100% of the trades represent short covering for the entire position to be covered. This is a very big deal for such a thinly traded stock and it means that any downside is limited by that pent-up buying interest and any positive company or industry news could spark short covering that would push the stock up very quickly in a very short period of time. Many commentators believe that RAVE has been targeted by short sellers because it’s thinly traded stock allows speculators to push the price down rather easily, but that also works going back in the other direction as well and we would not be surprised to start seeing short term traders taking a hard look at Rave on the long side. Regardless whether that transpires, we believe the current situation represents a tremendous opportunity for investors, as we believe that RAVE shares are dramatically oversold (RSI below 30 last four trading days) and ripe for a strong double-digit percentage move to the upside in the near term with the possibility of 100%+ gains over the next 12 months with significantly more if either Pie Five or Blaze Pizza files an S-1 in preparation for an IPO.
Entry filed under: micro cap, small cap stocks. Tags: Blaze Pizza, fast casual pizza, Fast Casual Restaurant Stocks, Fast Casual Restaurants, Micro Cap Restaurant Stocks, micro cap stocks, Pie Five Pizza, Pizza Inn, RAVE, Valeant, VRX.