Jack in the Box: Full of Surprises
Consumer confidence is in the gutter, and that's good news for the fast-food industry. High fuel and food prices may be pinching consumers, but overworked Americans are unlikely to cut back on dining out. They are likely, however, to "trade down" to the more affordable fare that fast-food restaurants offer.
Jack in the Box (symbol JBX) benefits from people ditching fine dining for the drive-through. And its shares appear attractively priced compared with other fast-food stocks. At its June 25 close of $24.45, the stock trades at almost 12 times the $2.07 per share that analysts expect the company to earn in calendar 2008 (analysts expect $2.02 for the fiscal year that ends September 30). The average fast-food stock trades at 16 times estimated 2008 earnings, according to Thomson Financial.
Unlike the fast-food giants, Jack in the Box can generate value for shareholders by selling off company-owned stores to franchisees. In 2004, franchisees owned only 20% of Jack in the Box restaurants. Now, franchisees own one-third of the more than 2,100 Jack in Box locations. At McDonald's (MCD), franchisees own 78% of the stores, while the figure is 90% for Burger King (BKC). Jack in the Box wants to boost the percentage of franchised stores to about 70% by 2014.
Franchising insulates fast-food companies from some of the rise in commodity prices, produces steady revenue streams, and gives the companies a one-time pile of cash. Stifel Nicolaus analyst Steve West estimates that Jack in the Box could generate about $385 million (or $6.43 per share) from selling its restaurants to franchisees. The San Diego company's management says it plans to return the proceeds from the sales to shareholders though stock buybacks.
To goose earnings further, Jack in the Box is giving its restaurants a facelift. The remodeling aims to make the restaurants more inviting to customers and to make their kitchens more energy-efficient. "People eat more at restaurants that are new and clean," says West, who estimates that the company earns an average return on invested capital of 20% when it overhauls a restaurant.
The kitchen upgrades alone could trim energy costs by 8% per year, says Brian Moore, an analyst with Wedbush Morgan Securities. That could translate into a 0.20 percentage point increase in gross profit margins. Jack in the Box has already remodeled more than 500 stores and plans to complete a systemwide makeover by 2011.
The subprime-mortgage mess is a hurdle the company must clear. Many of its customers live in areas hardest hit by the housing slump. For instance, 54% of Jack in the Box stores are located in California, Arizona and Nevada. "Most of the bad news is priced into the shares, but the company's fundamentals are likely to lag for the next two to three quarters," West says.
Jack in the Box, like other fast-food chains, isn't entirely immune from the deteriorating economy. On May 14, the company reported that it earned 44 cents per share in the quarter that ended April 13, beating the average analyst forecast by a penny a share, according to Thomson Financial. But it also reported that same-store sales were down 0.1% in the quarter, compared with an increase of 6.4% in the same period a year ago.
Management had forecast a quarterly gain in the range of 1% to 2%. The stock suffered because of the sales miss, plunging 16% between its May 13 close and May 19.
But Jack in the Box could bounce back sooner than expected. To increase store traffic, the company has launched value promotions, including one that offers two free tacos to guests with a gasoline receipt. And new products, such as the BBQ Sirloin Burger, have accelerated sales, Moore says.
Moore and West rate the stock a "strong buy" and "buy," respectively. Valued on the sum of its parts, Moore says Jack in the Box is worth $33 per share. West has a 12-month price target of $29.