THE WEEK THAT WAS – ANALYST RATINGS CHANGES, CONFERENCE CALL TRANSCRIPTS AFTER EPS REPORTS
Jack In The Box
THE WEEK THAT WAS – ANALYST RATINGS CHANGES, CONFERENCE CALL TRANSCRIPTS AFTER EPS REPORTS
Jack In The Box
INCOME STATEMENT BELOW PROVIDED BY YAHOO/FINANCE
MOST RECENT CONFERENCE CALL TRANSCRIPT
CONCLUSION: JACK stock is reasonably priced statistically, but the Company is operating in a very competitive segment. Its unit growth has been unimpressive in recent years for the simple reason that the return on investment for newly built locations in today’s real estate environment is not high enough to encourage franchisees. The chain is here to stay, especially with its strong geographical presence in California and Texas, but most of the financial levers (re-franchising, balance sheet leverage, stock buybacks) are already utilized to create value for shareholders. We have difficulty picturing a catalyst, from an operational standpoint, that could ignite the fundamentals and improve the franchisee or the investor attitude toward Jack In the Box. However, a significant development that could provide great comfort to all stakeholders would be recruitment of a replacement for Leonard Comma with an outstanding reputation. No doubt the Board of Directors will do their best in this regard and, on that basis, the reward/risk relationship becomes interesting at this point.
THE COMPANY: Jack in the Box operates and franchises 2,243 Jack in the Box QSR restaurants with corporate headquarters based in San Diego, CA and originating in 1951. Jack’s top ten markets, located principally in California and Texas, comprise approximately 70% of their total system. Noteworthy also is that Jack in the Box is at least the second largest QSR burger chain in eight of these ten markets. As of September 29, 2019, the Jack in the Box system included 2,243 restaurants in 21 states and Guam and 137 are Company operated. Jack in the Box initiated its re-franchising program over five years ago and as of September 29, 2019 they have increased franchise ownership to 94% from 81% in 2014. There has been periodic interest from activist investors over the years, less so recently as Qdoba has been sold (in March, 2018), most of the re-franchising has been completed, and the balance sheet is already levered to 4.7 times trailing EBITDA. In recent news, Lenny Comma, with JACK for 15 years and CEO since 2014, turned in his resignation on December 11, 2019. His resignation is in the wake of well publicized tension between corporate and the franchise community, and a search for a new CEO has begun.
UNIT LEVEL ECONOMICS COMMENTARY: The AUV at Company stores rose 5.7% in fiscal 2019 and was primarily driven by the decrease in the average number of Company restaurants which was a combination of the re-franchising initiative of 135 locations and to a lesser extent a decrease in traffic. The AUV for franchise stores rose less than 1 basis point in fiscal 2019. Cost of Goods Sold at company stores increased in 2019 by 20 basis points primarily due to the shift in product mix and higher ingredient costs. This was partially offset by menu price increases. Labor and Related Expenses increased 90 basis points in 2019 due primarily to higher average wages. Occupancy and Other Related Costs decreased in 2019 by 100 basis points primarily driven by the decrease in the number of locations from re-franchising and the subsequent reduction in maintenance and repair expenses. Store Level EBITDA decreased 10 basis points primarily as a result of the increase in Labor and COGS but offset to some degree by the lower Occupancy and Other Related Expense of 100 basis points.
DEVELOPMENT COMMENTARY: During Fiscal 2019 the Company did not have any unit development activity. However, the franchisees opened 19 new locations and closed 13 under performing units for a net new store growth of 6 restaurants.
SAME STORE SALES COMMENTARY: Jack in the Box same store sales increased 1.3% in 2019 driven by menu price increases and a favorable shift in product mix that offset the decrease in traffic.
Fourth quarter same store sales were the best in four years, up 3.5% driven by average check growth of 2.8% and transaction growth of 0.7%. Diluted EPS from continued operations (GAAP) was $0.86 vs $0.68 for the quarter, $3.52 vs. $3.62 for the year. Non-GAAP Operated EPS was $0.95 vs. $0.77 for Q4, $4.35 vs. $3.79 for the year. Adjusted EBITDA (non-GAAP) was $66.9M in Q4, vs. 54.0 in ’18, $269M for the year, vs. $264M in ’18. Restaurant level margin (EBITDA) at company stores was down 190 bp in Q4 to 24.2%, as a result of wage and commodity inflation (4.4% in Q4), partially offset by menu price increases. The Company reports “Franchise Level Margin” as a percent of franchise revenues, which was relatively flat at 41.1% vs. 41.3% in ’18. The company repurchased about 1.4M shares in Q4 at an average price of $87.33 and purchased another 0.7M shares as of 11/20/19. An additional $100M had been authorized on 11/15.
Guidance has been provided for the year ending 9/27/20, calling for systemwide same store sales of 1.5-3.0%, restaurant level EBITDA margin of about 25.0% with commodity inflation of about 4% and high single digit wage inflation. SG&A will be 8-8.5% of revenues and 1.7-1.9% of systemwide sales. There are expected to be 25-35 new franchised locations.
Management emphasized on the conference call their focus on the “guest experience”. Involved in this effort is faster drive thru service, new digital menu boards, designated parking for pickup and delivery. Better “value bundles”, snacks and side items are helping sales and will continue to evolve. The breakfast daypart continues to be an important focus and delivery service is available at 90% of the system through various providers. Guidance for EBITDA in fiscal 2022 is about $300M, up about 9-10% from Adjusted EBITDA of $265-275M in the current year.
It should be noted that Leonard Comma’s retirement was announced in early December, just weeks after the conference call on 11/21. A CEO search has begun and Comma’s departure date is not established.
CONCLUSION: Provided at the beginning of this article
ASSET LIGHT FRANCHISING – COMPLAINTS FROM FRANCHISEES – LET’S CLEAR THE AIR!!
The long term investment appeal of well established franchising companies is accepted by the investment community. Most of the prominent franchisors’ equities sell at price to trailing twelve month EBITDA multiples in the mid to high teens (Denny’s (DENN), Dine Brands (DIN), Dunkin’ Brands (DNKN), Pollo Loco (LOCO), McDonald’s (MCD), Restaurant Brands (QSR), Wendy’s (WEN), even higher in a couple of instances Domino’s (DPZ), Shake Shack (SHAK), Wingstop (WING), lower in a number of “challenged” situations like Jack in the Box (JACK), Red Robin (RRGB), Brinker (EAT), Fiesta Rest. (FRGI).
The attraction of asset light franchisors revolves around the presumably free cash flow for franchisors, a steady stream of royalty income unburdened by capital expenditures to build stores. The operating leverage is at the store level. Franchisees are responsible for building the stores, then controlling food costs, labor, rent and all the other operating line items. Franchisors receive the royalty stream and have the obligation of supporting the system with brand development, site selection advice, marketing support, and operating supervision. These supporting functions, it should be noted, are optional to a degree, and we have written extensively about system support sometimes being short changed by corporate priorities such as major stock buybacks.
THE CURRENT WORD, IN THE FIELD, AS WE HEAR IT
We acknowledge that in every franchise system there will be some operators less satisfied than others. In the same way, customer reviews on Yelp or Facebook are more frequently written by critics. Bad news is more noteworthy and more customers are inclined to criticize than applaud, so we have to listen to the complaints but dig further for the reality. With that in mind, we hear the following from franchisees of various restaurant systems:
“I’ve been in this business for thirty years, and I’ve never seen it this bad. Everyone is making money but me; the landlords, the franchisor, the banks. My margins have been killed, and I’m up against my lending convenants”.
“All the franchisors want to do is build sales to build their royalties. The dollar deals are trading people down. My franchisor doesn’t care about my margins. I can’t maintain my margins, especially with the increasing cost of labor, let alone build it”.
“The franchisor is putting pressure on me to sell, even though I’ve always been considered a good operator, with high performance scores. I’m up to date on my development agreement, but they want somebody else to take me out, and the new buyer will agree to what I consider to be a ridiculously aggressive development contract”.
“The franchisor has replaced experienced long term field support with lower priced (and inexperienced) younger people. They’re cutting corporate overhead, but these kids, who never ran a store, are telling me to how to control costs.””
“I’m doing my best with the development objectives, but it is almost impossible to build stores with today’s economics. Rents are too high, labor costs are killing me, and I can’t raise prices in this promotional environment”.
“As if things aren’t tough enough, I’m being nickeled and dimed with demand for higher advertising contributions and fees on services (including software) that I thought would be provided”.
The valuations provided to the publicly held companies do not reflect the situation as described by the admittedly anonymous franchisees. The commentators quoted above don’t want to aggravate their franchisor, and we don’t want to be unfair or misleading to particular companies by relying on just a few conversations, though they do support one another. For the most part, franchisees are strongly discouraged from talking to the press or investment community. The companies will say that “competitive” issues require some secrecy, but there are few secrets in this industry.
The optimistic view, as represented by the valuations in the marketplace, is that the comments above are not typical or representative of the health of the subject franchise systems. Allow me to provide a short story which leads to a suggestion.
A SHORT STORY
Twenty six years ago, in 1992, IHOP had just come public. I was a sell side analyst, thought the numbers were interesting and the stock was reasonably priced. The company, led by the now deceased CEO Kim Herzer, invited me to attend their franchisee convention, which I did. I obviously had the opportunity to interface with many franchisees and it was clear that, while all was not perfect, the franchisor was providing a great deal of support that was embraced by an enthusiastic franchise community. IHOP stock tripled over several years for me and my clients who owned millions of shares. I attended several more of their annual conventions and maintain some of those relationships to this day. Obviously, the conviction I gained from their open attitude was critical to the success of the investment. I should add, that many of those buyers in 1992 owned the stock for many years, not living and dying on quarterly reports.
As you are no doubt by now anticipating, my suggestion to publicly held franchising companies: open up your franchisee conventions to the investment community. The companies may quickly respond that lenders are already invited to franchise conventions, but franchisees are unlikely to express their system oriented concerns when they are making a pitch to a potential lender. Companies may also respond that their lawyers think it would be a bad idea, not consistent with full disclosure and analysts would be getting “inside information”. Let’s not allow the lawyers to provide “cover”. A good lawyer will provide a solution to the problem, not just provide the pitfalls. Analysts attending a franchise convention are not being told what sales or profits are going to be. Attending a franchise convention is a “channel check”, no more than talking to a supplier or customer of a manufacturing company, which any decent analyst will do.
The anecdotal critical comments, as described above, have likely been heard by others, but may be atypical of most restaurant franchising companies. There are no secrets in this business. One of the investment appeals of this industry is its transparency. Notable news is going to leak out anyway. The objective of any publicly held company is to build stock ownership by well informed investors. Investment analysts pride themselves on their ability to “build a mosaic”, enhance the information provided in quarterly reports, SEC filings, and conference calls, with “channel checks”. What channel check would be more pertinent than meeting the franchisees of a company that is dependent on franchisee success? Putting it another way, and taking the highest valuation relative to EBITDA as an example: Wingstop (WING) is a company I have the highest regard for. However, you could call it irresponsible to pay almost fifty times trailing EBITDA for Wingstop stock (and I haven’t) if I couldn’t talk to franchisees of my own choosing?
There’s no particular need to invite this writer if I’m not considered influential enough. I have not spoken to these analysts on this subject, but qualified industry followers such as David Palmer, Nicole Reagan, Matt DiFrisco, David Tarantino, Jeff Bernstein, Andy Barish, Bob Derrington, Mark Kalinowski, Michal Halen, Gary Occhiogrosso, Howard Penney, Jonathan Maze, Nicholas Upton, John Hamburger and John Gordon provide the beginning of an invitation list. I rest my case.
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