Jack In The Box: Value Creation Formula Being Ignored By Wall Street

Nov. 22, 2019 1:03 PM ETJack in the Box Inc. (JACK)1 Comment

Summary

  • After divesting Qdoba, management is finally laser focused on the namesake brand.
  • The chain this week posted yet another year of positive same-store sales growth, not an easy task in this competitive environment.
  • Going forward, positive SSS, reduced share count, and dividends offer investors a multi-pronged path to profits.
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Shares of Jack in the Box (NASDAQ:JACK) understandably have been shunned by Wall Street in recent years. Before divesting its Qdoba chain in 2018, investors could not really put the company in a particular box (pun intended) as it owned a mostly franchised fast food operation (Jack in the Box), as well as a mostly owned and operated fast casual banner (Qdoba). No matter how the company decided to refocus, it stood to reason that both chains operating on a standalone basis would perform better. Lately, JACK's same-store sales have accelerated (+1.3% in fiscal 2019 vs. +0.1% in fiscal 2018) and more benefits seem to be in store.

After selling Qdoba, management embarked on a refranchising initiative that brought in cash, re-engaged with franchisees, and has now resulted in a capital-light, 94% franchised chain of more than 2,200 locations. Such a business model warranted an increase in leverage as well, with a recent securitization transaction at 5.0x net leverage, bringing in even more cash to deploy into dividends and stock buybacks. The company also expects an acceleration of new unit growth, given that it no longer needs to spend time and money financing unit growth at Qboba internally. Taken together, the bullish thesis on JACK goes something like this:

On the business side, management will now be freed up to focus exclusively on the Jack in the Box chain and, as a 94% franchised model, will be able to better assist franchisees driving traffic to existing units, and also finding talent to open new locations at a faster pace than in prior years. Operationally, that should drive higher revenue for the parent company as well as operating leverage to the bottom line.

On the capital allocation front, the refranchising of roughly 140 locations since 2018, coupled with proceeds from the new debt financing, gives JACK a ton of cash to repurchase and retire stock at attractive prices. While that is more of a one-time benefit, going forward capital expenditure needs will diminish as it no longer needs to fund new units of Qdoba, and free cash flow will rise and be available for steady and consistent yearly stock buybacks over the intermediate to longer term.

The company's most recent quarterly financial release and conference call confirm that this plan is well underway. During the last quarter alone, JACK acquired 1.4 million shares of its own stock, with another 700,000 shares bought back in October and November so far. That equates to nearly 10% of the entire share count, which stood at 23.65 million as of November 15th. In addition, $109 million of buyback authorization remains unused through November 2020, and the Board of Directors just authorized another $100 million through November 2021. CEO Lenny Comma mentioned on the Q4 call that the company expects to repurchase 30% of its stock over the next five years.

On the operating side, things appear to be tracking well too. Fiscal 2020 guidance is for same-store sales to grow between 1.5% and 3% and new unit openings are slated to accelerate from 2019 levels. While labor cost pressures continue to offset some margin gains, we still believe company-wide EBITDA will grow on an annual basis.

Taken together, we expect free cash flow per share to surge from $5.00 in 2019 and approach $6.00 in 2020, $7.00 in 2021, and $8.00 in 2022.

In that scenario, or anything in a similar ballpark, JACK's stock appears materially undervalued after a post-earnings report sell-off. The near-term drop is likely due to the company moving from quarterly guidance to annual guidance in terms of same-store sales. Analysts on the call repeatedly asked management how sales were tracking in the first half of the current quarter, but it remained firm that it is managing the business for the long term and doesn't think giving weekly or monthly metrics is helpful. We certainly agree with the longer term view, but admit that many folks will just assume that means that October and November business has been soft. While that is irrelevant in the long-term, short-term traders likely keyed off of that conversation.

As you can see, investors today can pick up JACK shares quite cheaply:

ChartData by YCharts

In fact, at current prices JACK fetches less than 14x our 2020 free cash flow estimate, a number we expect to grow materially in the out years due to continued share count reductions. We believe fair value for a 94% franchised fast food chain, given peer valuations and recent buyout deals, would be roughly 20x free cash flow. A couple of years from now such a valuation would result in upside of 75% from the current stock quote.

Given the free cash flow generation of the business, coupled with a meager starting valuation, it is hard to see material downside from here, even if the company cannot grow the underlying EBITDA of the company. All in all, we see the risk/reward opportunity as meaningfully unbalanced to the upside.

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This article was written by

Dining Stocks Online (DSO) publishes investment research on the dining sector of the consumer discretionary industry. DSO's research is compiled and edited by investors with more than two decades of experience assisting in the allocation of capital to the public dining sector, both personally and for advisory clients. DSO aims to become a valuable provider of niche research exclusively devoted to publicly traded dining chains.

Disclosure: I am/we are long JACK. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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