Applebees APPB
August 08, 2000 - 7:48pm EST by
2000 2001
Price: 15.50 EPS 2.33
Shares Out. (in M): 27,233 P/E
Market Cap (in $M): 633 P/FCF
Net Debt (in $M): 98 EBIT 0 0

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Applebees (APPB) operates and franchises a chain of 1210 units, with 268 company owned and 942 franchise operations. I classify Applebees as an asset play, with the asset being its reliable annuity-like income source from its franchises. The stock is in the dumps this time due to slowing same store sales and a projection of lower than expected earnings for Q3 due in part to increased ad spending and costs associated with a new menu rollout, despite actually projecting a higher EPS growth rate than originally projected at the beginning of the year.

With a market cap of 633 million (27233 shares), APPB is attractive for the following reasons:

· solid balance sheet for a restaurant company. The first quarter balance sheet lists 7.6m in cash, 16.4m in receivables, 180m in equity excluding intangibles, and 180m in total liabilities.

· plenty of cash flow. Again, using 1st quarter figures, APPB generated 96m in cash flow (defined here as income plus depreciation) in the previous 12 month period while spending 47m in capital expenditures. CapEx is planned at 55-60m for this year, leaving 30 to 40m in free cash flow this year.

· a buyback plan. APPB has consistently purchased its own shares and recently authorized another increase in the plan. As APPB’s stock price decreases, the buyback will become far more effective in increasing earnings per share. In a sense, you might want to root for small same store decreases for the next year so the stock price will crater and the buyback plan will do some serious good.

· lots of franchise income. APPB generated more than 73m in franchise income in 1999, and though franchise income is now only growing by single digits, it represents a stable source of income since the overall restaurant chain is quite healthy and there are no reasons to suspect a quick deterioration in performance. In the past quarter APPB had an exceptinal 9.9% net margin.

Let me roll out the negatives:

· APPB’s days as a fast grower are effectively over for now. The size of the chain precludes rapid expansion, and the company’s stated EPS goal is in the range of 10% to 15% per year. Saturation in domestic markets is seen to be 1800 at present, or 10% unit count growth over the next 5 years. APPB could increase its own company count by purchasing franchises, but with the stock at this level a buyback seems to be a far more effective use of cash. A Mexican concept failed, and like most other restaurant chains APPB has no clear growth vehicle beyond its core concept.

· Same store sales (SSS) are slowing. After a strong past 12 months, SSS at APPB are slowing along with many in the casual dining business. I’ve listed the SSS history below, along with company SSS, franchise SSS, and company and franchise unit counts

2Q00 1.3, 1.2f, 268 company, 942 franchise units
1Q00 5, 3.8f, 266 company, 919 franchised units
4Q99 7.2, 5.4f, 262 company, 906 franchised units
3Q99 5.4, 3.3f, 269 company, 864 franchised units
2Q99 3.6, 2.3f, 257 company, 849 franchised units

· Q3 performance is going to be tepid. In an attempt to increase SSS, APPB is going to increase ad spending in Q3 during the Olympics but expects resulting margin erosion The company is also rolling out a new menu which in past years has been a problematic event but management assures us they’ve got everything covered now.

Management still sees $2.34 to $2.40 for the entire year, 56 to 59c in Q3, 61 to 64c in Q4; based on 23 ¼, that’s a single digit PE. Let me be candid here - this isn’t the stock to bet the farm over, and APPB represents one of a entire host of similar companies (e.g., OSSI, PZZA, etc) that I could have mentioned based on the low level of their market cap to cash flow. The commodity restaurant industry in particular is brutally competitive, and you aren’t going to get any real PE expansion here so consider this as a trading vehicle. And as I mentioned above, a little problem in EPS - assuming it isn’t something fundamentally wrong with the company which APPB’s past history give little indication - wouldn’t be such a bad thing if you really want to make serious money here. APPB’s management has given every indication they understand the importance of the buyback plan, and I think they can be trusted to use their resources wisely.

And in a fwiw, you can’t help but notice how many mature concepts there are in the restaurant industry. Eventually you would hope there might be some acquisition activity, though there’s been precious little to-date.

For a REALLY good idea look at GBL….



A SSS reversal in 12 months; a steep price drop so the buyback plan can be more effective
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