Description

How much would you pay for a business that has the following results:

In the last 2 fiscal years, revenue has grown by a compound rate of 14%; earnings by 30% and EPS by 32%. Return on beginning assets was at 9.2% and return on beginning equity was at 34% at the end of the last fiscal year. Its debt to equity ratio is a comfortable 0.8.

Would you pay a price to buy this stock at a P/E ratio of 12.7x Fiscal 2001 earnings? How about a Price-to-cash-flow ratio of 6.4? I did. I bought this company’s shares recently (full disclosure). This company is Jack in the Box (JBX).

JBX is a 1,600-plus restaurant chain in the US. It is still a regional chain, with most of its restaurants located in the West and the Southwest. JBX is a fast food hamburger chain. It is targeting the 18- to 34-year old male. You will not find promotions tied to kid shows or toys give-away to draw in the mom-and-kid crowd during lunch.

JBX’s advertising is innovative. It features Jack, its fictitious founder, whose rounded head is a stand-out. It has a diversified menu, with burgers and fry, finger food, taco, etc. Its burgers are fat laden (triple meat, cheese and bacon), but is targeted at its market of young male. Its prices are competitive with the offerings from its competitors.

I visited a number of JBX restaurants and sampled its offerings. Its burgers, finger food and tacos are very good. Its fries need some improvement. The service is quick and friendly. Management is working on a 30-second assemble-to-order program to continue to improve service and quality of its food. It restaurants are clean.

JBX has excellent growth potential. From its roots in the West, it has begun to penetrate the Southeastern part of the country. Its stores in the Carolinas are performing well and ahead of plans. JBX plans to grow its restaurant count by approximately 10% a year in existing and new markets. It also plans to increase its same store sales by 3 to 4 % a year. It has grown its same store sales by 25 consecutive quarters.

The management team has been with the company for a long time. It has been making continuous improvement in its operations. It has demonstrated that it can execute continuously well. Management is very efficient is the use of its assets and capital, resulting in its high return on assets and return on equity (one of the highest results within the industry - see table below). This allows the company to fund its growth in such a capital intensive business with cash generated from operations and to pay down debt at the same time.

So why is JBX’s stock price so attractive? While the top line growth in Fiscal 2001 (ending October 2001) will be in-line with JBX’s long term growth target, its bottom line results are being impacted by utility and labor cost. In the second quarter (ended April 15), JBX’s operating margin declined 1.2% compared to a year ago. Analyst is also concerned with the potential impact on the top line by the softening economy and interruption of restaurant operations due to power black out in the West (which is turning out to be a non-event as the summer wears on).

At a closing price at $27.53 on 7/20/01, JBX’s shares are trading at 12.7 times analyst consensus estimate of $2.17 for Fiscal 2001 (JBX’s guidance is between $2.15 and $2.25). Its Fiscal 2000 EPS was $1.97. If management meets its guidance, year-over-year EPS growth will be between 9 to 14%. If JBX meets its growth target of 14% a year in the next 2 years, and assume if JBX only grows its bottom line at the same rate of top line growth (this is conservative because JBX has demonstrated that it can continue to leverage operational efficiency in the past, resulting a higher bottom line growth rate), one can expect JBX to earn between $2.80 to $2.92 per share in Fiscal 2003. If we assume a PE ratio of 18x (typical for estaurant
groups - see table below), we can expect JBX to trade at $50 to $53 at the high end. This will result in almost doubling one’s investment in 2 years.

There will be upsides: (1) bottom line growth may be faster than top line growth as management continue to improve operational leverage; and (2) with the free cash flow, management can continue to pay down debt, resulting in reduction in interest payment or to buy back shares.

What are the down side risks? The economy can tank, slowing top line growth. Utility, food, and labor cost can continue to climb, pinching the operating margin. I cannot predict how low these shares can go if the worst case scenario hits. Its shares traded as low as $18.5 in the last 12 months. However, with its strong financial performance and a
acceptable downside risk, I can afford to wait out any dip in the stock price. In fact, I may buy some more shares if the price re-test its low.

Metrics JBX MCD YUM WEN
ROA 9.20% 9.00% 8.90% 9.30%
ROE 34.60% 21% N/A 16.00%
Debt/Equity 0.8 0.9 N/A 0.2
P/E (TTM) 12.7 21 18 17
Price/cash flow 6.4 13.6 9.5 10.8
Revenue growth 14% 6% N/A 7%
EPS growth 15% 12% N/A 8%

Catalyst