Stupid Investment of the Week

BOSTON (MarketWatch) — Stock investors are looking for reasons to buy amid the turmoil. Among the logic behind picking new names after dismal year-to-date performance:

And those reasons are precisely why Steve W. came back from a recent business trip thinking he might buy stock in Spicy Pickle Franchising, the Denver-based company behind the Spicy Pickle restaurants currently open in more than a dozen states and attempting to spread nationwide.

Somewhere between a bowl of corn-and-green-chile bisque and sandwich served on Panini bread, Steve saw something about the company looking for investors and started thinking Spicy Pickle might be just the taste his portfolio was looking for.

As Steve explained it to me by email, he was thinking it would be the classic Peter Lynch buy-what-you-know play, a company with a terrific product in the early stages of development.

Alas, as I told Steve, once you strip away the satisfaction of lunch, Spicy Pickle

is likely to leave a sour taste in your mouth, as it’s the Stupid Investment of the Week.

Stupid Investment of the Week highlights the concerns and conditions that make a security less-than-ideal for the average investor, in the hope that by spotlighting danger in one situation investors will find it easier to avoid trouble elsewhere. While obviously not a purchase recommendation, the column is not meant to be an automatic sell signal, as there may be times when dumping a worrisome investment serves to compound the problem.

Off the menu

In the case of Spicy Pickle, it’s more a question of whether investors who have ridden the stock down — more than 75% year-to-date — want to hang around. For newcomers to the stock like Steve, a closer look is almost certain to lead to indigestion.

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Spicy Pickle restaurants are part of the “fast casual” space, the point where customers want more than simple “fast food,” but want to avoid the higher price point of “casual dining.”

I’m no restaurant critic — though it’s clear from looking at me that I don’t skip many meals — but having eaten at Spicy Pickle on past trips to Colorado, I can attest to the fact that they make a really good sandwich — over 150,000 combinations if you want to build your own — at a reasonable price. The firm boasts of no fillers, no preservatives, and no extenders in its food, and claims the “world’s best” spicy pickle.

That said, the concept is not too dissimilar from Panera Bread
The stock, however, is about as far away from Panera — which at roughly $40 per share has both a market capitalization and annual sales in the neighborhood of $1.2 billion — as can be.

For starters, Spicy Pickle is an OTC Bulletin Board stock that traded recently for about 33 cents per share — with a total market cap of around $16 million — that is trying to build its business at a time that is undeniably horrible for the economy, terrible for franchisors and increasingly hard for restaurants.

Those conditions blow away all of Steve’s thin reasons for thinking it is a good idea, especially because any penny stock in a tough business may be as much a candidate to go all the way to zero as it is to strike it big.

Restaurant industry trends have shown that the troubled economy has people eating out less, and putting out fewer bucks when they do. While that may be pushing some diners from casual restaurants to fast-casual spots like Spicy Pickle, it may also be sending some fast-casual customers to the value meals at traditional fast-food joints. About the only conceivable plus is that the economy slows competitors and makes desirable restaurant locations available.

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The problem is that Spicy Pickle would have to be better-capitalized than its competition to cash in that way. It isn’t.

Recipe for disappointment

Spicy Pickle President Marc Geman acknowledged in a telephone interview the hard times making it tough on all restaurants, but said the company is trying out a value-oriented menu that might help out cash-strapped customers who might prefer the fast-food ticket price.

Perhaps a bigger economic challenge is the one facing franchisees.

“Franchisees rely on small business loans and credit to make it work,” Geman said, “and it’s clearly terrible conditions for credit right now. … If you are a growth company, it makes it pretty hard to grow.”

That’s one reason why Spicy Pickle recently did a stock-swap purchase of Bread Garden Urban Cafes, adding 11 restaurants centered in the Vancouver area. That helps fuel growth, although there are no current plans to convert Bread Gardens to Spicy Pickles.

“It’s worse for the lower-tier, less-established players,” said John Owens, restaurant analyst for Morningstar Inc., which does not track Spicy Pickle shares but does categorize the stock as “distressed.”

“It’s very difficult for franchises to get credit to build or remodel new restaurants, and smaller chains might find it even more difficult to compete against bigger chains like a Panera and Chipotle Mexican Grill
” Owens said. “Those chains have more advertising muscle, greater scale and power over their suppliers, and they have a lot of advantages right now, including the strongest balance sheets and cash-flow in that part of the industry.”

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Spicy Pickle Franchising has negative free cash flow, frighteningly low revenues and not much means of support. The stock peaked at more than $2 per share, but that was back in the fall of 2007, after a promotional effort where Spicy Pickle engaged the OTC Journal in a promotional effort.

Geman noted that he has been long-time friends with Larry Isen, the guy behind the OTC Journal, who invested in the company on his own, long before ever being approached about taking on the promotional effort. Still, OTC Journal’s disclosures, available on its own Web site, shows that Isen directly or indirectly controls more than 1.67 million shares, or 3.3% of the outstanding float, as of Oct. 10. The firm has sold more than $1.87 million worth of Spicy Pickle shares.

In microcap penny stocks — which are priced too low to have short-sellers — many analysts consider having a known promoter as a big holder to be a negative, because it increases the possibility that any wave of good news will meet the resistance of the promoter’s big stake being sold.

Put it all together, and you have a stock that’s likely to leave investors with indigestion.

“This is definitely a high-risk situation,” said Charles Rotblut, senior market analyst for “The restaurant may be great but the timing isn’t, particularly since their growth is dependent on franchises getting financing. … I’d be scared of going into this company right now.”

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