In this segment from the MarketFoolery podcast, host Chris Hill and Motley Fool analyst David Kretzmann talk about fast-food second-stringer Jack in the Box(NASDAQ:JACK), which hasn’t been benefiting from the relative recovery the broader restaurant industry has enjoyed recently. In some ways, though, it’s facing issues of its own making.
It apparently got a poor deal when it sold its Qdoba chain, its financial and refranchising strategies aren’t paying off yet, and management is offering no outlook for growth. What does the future hold for shareholders? These Fools discuss.
A full transcript follows the video.
This video was recorded on May 17, 2018.
Chris Hill: Jack in the Box’s second quarter earnings came in light. Their same-store sales were down ever so slightly, 0.1%. The stock is down about 6% this morning, and I totally understand why, because management said nothing that would give anyone any optimism for the rest of this fiscal year. Management was basically like, “Yeah, this is pretty much how it’s going to be for the next six months.”
David Kretzmann: Yeah. And, I guess, to be fair, a lot of restaurants are still struggling. But, in general, the restaurant picture in the U.S. is looking brighter than it’s been in a long time over the past couple of years. But, in this case, their company-owned same-store sales for the quarter were up just under 1%, but traffic was down almost 2%. So, it’s really just, people are spending more when they go in to Jack in the Box. That’s what’s carrying their comps.
But, there’s also the downside that those company-owned same-store sales now represent an increasingly tiny part of their overall system. Right now, they’re focusing on refranchising. So, more and more of those company-owned stores are becoming franchised at this point. I think 92% of the company’s total restaurants are franchised.
So, really, if you’re investing in Jack in the Box today, they sold off Qdoba — which we can talk about. The more I look at that, the more I wonder. It seems like they sold at a bad price, and maybe a bad time. But, you really just have to buy in to this concept becoming more relevant in the coming years, but also management’s strategy of really bringing on a lot of debt to buy back stock and pay a dividend, that kind of thing. They’re trying to be Domino’s, but without a concept that’s doing as well as Domino’s.
That’s really the direction they’re going with this franchising strategy. You lever up the balance sheet, you return a lot of cash to shareholders, but when your core concept is Jack in the Box and it just isn’t doing that well, it’s hard to replicate Domino’s.
Hill: [laughs] They’re trying to be Domino’s, but without Patrick Doyle running the company.
Hill: Let’s go back to Qdoba for a second. We talked about this right before we started taping. A little bit of background here — Jack in the Box bought Qdoba, which is basically their version of Chipotle. They bought it in 2003 for $45 million dollars. They sold it at the end of last year for just over $300 million. Just, on the surface, you can look at that and say, “Well, they made a heck of a nice profit off of that.” But, there were a bunch of years where, when Jack in the Box reported their quarterly earnings, it was Qdoba that was really doing the heavy lifting. It was Qdoba that was putting up the really impressive double-digit same-store sales growth.
So, like you, when they said, “We’re going to sell Qdoba,” I was sort of scratching my head over that, even though Qdoba had cooled off in terms of the performance. Like, the comps came down to single-digit growth instead of double-digit growth. But, this, to me, was not like — when Darden Restaurants, which is the parent company of Steve Broido’s beloved Olive Garden, and The Capital Grille, and others. When they announced they were going to sell Red Lobster, that made sense to me, because they have a bunch of restaurants in their portfolio, they were able to get some cash upfront for that, and they were able to focus on their other brands in the portfolio. Well, it’s not like Jack in the Box is trying to manage eight to ten different restaurant brands. So, I don’t know. History may not be kind to this decision to sell.
Kretzmann: Yeah, I really do think it will be looked back on as a questionable and probably a poor decision. If anything, you want to sell a concept when it’s performing well. A few years back, when Qdoba was really the driving force behind Jack in the Box’s positive results, that’s the time you want to sell. You want to sell high rather than sell low, which is really what they did. I think for a while, they were optimistic about Qdoba, when the results and performance were looking great, right alongside Chipotle, back in the glory years five-plus years ago. But management changed their tune pretty quickly over the past couple of years, as soon as Qdoba’s sales started to falter and maybe weren’t performing as well as the core Jack in the Box concept. That’s, all of the sudden, when they were saying, “Yeah, we might look to sell this.”
But, I would think that a lot of Qdoba’s struggles could be blamed on the wider restaurant slowdown that we saw in the U.S. over the past couple of years. Although, you also might argue that Qdoba should have taken advantage of Chipotle’s woes and performed better. In any case, Qdoba had over 700 restaurants in the U.S. at the time of this sale. But they really only sold it for just over $300 million. That leaves me scratching my head, because today, Chipotle has over 2,000 restaurants, so about 4-5X the restaurants of Qdoba, but Chipotle is trading at a valuation of over $11 billion. There just really seems to be a mismatch there.
I think they could have gotten a higher price for Qdoba if they had just waited, maybe, for a better market, or waited for the results to turn around with the wider industry. Something here just doesn’t add up to me. There might be something that I’m missing here, but Qdoba was primarily, if not entirely, company-owned locations, and still performing decently, although not as well as they had been a few years ago.
Hill: Apollo was the company that bought them?
Hill: It really wouldn’t surprise me — and of course, if this happens, we’ll find out exactly if Jack in the Box made a mistake selling them — it wouldn’t surprise me if Apollo spun out Qdoba in a couple of years into an IPO.
Kretzmann: Yeah. I think that’s the route that Jack in the Box probably should have gone. I think it’s still a relatively strong restaurant concept. It’s probably the closest to a No. 2 to the Chipotle fast-casual Tex-Mex concept. I just think that they easily could have gotten a higher valuation.
Hill: And by the way, the same-store sales, I mean, if you’re just looking at burger concepts, Jack in the Box is kind of in the middle of the group in terms of most recent same-store sales. 0.1% in the negative is not great, but it’s better than Sonic, Steak ‘n Shake, a couple of others out there. By the way, thank you. I meant to thank you. I believe you were the one who recommended a Twitter follow for me, Jonathan Maze. Was that you?
Hill: That was you, OK. Thank you!
Kretzmann: I’ll take credit, sure. [laughs]
Hill: [laughs] For anyone interested in the restaurant business, David had mentioned this guy to me, Jonathan Maze. His Twitter handle is @jonathanmaze. He’s the executive editor of Restaurant Business magazine, and a great follow for anyone interested in restaurant stocks. That little stat I just shared about same-store sales in the burger space, I didn’t do that research. [laughs] That came from following Jonathan Maze on Twitter.