CKE Restaurants: At a Discount to Its Peers

CKE Restaurants (CKR) is one of the largest quick service restaurants in the country with 1,141 Carl's Jr. locations in the West and 1,926 Hardee's units in the Midwest. It offers premium burgers such as the the Angus Thickburger or the Six Dollar Burger aimed at satisfying the cravings of young, hungry males.

Its TV commercials have earned a reputation for cutting edge humor and irreverence such as Paris Hilton's stint at eating a burger while washing a car or the tagline "don't bother me, I'm eating".

The high cost of fuel and commodities have thrown a damper on fiscal 2008 earnings, as CKR saw its bottom-line slashed by more than 33%. Earnings for fiscal year 2008 were $31 million on revenues of $1.53 billion versus earnings of $50 million on revenues of $1.54 billion in 2007. CKR has ample room for improvement, as a dismal 2 cents of every dollar sold fell to the bottom line. CKR's Hardee's units require the most attention as their restaurant operating costs as of a percentage of sales are a whopping 85.7%, more than 700 basis points higher than Carl's Jr.'s 78.6% rate. The combination of growing revenues and cutting costs at Hardee's is just what the Dr. ordered, but will the patient improve? Wall Street is indeed skeptical of this patient getting healthy anytime soon.

The impact on the share price has been brutal as CKR has seen more than a 50% haircut from its 52 week high of $23.74 and now trades pennies above its 52 week low of $10.34. As usual, Wall Street has overreacted and the punishment has been extreme, providing a nice window of opportunity for those "bargain Hunters" that can smell "value". One value player that has noticed CKR on his radar screen, is Richard Pickup, who has "backed up the truck" to become CKR's largest shareholder, accumulating a 9% stake.

Management has been working hard to improve the situation. The company is in the midst of a major remodeling and re-franchising effort as 200 store remodels were completed and 136 company stores were resold to Franchisees in 2008. G&A costs were slashed 2% and CKR been successful in obtaining better terms on its bank credit facility. The cash dividend was raised 50% from $0.16 to $0.24 and currently yields 2.3%. The company has stressed that its "free cash flow" is impressive, as $281 million was returned to shareholder's in 2008 through $14 million in cash dividends and $267 million in stock repurchases.

CKR's stock repurchase plan has been very aggressive. Out of an authorized amount of $400 million, only $43 million remains available for further buybacks. In April of 2007, CKR bought back a large block of 4.1 million shares from the hedge fund "Pirate Capital", unfortunately ,the timing was poor as CKR paid a whopping $18.97 per share in the transaction. Look for CKR to up its buyback authorization amount by an additional $100 million in the near future.

The shares are cheap when compared to CKR's peer group. Analyst's 2009 estimates of $0.77 EPS, translate to a forward price multiple of 14 compared with the forward PE's of other major competitors such as McDonald's (MCD), with a 16 multiple, Yum Brands (YUM) at 19 and both Wendy's (WEN), and Burger King (BKC) sporting an 18 multiple. Analysts have been largely bullish on the shares despite CKR's recent earnings woes, as seven of their last ten research actions have been positive, while three have offered no lower than neutral or hold ratings.

The company also offers an interesting "Dual-branding" concept that could pay big dividends as over 300 Carl's Jr. locations now offer Mexican food through their "Green Burrito" format while Hardee's offers a similar "Red Burrito" line. The shares present compelling value at these distressed levels and just a minor improvement in operating margins could rekindle Wall Street's appetite for the stock, rewarding hungry shareholders handsomely.

Disclosure: Long

Comments

[PJ568]

Low earnings and high leverage of 5.5x is not a very compelling value argument. Two years ago leverage was 2.5x. Since then, minimal earnings and large buybacks funded with debt. Maybe management needs to focus on the fundamentals necessary for survival?

[AmesTiedeman]

I think your analysis is sound. I think this name will go up over the next 2=3 years. I also think the buy out of Wendy's has put a floor on this one.