The $714.4 million California-based Applebee’s and iHop operator DineEquity (DIN, Financial) reported its second quarter results. DineEquity reported (-)3.8% year over year to $311.4 million and (-)32% drop in profits to $35 million (11.3% margin vs. 15.9% in the year prior period).
In addition to low 0.3% rise in revenue costs, the chain operator recognized higher operational costs at 9.8% year over year resulting in lower profits for the period.
Among other guidance figures provided for fiscal year 2017, DineEquity expects its adjusted free cash flow in the range of $76 million to $86 million. This compares to $120.9 million, $142.3 million, and $122.5 million in fiscal years 2014, 2015, and 2016.
"We are investing in the empowerment of our brands by improving overall franchisee financial health, closing underperforming restaurants and enhancing the supply chain. We are focusing on operations and elevating the guest experience, whether in our restaurants or off-premise. We believe 2017 will be a transitional year for Applebee's and we are making the necessary investments for overall long-term brand health and expect to see improvement over the next year.
"IHOP remains on solid ground, despite soft sales this quarter. I am optimistic about the growth in both effective franchise restaurants and system-wide sales. IHOP is currently rolling out initiatives to address the convenience needs of our guests, which are inclusive of online ordering as well as accelerating tests for delivery and development of an IHOP mobile application. We believe these will create enhanced revenue channels."
Richard J. Dahl, Chairman and interim Chief Executive Officer of DineEquity, Inc.
Valuations
DineEquity is undervalued compared to peers. According to GuruFocus data, the company had trailing P/E ratio 8.4 times vs. industry median 24.8 times, P/B ratio 2.9 times vs. same as industry median, and P/S ratio 1.14 times vs. 1.06 times.
The company also had juicy 9.64% dividend yield with 80% payout ratio.
Average 2017 revenue and earnings-per-share estimates indicated forward multiples 1.17 times and 8.7 times.
Total returns
DineEquity has provided (-)45.9% total losses to its shareholders so far this year vs. the S&P 500’s 10.4% (Morningstar).
DineEquity
According to filings, the first IHOP restaurant opened in 1958 in Toluca Lake, California and the first restaurant in what became the Applebee’s chain opened in 1980 in Decatur, Georgia. In 2007, IHOP acquired Applebee’s for $1.9 billion.
DineEquity, Inc., together with its subsidiaries, owns and franchises the Applebee's Neighborhood Grill&Bar®(“Applebee's”)concept in the bar and grill segment within the casual dining category of the restaurant industry, and owns, franchises and operates the International House of Pancakes®(“IHOP”)concept in the family dining category of the restaurant industry.
As of December 31, 2016, all but 10 of DineEquity’s 3,749 restaurants across both brands were franchised.
The company believes this highly franchised business model requires less capital investment and general and administrative overhead, generates higher gross profit margins and reduces the volatility of adjusted free cash flow performance.
Most of DineEquity’s revenue is derived from domestic sources with approximately 96% of its total 2016 revenues being generated from franchise and rental operation.
DineEquity generate revenue from four operating segments (as of December 2016).
1 Franchise operations
Operations include primarily royalties, fees and other income from 2,016 Applebee’s franchised restaurants and 1,723 IHOP franchised and area licensed restaurants.
In the first half, revenue from franchise operations declined (-)3.4% year over year to $239 million (76.8% of sales) and registered gross margins of 69% (most profitable) compared to 71% in the year prior period.
2 Rental operations
Operations include primarily rental income derived from lease or sublease agreements covering 691 IHOP franchised restaurants and one Applebee’s franchised restaurant.
In the first half, revenue in rental operations declined by (-)2.6% year over year to $60.6 million (19.5% of sales) and had gross margins 25.2% vs. 25.7% in the year prior period.
3 Company restaurant operations
Accounts for retail sales from 10 IHOP company-operated restaurants.
Revenue in company operated restaurants fell (-)19.4% year over year to $7.5 million (2.4% of sales) and registered gross losses of (-)$0.3 million compared to (-)$0.6 million in the year prior period.
4 Financing operations
Operations include primarily interest income from approximately $88 million of receivables for equipment leases and franchise fee notes generally associated with IHOP franchised restaurants developed before 2003.
Revenue in the financing operations fell (-)12.5% year over year to $4.2 million and delivered 100% gross margin profitability in the first half compared to 95.8% in the prior year period.
Restaurants
Applebee’s
In the first half, Applebee’s domestic system-wide same-restaurant (1) sales decreased by (-)7% year over year. According to filings, the Applebee's sales percentage decrease was due to the combined effects of declines in comp sales and restaurant closures.
Further, DineEquity’s revised expectations for Applebee's domestic system-wide same-restaurant sales performance to range between negative 6.0% and negative 8.0% in fiscal year 2017.
IHOP
In the first half, IHOP’s domestic system-wide same-restaurant sales decreased by (-)2.1% year over year.
In addition, the company revised expectations for IHOP's comparable same-restaurant sales performance to range between negative 1.0% and negative 3.0%. This compares to previous expectations of between 0.0% to positive 3.0%.
Sales and profits
In the past three years, DineEquity registered revenue decline average (-)0.34%, profit growth average 10.8%, and profit margin average 12% (Morningstar).
Cash, debt and book value
As of June, DineEquity had $112.3 million in cash and cash equivalents and $1.4 billion with debt-equity ratio 5.58 times compared to 5.5 times in the year prior period. Overall equity declined by $4.68 million while debt also decreased by $11.4 million.
66.5% of DineEquity’s $2.19 billion assets were goodwill and intangibles while book value declined by (-)1.8% year over year to $251.5 million.
Cash flow
In the first half, DineEquity’s cash flow from operations declined by (-)61% year over year to $20.9 million brought by lower profits, and cash outflows in asset dispositions, accounts receivables, tax receivables and payables, accounts payables among others.
Capital expenditures were $6.9 million leaving DineEquity with $13.95 million in free cash flow compared with $51.98 million in the year prior period. Nonetheless, the company handed out 3.2 times its free cash flow in dividend payouts and share repurchases in the first half while having reduced its debt by $7.17 million.
The cash flow summary
In the past three years, DineEquity allocated $19 million in capital expenditures, reduced its debt by $52 million (net issuances), generated $354 million in free cash flow, and provided $333 million in dividends and share repurchases at an average payout ratio of 93.6%.
Conclusion
DineEquity’s recent half operations indicated unappealing and declining business figures. Even the company’s biggest revenue and profit generator—Franchise at 76.8% of sales and 69% margin—exhibited declining revenue as of the recent period.
The company also revised its Applebee’s and IHOP’s declining sales figures for this year.
Along with these findings, DineEquity has a leveraged balance sheet accompanied by good amount of goodwill and intangibles while having been overly generous to its shareholders in recent years in terms of free cash flow payout ratio at 93.6%.
Average analysts price target was $52.33 vs. $39.72 at the time of writing.
Declining sales figures despite retention of profits in recent years accompanied by leveraged balance sheet makes DineEquity a pass.
Notes
- Company filings
“Domestic same-restaurant sales percentage change” reflects the percentage change in sales in any given fiscal period, compared to the same weeks in the prior fiscal period, for domestic restaurants that have been operated throughout both fiscal periods that are being compared and have been open for at least 18months. Because of new restaurant openings and restaurant closures, the domestic restaurants open throughout both fiscal periods being compared may be different from period to period. Domestic same-restaurant sales percentage change does not include data on IHOP area license restaurants.
Meanwhile, exact revenue per restaurant is difficult to extract from company filings such as the image provided below from recent 10-Q filing while overall revenue from the first half was $311 million.
Disclosure: I do not have shares in any of the companies mentioned.
