Dine Brands Global (DIN -2.85%) has capitalized on strength in the once-wobbling Applebee's franchise for several quarters. But has the chain's momentum stalled? The company reported second-quarter 2019 earnings on July 31, and notably, Applebee's comparable-store sales dipped by 0.5% against the prior-year quarter. This is admittedly a very slight dip in a widely watched metric. Yet it has implications specific to Dine Brands' store-count strategy. Let's walk through the reasoning.
A weakening trend
Investors have closely tracked Applebee's comps for several quarters because they provide an indication of the success of Dine Brands' turnaround plan for the franchise. Applebee's management has revamped the chain's menu, instituted better ordering technology within restaurants, and focused on off-premises sales (takeout, delivery, and catering) to breathe new life into the brand's business model.
In any given quarter, rising comps reveal that Applebee's is attracting higher traffic and/or striking the right balance between promoting margin-friendly core menu items and highlighting discounted limited-time offerings (LTOs).
As John Cywinski, president of Applebee's, explained below in an excerpt from the company's earnings conference call, a miscue on a new menu item was partly responsible for the disappointing comps performance in Q2 2019:
I believe our May-June performance could have been stronger had we introduced our new Loaded Fajitas with a compelling nationally advertised price point. While we achieved significant trial, we failed to attract that very important value-seeking guest, resulting in a little less incrementality than anticipated.
These value seekers represent 20% of our guests and are fundamentally price-driven, as well as active switchers among brands throughout the category. Bottom line, when we're aggressive on price, value seekers tend to be with us, and when we're not, they tend to seek a deal elsewhere. Based upon this learning, you'll see us be more overt in the back half of the year from a tactical value perspective. Now on the plus side of the equation, we addressed the gap in our menu and successfully introduced a permanent new fajita category, as well as a new sizzling platform for future innovation.
To me, this quote is informative because it reveals the potential of Applebee's flexible menu structure, which favors LTOs, but the quote also exposes the tenuousness of comps growth, which relies on accurately priced value offerings to keep one-fifth of the chain's customer base from straying to competitors.
A wrinkle in the comps calculation
As I wrote late last year, Applebee's comps have been undergirded by the regular closing of underperforming stores each quarter, which has the effect of removing unfavorable comparisons from the company's store base. I explained then that this isn't necessarily a worrisome phenomenon, as shareholders should want management to cull poorly performing units to boost profits.
While store closures have made it easier to post better comps, this effect is waning as store counts reach optimal levels. In fiscal 2018, Dine Brands closed 84 Applebee's locations, or roughly 4.2% of the total store base. In fiscal 2019, the company is on track to complete net closures of between 20 and 30 stores.
This means that comps growth will rely more on the traditional drivers of pricing and customer traffic, with less of a boost deriving from store count changes. Thus, the true strength of the revamped Applebee's value proposition will be easier for average shareholders to ascertain in the quarterly comps trend.
That trend is worth delineating. Since a sterling 7.7% improvement in the third quarter of fiscal 2018, comps growth has weakened each quarter, culminating in the negative performance in the most recent three-month period. Shareholders likely hope that the second quarter's dip is temporary, and that a stumble on a fajita value offering is the simple culprit. But the declining comps trajectory to date looks ominous to me.