Jack in the Box Inc. (JACK, Financial) is a popular fast-food restaurant chain headquartered in San Diego. With restaurants throughout the U.S., the company is in the final stages of converting from a company-owned store business model to an asset-light franchise business model.
Having also acquired the Del Taco brand in March 2022 for $575 million, the company caught my attention because of the huge return of capital it has provided to shareholders. As Jack in the Box moves toward replacing its own capital with franchisees' capital, it is buying back shares. The company is now 93% franchised with 2,181 restaurants in 21 states, but still has significant expansion opportunities in the U.S. and internationally.
During the pandemic, the restaurant operator benefited fromits drive-thru business and digital ordering, but the stock has since declined and is now below its pre-pandemic price.
Currently, Jack in the Box is significantly undervalued based on the GF Value Line, which uses the stock's historical price multiples, past returns and estimates of future earnings performance to determine its intrinsic value.
Strong cash flow compounder
What further piqued my interest in Jack in the Box is the strong cash flow compounding it has been delivering as a result of converting to an asset-light franchise model as well as the heavy share buybacks. We can see the company has compounded owner earnings at an over 11% growth rate per year for the past decade.
Owner earnings is a cash flow concept introduced by Warren Buffett (Trades, Portfolio) in his 1986 Berkshire Hathaway (BRK.A, Financial)(BRK.B, Financial) letter to investors. At that time, companies were not required to produce a cash flow statement, nor was stock-based compensation such a big concern. Buffett's formulation of owner earnings removes non-cash distortions from earnings and focuses investors' attention on how much cash they are getting as owners of the company at the end of the period. The equation for the metric is: Owners Earnings = (a) Net Income plus (b) depreciation, depletion, amortization, and other non-cash charges minus (c) average annual maintenance capital expenditures.
For perspective, Jack in the Box has delivered $41.68 of owner earnings per share over the last 10 years and the current share price is around $73.50.
Additionally, owner earnings and GAAP earnings per share are generally in sync, which is a sign of high-quality earnings.
Same-store sales
The following chart shows the same-store sales growth for Jack in the Box and Del Taco over the last eight years. Same-store sales have improved for both restaurants in the last two to three years. The company expects to increase same-store sales in the mid-single digits in 2023. This is apart from expected growth in total store count. Further, it s planning to open 120 new restuarants in the next three years.
As such, Jack in the Box's focus appears to be shifting from refranchising previously owned corporate locations to growing the number of new franchised restaurants.
Source: Company presentation.
Balance sheet and debt
The following chart shows Jack in the Box's balance sheet. Note the company's negative equity, which is an accounting artifact of its share buybacks. Because the company buys backs its own shares, it is basically erasing its equity account. This does not really mean much in practical terms, even though theoretically the company is insolvent (i.e., its liabilities, exceed its assets).
Jack in the Box had total long-term debt of $1.8 billion as of Oct. 2, 2022. As shown in the following table from the 10-K filing, the maturity schedule is fairly spread out (figures are in thousands).
| 2023 | 30,169 |
| 2024 | 29,623 |
| 2025 | 29,315 |
| 2026 | 289,183 |
| 2027 | 516,045 |
| Thereafter | 960,480 |
While the company's debt-to-Ebitda ratio is rather high at over 10, it generates consistent cash flow.
Share buybacks
Jack in the Box has been buying back its own stock at a furious pace. Over the last 10 years, shares outstanding have declined by 8.19% a year.
Stock buybacks, also known as a share repurchase, allow a company to reinvest in itself. The repurchased shares are absorbed by the company, reducing the number of outstanding shares on the market. Because there are fewer shares on the market, the relative ownership stake of each shareholder increases.
Buybacks are a more tax-efficient way to return capital to shareholders as compared to dividends because the shareholder does not incur any additional tax on the buyback process. Tax is only applicable on the actual sale of shares, whereas dividends attract income tax payable by the shareholder, unless the shares are held in a tax-exempt or tax-deferred account.
Valuation
The cumulative shareholder return generated by the company's buybacks have been tremendous. The orange area of the diagram below shows the cumulative buybacks and the blue area is the cumulative retained earnings. Both continue to grow.
Meanwhile, the green line shows Jack in the Box's market capitalization, which is not far above the level seen in 2012 even though the buybacks and retained earning have being compounding at about a 9% annual growth rate. Its a clear visual depiction of the value being created by the restaurant chain and the discrepancy between value and price.
Much of the above can be explained by the compression of the company's price-earnings ratio. The market in the last decade has been besotted with growth and tech stocks, throwing value stocks such as Jack in the Box in the discard pile. This has resulted in the compression of price-earnings and price-sales ratios.
The GuruFocus Valuation Box also provides a solid endorsement that the stock is good value, particularly based on the discounted cash flow method (both on an earnings and cash flow basis).
Conclusion
I am excited by Jack in the Box's current valuation. The management team appears to be very competent and focused on franchisee profitability and growth, which should ensure the long-term success of the company. The restaurant operator is also investing in digital operations to remain on trend with changing consumer preferences.
As such, I expect the company to do very well in the next few years as value investing is coming into vogue again; stocks like Jack in the Box, with a strong ability to compound cash, should shine. However, I think the company should shift to deleveraging now rather than just buying back stock. With higher interest rates, the leverage can become dangerous.
My medium-term target (one to three years) for the stock is $110, a number which it exceed in 2021.
