"Sin stocks" are popular because they benefit from extremely
loyal customers. But the problem for growth investors is that
most of these companies are fairly mature and well past their
years of producing big capital gains.
Phillip Morris (
is a good example. Although PM pays a solid 4.3% dividend yield,
it's returned only 27% in the past two years, underperforming the
S&P 500 Index's 38% return. Strong customer loyalty drives a
nice stream of income, but in this case, it leaves something to
be desired in the growth department.
That's why I am intrigued by a rare small cap in the sin stock
field. Not only does this company benefit from extremely loyal
customers, it also offers big upside. That has led to a 37% gain
in 2013 after a recent 30% jump. Take a look at the big gain
But while investing in sin stocks isn't for everyone, they can
also be quite lucrative, and today I'm going to tell you about
one that definitely fits the bill.
Rick's Cabaret International (Nasdaq: RICK)
owns and operates more than 50 high-end nightclubs that cater to
business professionals in the U.S. Rick's gets most of its
revenue from its core nightclub business, but the company also
offers some revenue diversification with a growing presence in
the restaurant business, industry trade publications, trade shows
and more than 25 websites.
As you can see from the chart, Rick's is having a great year.
Even better, the company is still at the front end of a long-term
growth cycle -- and that's a big opportunity for early investors.
As it stands, Rick's is valued at $110 million and owns just over
50 high-end nightclubs. But management recently said it thinks it
can eventually increase that nightclub count nearly tenfold, to
500. That might sound like wishful thinking from an overly
optimistic management team loaded up with options. But here's the
upshot: This is an industry that is ripe for consolidation.
Think of it as the corporatization of the high-end nightclub
industry. Rick's is able to purchase existing clubs and implement
more efficient systems and operational standards to increase
revenue while also expanding margins. That is a highly scalable
business model -- and it's the key to the Rick's growth story.
Speaking of the business model, there are two factors that make
The first is that it gets 40% of its revenue from alcohol sales.
Not only does that provide huge margins after big markups, it's
also an important source of revenue diversification and stability
as alcohol consumption is almost immune to recessions. Rick's is
also unique because it requires its performers to pay fees to
perform at its clubs. It's a smaller revenue line -- but it's
also another strategy for Rick's to drive sales and offset
Rick's is taking a strategic approach to location expansion as
well, focusing on high-growth and urban markets in states with
low levels of unemployment. That has made Texas one of its
favorite targets. In just the past two weeks, Rick's announced a
49% stake in a gentleman's club in Dallas and a deal to buy a
property in Beaumont for a new restaurant and sports bar.
That's another key aspect of the Rick's expansion strategy.
Unlike many restaurants or retailers that rent or lease their
facilities, Rick's owns 90% of the real estate assets that house
its restaurants and clubs. This is important to Rick's business
because alcohol licenses are granted on location and usually
cannot be moved. That lets Rick's control its own fate with
locations and lease rates. It also creates another powerful
source of income and a solid tax write-off.
Risks to Consider:
Owning its real estate assets has weighed on Rick's balance
sheet, with $75 million in long-term debt. Although earnings and
cash flow remain strong, a leveraged balance sheet can create
liquidity problems in an economic contraction.
Action to Take -->
Rick's is a rare sin stock that benefits from customer loyalty
while also offering big upside. Analysts are calling for earnings
of $1.37 in 2013, a 43% increase from last year. But in spite of
that bullish projection and an outsize gain on the year, this
growth stock looks undervalued. If shares traded with the same
forward price-to-earnings (P/E) ratio of 18 times as its peers,
Rick's would jump to $27, a 125% increase from current