Seeking Alpha
What is your profession? ×
Long/short equity, long-term horizon, hedge fund manager, CFA
Profile| Send Message|
( followers)

CKE Restaurants (CKR) owns, operates, franchises, and licenses quick-service restaurants in the United States, primarily under the Carl's Jr. and Hardee's names.

Market cap: $600 million; Enterprise Value: $1 billion

Next earnings date: Wed, Jun 25 evening

The company is estimated to earn $0.83 per share this year (FY ending Jan ’09) and $0.94 next year. At around $12, the stock doesn’t look expensive at 14x ’08 EPS. However, the earnings estimates look high and a stretch to achieve, considering the company earned only $0.68 last year (ignoring an $0.11 expense to mark-to-market interest rate swap agreements), which was down from the previous year. Revenue is slated to be flat this year, so the estimates assume a fair amount of margin expansion, reversing the recent trend. Also, the earnings look overstated due to an understatement of depreciation expense. D&A is running at about $15Mn/quarter, while capex is more than double this amount. This would be excusable if the company were growing, but it is not. Thus, D&A should be going up over time, compressing margins and putting pressure on earnings. If you were to assume that D&A rises to the level of capex, the company would have no earnings. Trailing twelve month free cash flow has been consistently negative for a while. The company has been raising cash by selling company owned restaurants to franchisees, but this has the effect of reducing future revenue and operating income.

The stock had been steadily dropping from $20 to $10 until a month ago, from where it has jumped to the current level. Throughout this period, the company has been buying back a good amount of stock (at an average cost of $17 last year) although it is not generating any cash. As a result, the debt level at the company has gone up a lot. While taking on seemingly low cost debt to buy back stock boosts EPS in the short run, it makes the company a lot more vulnerable to future rate increases and performance hiccups.

From a fundamental point of view, the continuing economic weakness in the US economy should put pressure on revenues. The unrelenting increase in food and energy costs will pressure margins. To add to this, you have the increase in depreciation due to the high amount of capital expenditures. To top it off, interest expense continues to rise due to the increase in debt. All in all, CKE has the makings of a disaster.

Fair value for CKE stock: $8 (12x multiple on ’07 adjusted EPS of $0.68).

Disclosure: Author has a short position in CKE