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Denny’s Cooks Up Tasty Q2 Appetizer

Posted: Jul 18, 2008 10:35 AM by Glenn Curtis

Tickers in this Article: DENN, SBUX, DIN, MCD

Despite intense competition for the breakfast crowd in a slowing economy, Denny's (Nasdaq:DENN) is doing fine. It released preliminary second-quarter numbers on Monday, and while they weren't earth shattering, they certainly were worth a second look. The restaurant chain expects decent same-store-sales numbers, and its move toward a greater percentage of franchised locations bodes well for its margins in the future.

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Franchise Business On The Rise
Casual dining is a tough business, particularly these days. Consumer can be very fickle, and the competition is just brutal. Major breakfast rivals include: Perkins, Dunkin Donuts, Starbucks (Nasdaq:SBUX), McDonald's (NYSE:MCD) and IHOP, operated by DineEquity (NYSE:DIN).

In this incredibly competitive environment, it makes more sense for Denny's to focus on franchising and less on the operations aspect of the business. To that end, I was pleased to see that 77% of its total locations were franchised and licensed restaurants at the end of the second quarter, and only 23% were company owned. This compares to 68% franchised and licensed restaurants and 32% company restaurants at the same time last year. (For more on franchising, read Share The Wealth With Franchises and Is Buying A Franchise Wise?)

Franchising could also give a boost to margins going forward. Operating a business can be very costly, particularly these days in terms of payroll and other costs. Second, it could lead to increased profits, which in turn could draw in sell-side analyst coverage. For the record, Denny's expects adjusted income before taxes of $5-$5.5 million compared with $1.5 million in the prior year period.

Comps Hold Their Ground
Denny's same store sales (comps) declined 2.8% in the second quarter. Company store comps declined 0.7% and franchised restaurant comps dropped 3.7%.

Now, these numbers aren't going to warrant a parade of fireworks, but they were respectable given that the company was going up against a tough comparison. In the comparable period last year, Denny's posted a 2.8% jump in company comps and a 4% comp increase at franchised stores.

When compared to some other big name chains, these numbers were a mixed bag. For example, in its second quarter IHOP saw a comps increase of 2.6%. Meanwhile, in its second quarter Starbucks saw its U.S. comps drop in the mid-single digits.

Bottom Line
It's nice to see that the company is focused on franchising, but it still needs to find new and innovative ways to improve its menu and even the aesthetics of its restaurants if it wants to seriously grow revenue at company-owned stores over time. I'd still be reluctant to buy Denny's stock at this point, particularly because this space is just so competitive and the economy is so fragile. However, its same-store results and focus on franchising are positives that deserve attention.

Put your money where your mouth is, in our related article Sinking Your Teeth Into Restaurant Stocks.

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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