Description
Downside Case $80 (-10%)
Base Case $98 (+11%)
Upside Case $138 (+55%)
Investment Thesis: We think JACK is a compelling long into year-end and 2019 based on 1) likely accelerating sales trends over the next several weeks and into 2019, 2) the upcoming leverage event in 1Q19, 3) 40% of market cap being returned to shareholders through 2022, 4) inexpensive valuation on current and out-year numbers and 5) a very likely (in our view) takeout.
The risks to our thesis are 1) a deceleration in sales trends and 2) news that no buyers are interested in JACK, which could cause the reversal of the ~6% takeout premium that is built into shares after Thursday’s sale process report. We think both of these risks are unlikely, plus the stock is so cheap and there is so little sales leverage in the highly-franchised model that softer sales trends wouldn’t necessarily have a significant impact on the share price.
Variant View: The market is pricing JACK for continued sales softness and a big miss on their recently-established 2022 targets ($4bn systemwide sales, $300m EBITDA, $175m FCF), but we think the targets are very achievable even with fairly conservative operating assumptions.
The market’s skepticism on the targets is understandable: over the past 5 years, operating FCF has been flat and averaged roughly $100m/year, but we model it accelerating to ~$175m in 2022, or a 25% CAGR. However, unlike other long-term targets in the QSR space that we think are too aggressive (like WEN’s), JACK’s targets only require +LSD unit growth and +LSD SSS growth. We think this is very achievable.
We also think the market is underappreciating the per-share FCF that JACK’s $175m target represents. By returning close to $1bn of capital from 2019-2022 (~40% of current market cap), share count should decline at a 10% CAGR. The sellside is modeling share count too high, which means that FCF/shr should be ~$9/shr rather than the sellside’s $8/shr.
The capital return will also be front-loaded in 2019 as JACK takes leverage up to slightly over 5x in 1Q19. We think that there will be a significant ASR ($200-$300m) early in 2019 plus continued buyback with available cash flow through 2022. This should provide a nice catalyst for the stock in 1Q19.
On near-term sales trends, we think that the next few weeks should show an acceleration in the high frequency "alternative data" given management’s comments from the earnings call that weekly sales trends have improved vs. earlier in November. We also think the market doesn’t appreciate that JACK’s compares from December through spring ’19 are much easier than they look. Although compares don’t appear to ease on a 1yr basis, SSS in 2018 failed to accelerate on easing compares from 2017. We think there were some clear product missteps in early 2018 that drove these softer trends. Value promotions tend to be very important for the QSR industry in 1Q because consumers are usually dealing with their holiday spending hangovers, and JACK really had no value promotion at all in 1Q18. We don’t know exactly what JACK will be running in 1Q19, but management has indicated there will be a compelling value promotion.
Event Path: We think there is a strong near-term and longer-term event path for JACK. In the very near-term, we think there will be ongoing news flow about the sale process that was reported this past week. We think the process could conclude in early 1Q19 with a sale price anywhere from $100-$120/shr.
Slightly longer-term, we think that JACK’s leverage process could conclude in Feb or Mar and we could see a $200-$300m ASR announced. Together with improving sales results, we think this would drive stock outperformance well into 2019 as the ASR is executed.
Risk/Reward & Valuation Range: In a non-takeout scenario, applying a range of 5% to 7% yield on our 2022 FCF/shr estimates produces a range of $98-$138/shr, or 11%-55% upside from current prices.
In a takeout scenario, the SONC valuation provides a good comp for JACK’s takeout value. We think that JACK should go for at least as much as SONC, if not a decent premium. Depending on whether you base the valuation off of FCF yield or EBITDA, SONC’s takeout at 4.5% FCF yield or 15x EBITDA means that JACK should be worth $111 or $125, respectively. And those numbers are based off of somewhat-depressed 2019 estimates. Walking out to 2022 FCF estimates for JACK, applying SONC’s 4.5% FCF yield and discounting back to 2019 yields >$150/shr.
In a downside scenario where sales trends soften over the next several months, JACK’s highly-franchised model means that a 1% decline in sales trends only reduces EBITDA by ~2%. So even if sales soften by several %, we think realistic downside is limited to about 10% from here, or ~$80/shr, taking into account both lower numbers and a likely lower multiple. We also think that JANA’s involvement and the sale process provides a significant backstop for shares.
I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.
Catalyst
We think JACK is a compelling long into year-end and 2019 based on 1) likely accelerating sales trends over the next several weeks and into 2019, 2) the upcoming leverage event in 1Q19, 3) 40% of market cap being returned to shareholders through 2022, 4) inexpensive valuation on current and out-year numbers and 5) a very likely (in our view) takeout.