On May 13, fast-food restaurateur Jack in the Box (Nasdaq:JACK) reported second-quarter earnings that came in ahead of analyst projections for the quarter. Management raised the lower end of its full-year earnings forecast on cost controls and favorable sales trends. It is also selling off company-owned restaurants at a decent clip, which provides food for thought in terms of how this impacts the bottom line and overall company valuation.
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Second-Quarter Review
Reported sales fell 2% to $578.4 million as the opening of 18 new namesake stores and 15 Qdoba Mexican Grill locations didn't prove enough to offset same-store sale declines of 0.4% and 2.3%, respectively. Management cited positive comps in California, Texas and Las Vegas, but negative trends in Phoenix at the namesake stores. Attempts at more value-based meal combinations at Qdoba didn't help in offsetting the fact it is a more expensive fast-food option compared to rivals such as McDonald's (NYSE:MCD), which posted another month of positive comps in what has been an impressive run of top-line growth at existing stores. Burger King (NYSE:BKC) also posted a 1.6% improvement in comps at U.S. and Canadian locations, demonstrating that fast food locations are holding up quite well in a down economy. (For more, read Using Consumer Spending As A Market Indicator.)
JACK was able to boost operating margins to 16.5% of sales despite higher commodity costs, which included a 6.6% jump in beef prices. SG&A expenses also rose on impairment charges, but was more than offset by gains from the sale of company-owned stores to franchisees. Management subtracts these gains from total expenses, which served to boost operating earnings 10% to $53.1 million. Lower interest expense also boosted the bottom line, which came in at 52 cents per diluted share, or 18% above last year's level.
Outlook
The company's only third-quarter guidance was in terms of comps, which management expects to range from flat to slightly up at the namesake stores and to fall as much as 4% at Qdoba. This is also around where full-year trends should end up, and management projects that it will lead to $2.08-2.20 in operating earnings, including gains from selling off company-owned locations. Its long-term goal is to shift franchised locations to 70-80% of the total store base by 2013. As of quarter end, the percentage of franchised stores stood at 41%, which is up from 35% one year ago. Rivals such as Sonic (Nasdaq:SONC) are also selling stores to franchises, as franchised locations already account for 80% of the total store base. (Read more in our related article, Is Buying A Franchise Wise?)
Upside
The upside of selling off existing stores is that it leads to lucrative royalty streams and eliminates the fixed and other costs of running physical stores. It also brings in capital, which management has been using to buy back shares and fund a re-imaging program to provide for "exterior enhancements, including new paint schemes, lighting and landscaping", among other improvements.
Bottom Line
It's important to note that gains from selling these stores positively impacts Jack in the Box's reported earnings. For the most recent quarter, net earnings were $29.9 million and store-sale gains were $17.2 million, or more than half of the bottom line. For the latest fiscal year, JACK reported earnings of $2.01 per share where store sale-gains again accounted for about 58% of that total. That means earnings from the core restaurant operations have averaged about $1 over the past three years. At a current share price of $23.40, that's a pretty high P/E multiple from "core" earnings, which could be a concern in a few years when most company-owned locations have been sold off and no longer benefit earnings. Again, the sale proceeds do benefit the company and shareholders, but probably shouldn't be valued at as high of a multiple as the core operations. (For more, see Sinking Your Teeth Into Restaurant Stocks.)
