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Tuesday, June 22, 1999

CKE Restaurants Inc.

Phone: 714-778-7109
Website: www.ckr.com
Price (6/21/99): $13 3/4

William Foley got too close to the grill -- and got burned. After turning around the Carl's Jr. fast food chain, the CKE Restaurants savior got ambitious. If he was able to right one burger franchise, why stop there?

So the company went out and acquired Hardee's and associated itself with Checkers (Nasdaq: CHKR) and Rally's (Nasdaq: RLLY). The three chains had a few things in common: they were struggling, debt-ridden, and could be had on the cheap.

Checkers and Rally's, companies that once reinvigorated the quick service industry with cost-conscious drive-through and walk-up window-service-only offerings that meant low overhead and even lower prices, failed to bounce back. The risk was limited since Foley only became interested in the companies when the share price of Checkers and Rally's was going for about the price of one of their signature burgers. Today those shares won't buy you half an order of fries -- and CKE owns 26% stake in Checkers and a 32% stake in Rally's.

However, with Hardee's CKE stepped in completely. It bought the chain from Imasco in 1997, and once it was able to double operating margins seemingly overnight it went out and bought more than 500 franchised units from the beleaguered Advantica (Nasdaq: DINE).

However, Foley's expertise was about to be laid thin. With Hardee's on the plate, as well as smaller non-burger entities, Foley found heaping servings of debt that the company had to pile on by the condiment table. Despite the transition of many Hardee's units into Carl's Jr. or upscale Star Hardee's concepts, the limited success sacrificed the company as a whole. Despite the temporary margin improvement, Hardee's still concluded its fifth consecutive year of lower same-store sales. Foley has made it a tighter operation -- not a more popular one. And, after four years of same-store sales growth at the Carl's Jr. chain, the comps turned lower this year -- and the stock got butchered in the process.


Anaheim-based CKE Restaurants operates nearly 3800 fast food eateries through its subsidiaries, franchisees, and licensees. At the end of the May that included 878 Carl's Jr. restaurants located in 13 Western states and Mexico, 2,784 Hardee's restaurants in 34 states and 10 foreign countries, and 112 Taco Bueno restaurants in Texas and Oklahoma.

Income Statement
12-month sales: $1959.5 million
12-month income: $70.9 million*
12-month EPS: $1.32*
Profit Margin: 3.6%
Market Cap: $713.6 million
(*Excluding extraordinary items)

Balance Sheet* (as of 1/31/99)
Cash: $40.3 million
Current Assets: $134.3 million
Current Liabilities: $201.6 million
Long-term Debt: $360.7 million
(*As of Jan. 31, 1999)

Price-to-earnings: 10.4
Price-to-sales: 0.36


When Foley replaced Carl Karchner in 1994, few investors knew what to expect. While optimism drove the shares higher, the stock ultimately closed at a split-adjusted $6 7/8 -- half of where it is today even after this brutal past year.

As Jack in the Box parent Foodmaker (NYSE: FM) has proven, breathing new life into a struggling chain is not easy but the payoff can be huge. The difference between Foodmaker and CKE is that Foley chose to diversify rather than continue to focus his attention on the Karchner-named franchise.

Some strategic decisions, like a move towards dual branding by adding Green Burrito Tex-Mex menu items at Carl's Jr, were revolutionary. Other moves, like buying JB's and Galaxy Diner, as well as helping out Rally's and Checkers, were not as successful.

Foley proved himself to be an imperfect genius in the restaurant world. While he was able to practically double the operating margins at Hardee's, they have not grown much after that. Actually, in the May quarter this year the margins and same-store sales dipped slightly at all of the concepts save for Taco Bueno. The fast-food taco chain actually reported its 16th consecutive quarter of same-store sales growth. Unfortunately, the impressive Taco Bueno is too small to make a material impact on CKE's income statement.

Knowing that CKE had failed even in the Foley era (JB and Galaxy Diner were sold off last year) might have kept investors on their toes. Watching debt grow tenfold over the past two years due to the Hardee's acqusition should have made shareholders edgy as well.

CKE is off to a bad start this fiscal year. While sales inched up in the first quarter, earnings fell shy of both analyst estimates and last year's May quarter. Analysts are now expecting earnings to run flat this year -- a troubling sign since the company is in the process of Hardee's conversions that were supposed to boost the top and bottom lines.

Was Hardee's Foley's folly? Right now the chain makes up 73% of CKE's total units, and as the newfound chain goes, so will CKE. The souped up Star Hardee's locations have shown promise, offering higher-end fast food fare, but it might not be enough to justify the capital expenditures needed to transform the stores during these debt-laden times.

Carl's Jr. is still being run with the same aggressive fervor that helped turn the concept around shortly after Foley's arrival. This week the new Famous Bacon Cheeseburger goes on the menu while the Western Bacon Cheeseburger's price gets reduced by a buck. It's a formula that has worked well for its bigger burger rivals. Offering value-priced items while keeping some high-margin premium priced eats seems to be an industry standard nowadays. It might not be vintage Foley, who is used to leading rather than following industry trends, but he is still not someone you want to bet against.

Last year, when the stock was in the $40s, caution was in order. Foley is, again, an imperfect genius. However, with the shares trading for a third of their previous highs, the market seems to be discounting the times when this imperfect genius has been right. Today CKE is trading for less then ten times last year's earnings. While things can always get worse, paying less than ten times last year's earnings for Foley's leadership is certainly a tempting value menu item. Shares of CKE have actually taken the form of the Carl's Jr. Western Bacon Cheeseburgers -- the prices have been slashed, but it's still the same meat inside.

-Rick Aristotle Munarriz (tmfedible@aol.com)

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