Fast food is a staple in the United States, but the sector is saturated with some well-known brands holding huge market shares. Jack in the Box (JACK 1.80%) has been working on expanding in this tough industry, recently adding a new concept to the mix via the acquisition of Del Taco, which specializes in Mexican cuisine. There are a couple of reasons to like this move, one of which could start to show up pretty quickly.
Fighting with giants
McDonald's (MCD -0.30%) is the 800-pound gorilla in the fast-food space, with over 40,000 restaurants located in 119 countries around the world. The company is a household name. Then there's Jack in the Box, which has around 2,200 restaurants in 21 U.S. states and Guam. It is not a household name.
That doesn't make it a bad company, just one that's still in the growth phase of its life. On the plus side, it still has over half the United States to expand into from here. On the negative side, McDonald's and other big competitors have already made a name for themselves in areas where Jack in the Box doesn't operate, so breaking into new markets won't be easy.
This is why Jack in the Box has looked to expand into a new concept, Mexican food, to help push its growth. Essentially, it can leverage its strength in markets where it already has a footprint to grow another fast-food nameplate. This is hardly a new model, considering that YUM! owns Pizza Hut, Taco Bell, and KFC. Given the long-term success that YUM! has achieved, owning multiple food concepts is a model that can work well in the restaurant industry.
Del Taco has around 600 or so locations across 16 states. The most obvious avenue for growth is for Jack in the Box to expand that footprint. But that's not a one-way street because there are a handful of states where Del Taco operates that are not served by a Jack in the Box. Given that there's an infrastructure in place to serve Del Tacos in those states, it gives Jack in the Box a foundation from which to expand. And there are still more states where Del Taco can be expanded, so the opportunity is bigger when you step back and look at the total picture.
There are also cost-saving opportunities that could make both brands more profitable. In states where the two concepts coexist, the supply chain can be merged with redundancies removed. Jack in the Box hopes to generate $15 million in run-rate savings by the end of 2023.
But the biggest near-term benefit might actually come from selling stores. The key is that Jack in the Box owns only around 8% of its total stores; the rest are franchised. Del Taco, on the other hand, owns just shy of 50% of its locations. While directly owning restaurants boosts revenue, there are much higher costs involved. Franchise locations, where most of the costs are on the franchisee, tend to be much more profitable.
To put some numbers on that, Jack in the Box's owned restaurants had a margin of 15.8% in the fiscal third quarter of 2022, while franchise margins were 41.4%. As a point of reference, franchises account for around 85% of McDonald's overall restaurant margins, hinting strongly that having more franchised locations is better in the long run.
This is why Jack in the Box is currently focused on turning owned Del Taco locations into franchise locations. It has a ready audience, too, in its large Jack in the Box franchisees. And it can cherry-pick the best operators, which will help to protect location-level performance during the transition. This is likely to be a multi-year effort, but one that has the power to increase overall profitability, and thus growth, in a meaningful way.
There are fears of a recession, and inflation is running hot right now, which are headwinds that Jack in the Box has to deal with, just like all of its peers. However, the fast-food company has a hidden opportunity to improve its margins and business growth as it integrates Del Taco, broadens the reach of the two concepts it owns into new markets, and, perhaps most notably in the near term, works to sell Del Taco-owned restaurants to franchisees.
For investors interested in the food space, Jack in the Box is worth a closer look now that it has expanded the ways in which it can grow both near-term and long-term.