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IHOP Serves Up Hot Q2 Results

Posted: Jul 27, 2007 09:16 AM by Glenn Curtis

Tickers in this Article: APPB, IHP

IHOP (NYSE: IHP), the well-known casual dining chain, recently reported a 37% improvement in net income over last year, and earned $0.82 per share - well north of the roughly $0.59 per share that Wall Street analysts had been expecting.

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What drove this growth? There were several factors, but most of the year-over-year improvement can be credited to three things:

1. The company added 15 new restaurants during the quarter.
2. Its same store sales numbers were up a respectable 2.5% during the period.
3. The company spent approximately $39.4 million to repurchase roughly 677,000 shares, reducing the share count and boosting EPS.

Time to IHOP on the bandwagon?
Going forward, I think that things may get even better from here.

First off, the company said that it expects to add a total of 61 to 66 new franchise restaurants into the IHOP system for the full year, which leads me to believe that we will see a lot of new revenue-generating locations in the second half of the year, certainly more than in the first half of the year, as only 23 locations have been opened so far this year.

Another reason that I am optimistic is because management expects the company to generate full year comps results of 2-4%; in this market, that's fairly healthy. Based on new menu introductions and promotional activity, actual comp store results may be in the upper end of management's guidance.

Applebee's is Part of the Equation
Then there is the Applebee's (Nasdaq: APPB) transaction. In mid-July, IHOP announced that it plans to acquire the well-known casual dining chain for $2.1 billion.

When the potential acquisition was reported, the two parties were talking about a potential combination; when the terms of the deal were first announced, it was unclear whether this would be a good combination or not. After all, any time you combine two companies within the same industry, any one of a number of things could go wrong. For example, there could be a cannibalization of sales, or management might not realize the synergies that they had initially anticipated. There are literally oodles and oodles of potential pitfalls. (For more insight, see Mergers Put Money In Shareholders' Pockets.)

However, I've learned since the deal was announced that IHOP would probably initiate a round of layoffs, and possibly sell off some of Applebee's real estate, as well as franchise the lion's share of its more than 500 locations.

That last little tidbit is a biggie, because many people wondered how IHOP would do it. After all, IHOP is a franchiser. It doesn't have extensive practical experience in operations. In any case, my gut tells me that there is a lot of pent up value in Applebee's real estate and that the company may actually raise a bunch of cash by selling off properties, which it could then (hypothetically) plunge back into advertising or possibly share repurchases.

Risky Business
Of course, this is not to say that the transaction is without risk, because there is a chance that the company could have difficulty franchising out those locations. Even if it does successfully accomplish that task, there is no guarantee that those stores will be successful.

That said, I think the fact that the company will be diversifying itself away from the increasingly competitive breakfast business while mitigating some risk by franchising out locations - not to mention pocketing some cash from real estate transactions - makes the acquisition appear very worthwhile.

It's All About Earnings
As things stand right now, IHOP is expected to earn $2.65 per share in 2007 and $2.98 per share in 2008. However, based on the momentum in same-store sales results and the number of new locations it plans to open later in the year, I think that the current 2007 estimate may still be conservative by $0.02 to $0.03 cents per share.

Looking out a little further, if the Applebee's deal is as fruitful as I think it could be, there could also be some upside to the 2008 estimate, perhaps as much as $0.10 to $0.15 per share (excluding any one-time or extraordinary charges).

The Bottom Line
IHOP is coming off a solid second quarter. Going forward, its organic growth and the pending acquisition of Applebee's appear poised to drive the stock even higher.

I would bet that if everything stays on track, IHOP could be trading at $80 per share within a year.

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By Glenn Curtis

Glenn Curtis started his career in the 1990s as an equity analyst for a regional firm in New Jersey. There, he covered companies in the technology, entertainment, and gaming industries. Curtis has since worked as a financial writer at a series of both web and print publications, including TheStreet.com and Registered Rep Magazine. He has held his series 6,7,24, and 63 securities licenses.

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