FOOL ON THE HILL
Jack Out of the Box

The momentum crowd is firmly encamped in the restaurant sector right now, making values hard to find. But at a P/E under 16 and offering steady growth, Jack in the Box looks like a relative bargain. The company gets kudos for its shareholder-friendly corporate governance, conservatively managed expansion, and disciplined debt reduction.

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By Matt Richey (TMF Matt)
May 14, 2002

Restaurant stocks have been on fire over the past year. The relentlessly strong U.S. consumer has provided growth to this sector in an environment where there has been little growth elsewhere. A handful of restaurant stocks have become Wall Street darlings. Panera Bread (Nasdaq: PNRA), P.F. Chang's (Nasdaq: PFCB), and Krispy Kreme (NYSE: KKD) are up 112%, 88%, and 80%, respectively, over the past year. At the same time, their valuations -- at P/E ratios of 73, 54, and 83, respectively -- have become awfully stretched. Even with their undeniably strong franchises, I wouldn't touch a single one of these stocks at their current prices. In my search for any values remaining in the industry, I ran across a familiar name that stood out: Jack in the Box (NYSE: JBX).

With a market cap of $1.3 billion, San Diego-based Jack in the Box is the nation's fourth-largest quick-service hamburger chain, behind McDonald's (NYSE: MCD), Burger King (owned by Diageo (NYSE: DEO)), and Wendy's (NYSE: WEN). Jack in the Box was recently reported to have 4.6% of the fast-food hamburger market, up from 4.4% in 2000. The company has 1,817 restaurants (mostly company-owned) in 16 states, with a concentration in the West and South. As a regional player, the concept still has plenty of room to grow across the nation, but management is taking it slow and steady. Over the past year, management grew the store base by an easy-goes-it 7% pace.

Everything about this company is steady. Sales over the past year were $1.9 billion, up about 10% over the prior year. This level of growth is pretty consistent with what the company has been racking up for years. The five-year average sales growth rate is 11.5%, and the seven-year average is 8.2%. The company has been consistently profitable over the years, with operating cash flow growth averaging 16% annually over the past five years. For the 12 months through January, operating cash flow of $173 million represented a margin of 9.3%. Since 1996, the company's operating cash flow margin has ranged as high as 12.2% (1998) and as low as 7.6% (1996), so the current 9.3% figure is a pretty typical representation of the company's profit margin capability.

On the balance sheet, all is smooth sailing, as well. The company has been steadily chiseling away at its debt load, reducing it from $472 million in 1995 to a current $256 million. The company manages its working capital efficiently, as can be seen by its low Foolish Flow Ratio of 0.56. The fact that this number is below 1.0 means that the company has non-interest-bearing current liabilities that more than finance all of the company's current assets, such as receivables and inventory.

Turning to the results of the most recent quarter, which ended in April, it's more of the same consistency. Sales grew 8.3% and earnings edged up 8.4%. The company announced the roll-out of a new point-of-sale system that will improve speed of service and allow the use of credit/debit cards. One black spot on the earnings report was a fractional decline in same-store sales. The 0.3% decline broke a string of 18 consecutive quarters of positive comps. That said, the company faced a tough comparison to the year-ago quarter, which had seen a 4.1% increase. For the fiscal year to-date (six months), same-store sales are up 0.3%.

Beyond the financials, a noteworthy positive for Jack in the Box is that the company clearly respects its shareholders. Investor Relations Magazine honored the company for having the best corporate governance among all small-cap companies. The award was based on a survey of more than 1,800 U.S. portfolio managers, securities analysts, and retail investors. One of the survey's responders commented, "Twice yearly outside directors meet without management present. The company really does believe in increasing shareholder value."

So we have a company that's gaining market share, growing consistently and responsibly, making steady progress in paying off its debt, and earning accolades for its shareholder-friendly corporate governance. Given this slew of favorable investment merits, I was surprised to find Jack in the Box trading at 15.8 times earnings versus an average P/E of 20.9 for the restaurant industry as a whole. Also, Jack in the Box has a return on equity in excess of 20% in an industry that averages 9%.

I like the odds of investing in a higher-than-average quality business for a lower-than-average price. Apparently, management of Jack in the Box sees their stock in a similar light -- the company announced a $30-million stock repurchase just a few days ago.

If you're looking for a conservatively run company with a good chance of beating the S&P 500 over the next few years, Jack in the Box is a good bet and worthy of closer inspection.

Matt Richey, a regular fast-food patron, is a senior investment analyst for The Motley Fool. At the time of publication, he had no position in any of the companies mentioned in this article. Matt's personal portfolio is available for view in his profile. The Motley Fool is investors writing for investors.