Jack In The Box: The Lesser Known Fast Casual Company

Chipotle Mexican Grill (NYSE: CMG  ) has been the storied player in the up and coming "fast casual" dining segment. At the end of 2013, Chipotle operated 1,595 restaurants  and planned to open another 180 to 195 locations in 2014. Considering that the company has been growing revenues at over 20% a year for the last ten years , it is no wonder investors love it, currently valuing their shares at 53 times last year's earnings, and 35 times this upcoming year's earnings.

Offering convenience, affordability, and healthy options, it appears that fast casual is going to become the next big thing in the food industry, and there is plenty of wealth to go around. As Jack in the Box (NASDAQ: JACK  ) is beginning to shift their long term corporate strategy towards their Qdoba business, putting less focus on the namesake Jack in the Box quick services restaurants, they could be a wise way to invest in the growing fast casual market.

Qdoba story
Customers of Chipotle and Qdoba could argue for hours about which is better, but when it comes down to it, they are nearly the same. In their latest 10-K, management of Jack in the Box explicitly listed several ways they plan to grow the business, and the general theme was get away from high competition, low margin hamburger restaurants and get into the higher margin growth market of fast casual dining.

At the end of fiscal year 2013 this past September, Jack in the Box operated 296 Qdoba restaurants, and had franchisees operating another 319, for a total of 615 across 46 states, Washington D.C., and Canada. During 2013, the company opened 68 new locations, half company-run and half franchised, but it also closed 62 underperforming restaurants.

Qdoba is well behind Chipotle in the number of stores in operation, but Jack in the Box's management has a long term goal to open 2,000 stores in the United States. During the first quarter of 2014 Jack in the Box announced expectations to open 50 new locations during the remainder of the year.

New strategy
Over the last ten years, Jack in the Box has seen their net profit margin hover around 3.5% , which is heavily weighed down by the company-owned hamburger restaurants. Cost associated with company-owned restaurants such as food and packaging, payroll and employee benefits, and occupancy costs accounted for 82% of the revenue those stores generated in 2013 . This compares to franchise costs that were just over 50% of franchise revenues in 2013.

Clearly, franchising is a higher margin business, and management recognizes this. 79% of the Jack in the Box hamburger restaurants are currently franchise owned, with a management goal of 80%-85% franchise ownership .

Chipotle has averaged net profit margins of around 9.5% over the last five years , which we could use as a reasonable proxy for what Qdoba restaurants should be able to achieve. As Jack in the Box begins to franchise more of their Jack in the Box hamburger restaurants and grow the Qdoba brand, investors should expect to see dramatic increases in profit margins in the coming years.

Bottom line
Even with the hamburger restaurants being the majority of Jack in the Box's business, they have still managed to average almost 18% return on equity over the last ten years. Management appears plenty capable of guiding the company responsibly.

Jack in the Box is currently trading at levels around 28.5 times earnings, slightly above an industry average of 27.8 times, and well below their prime competitor in the fast casual business, Chipotle, which is trading around 53 times earnings.

I believe that Jack in the Box would make a great investment because their management is committed to the right track. Qdoba has plenty of room to grow, and the framework is already laid out. Beyond high growth Qdoba, you are also getting a part of a steady quick service hamburger chain. Having both companies under one roof should help Jack in the Box adapt to changing economic conditions much easier than more specialized companies focused on one or the other.

Increasing margins alone should help dramatically increase Jack in the Box's earnings in coming years, but coupling that with their investment in a high growth market makes this company intriguing. 

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