Jack-in-the-Box Looks Ready to Pop

Jack-in-the-Box (NDQ:JACK) – August 31, 2009: $20.40 - 1:30 PM EST

52-week range: $11.82 (Nov. 21, 2008) - $30.35 (Sep. 19, 2008)

JACK operates and franchises Jack in the Box quick-service hamburger restaurants and Qdoba Mexican Grill fast-casual restaurants. They generate revenue through franchise royalties, company-operated restaurant sales, and distribution sales to franchisees.

As of July 2009, there were 2,199 Jack in the Box locations (including 921 franchised units) in the western and southern U.S. and almost 500 Qdoba restaurants in 42 states. The 58-year old, San Diego-based firm generated about $2.9 billion in system sales during fiscal 2008. Jack-in-the-Box has been a true growth story with earnings per share rising each year since 2003. Their low prices and drive-thru windows have been attracting customers despite the economic slowdown.

Here are their per share numbers from continuing operations as reported by Value Line (FYs end Sep. 30):

Value Line and Zacks each expect earnings of $2.13 and $2.35 for the FYs ending next month and in 2010. That makes the multiple just 9.6x trailing and 8.7x forward EPS. Compare those with the normalized P/Es from past years to see how cheap the current valuation is.

The last time JACK shares were offered at a single-digit multiple was in 2003. Buyers at that time saw their shares rise from a (split-adjusted) $7.50 to $19.50 in less than two years on their way to peaking at $39.80 in 2007. A rebound to even 12 times FY 2010’s $2.35 earnings projection leads to a 12 – 15 month target price of $28.20 or 38% above today’s quote.

Morningstar gives JACK their highest (5-Star) rating and sees ‘Fair Value’ as $32 /share. Is that $28.20 a reasonable goal? Sure. JACK shares actually traded at highs of $32.30, $39.80, $30.30 and $28.30 in calendar 2006-2007-2008 and YTD in 2009. With earnings higher now than ever before, that target price seems very conservative. Value Line gives JACK a ‘B+’ for financial strength while also noting their 80^th and 90^th percentile rankings for ‘stock price growth persistence’ and ‘earnings predictability’ respectively.

If you’re option savvy and want a reduced risk play you might consider this:

If Jack-in-the-Box climbs to at least $22.50 (+10.3%) by March 19, 2010:

• The $22.50 calls will be exercised.
• You will sell your shares for $22,500. · The $22.50 puts will expire worthless.
• You will have no further option obligations.
• You will end up with no shares and $22,500 in cash.

That would be a best-case scenario gain of $7,250/$15,250 = 47.5% achieved in less than seven months on shares than only needed to rise by 10.3% from the trade’s inception price.

What’s the risk?

If Jack-in-the-Box remains below $22.50 on March 19, 2010:

• The $22.50 calls will expire worthless.
• The $22.50 puts would be exercised.
• You will be forced to buy another 1000 shares.
• You will need to lay out $22,500 more in cash.
• You will have no further options obligations.
• You will end up with 2000 JACK shares.

What’s the break-even point on the whole trade?

On the original 100 shares it’s their $20.40 /share cost less the $1.65 /share call premium = $18.75 /share.

On the ‘put’ shares it’s the $22.50 strike price less the $3.50 /share put premium = $19.00 /share.

Your overall break-even would be $18.88 /share. JACK could drop (-7.4%) without causing a loss on this trade.

Disclosure: Author is long JACK shares and short JACK options.