Getting Jacked On Fast Food

Date AddedAugust 12, 2009 02:27:19 AM

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Frugality rules spending decisions, so it's no surprise that consumers are flocking to a cheap burger joint like Jack in the Box.

Value hunting has become the norm, especially when it comes to discretionary spending. Even eating habits have changed.
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Families are cooking at home more often, and when they do eat out, many have been trading down from their normal causal dining venues to lower priced fast food chains such as McDonald's ( MCD - news - people ) , Wendy's ( WEN - news - people ), Burger King ( BKC - news - people ), Jack in the Box ( JBX - news - people ) and KFC and Taco Bell (both owned by Yum! Brands ( YUM - news - people )).

Of these, the proprietary stock selection model employed by the Forbes Growth Investor has identified JACK as the stock with the best potential for near-term growth. After taking a deeper look at the company's fundamentals and upcoming prospects, I'd have to agree.

JACK is a fast-food restaurant company with 2,670 locations across the U.S. The vast majority (82%) operate under the Jack in the Box banner in 18 sales primarily in the West and Midwest regions of the country. About 60% of these locations are company-operated. The rest are franchised stores from which JACK derives fees and royalties.

Jack in the Box restaurants offer burgers, fries, breakfast items, snacks, soft drinks, shakes and smoothies. Restaurants also sell premium products such as entrée salads and specialty sandwiches. Most locations provide drive-thru service, which accounts for roughly 70% of sales at company-owned store.

The remaining 18% of stores operate under the Qdoba Mexican Grill banner found in 42 states and the District of Columbia. The Qdoba menu includes a broad selection of premium Mexican-inspired food items such as tacos, burritos, and nachos. The focus is on fresh ingredients and the food is prepared in full view of the customer. Qdoba also provides professional catering services for up to several hundred people.
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JACK also operates 61 Quick Stuff convenience stores/gas stations currently classified as discontinued operations. It already announced the sale of 55 of these locations. It intends to divest the remaining six by September.

Fiscal 2008 was negatively impacted by weakening economic conditions. Higher gasoline prices, rising unemployment and tumbling household budgets led to deteriorating same-store sales growth at both the Jack in the Box and Qdoba restaurants. For the former, same-store sales growth fell from +1.5% in Q1 to -0.8% in Q4. For the latter, it went from +4.5% in Q1 to -1.0% in Q4.

As a result, JACK took a number of actions designed to improve its competitive position and appeal more broadly to the current budget conscious consumer. This includes a re-imaging program aimed at updating store interiors/exteriors and expanding menu options and promotional efforts.

JACK has also been capitalizing on the current trend by consumers of trading down from higher-priced casual-dining chains. For example, its Mini Sirloin Burgers, launched in March, are a line of premium burgers designed to compete against more expensive similar products popularized by the casual-dining market. JACK has also benefited from the general increase in consumer confidence and sharply lower gasoline prices.

The benefits of these factors are evident in its recent operating performance. While Q2 revenues fell 1.6% to $578.4 million, this was due to its current strategy of shifting toward a franchise heavy business model. (JACK ended the quarter with 101 fewer company-owned Jack in the Box locations but 145 more franchised locations.)

A 0.4% rise in Jack in the Box same-store sales helped offset continual weakness in Qdoba, where same-store sales slide 2.3%. The consolidated restaurant operating margin was flat at 16.51% from the prior year but improved by 196 basis points sequentially--boosted by lower food and packaging costs, recent price hikes and better sales of higher-margin new menu items. Net income grew 12.5% to $29.6 million or 51 cents per share--7 cents above estimates.

Despite improvements, the economic recession remains our primary concern. After hitting recent lows, gasoline prices have started to creep back up, and the unemployment rate is still rising. A continuation of such trends would be particularly troublesome for Qdoba and will not help JACK's bottom line. Competition presents another challenge. In general, casual dining companies have been aggressively promoting value-priced menu items in order to drive traffic to their restaurants.

Despite the challenges, near-term prospects remain promising for JACK. Its ongoing store re-imaging program should continue to enhance the company's competitive position within its markets. Favorable customer reception of new products such as its Teriyaki Bowls and aforementioned Mini Sirloin Burgers are also encouraging. The popularity of the latter has already resulted in the recent launch of its Mini Buffalo Ranch Chicken Sandwiches. Continual expansion of this product platform and other new menu item launches should help sustain JACK's recent sales momentum.