Keeping up with changing tastes makes it difficult to stay competitive in the restaurant industry. And with all the specialized eateries these days, consumers have more choices than ever. But stodgy old IHOP (NYSE:IHP) continues to show it has a full stack of offerings pleasing to the palate.
Yesterday the company reported first-quarter results that the market seemed to find tasty. Net income increased 25% and a 7.7% decrease in diluted share count from share repurchases over the past year boosted diluted EPS by 36%. Thanks to the franchise restructuring implemented in 2003, margins from earnings before taxes increased to 22.9%, as compared to 19% in Q1 of last year.
The whipped-cream topping was the success of limited-time menu offerings, which contributed to a 5.1% increase in same-store sales systemwide. Based on the priceless look on my wife's face as she took her very first bite of a Cinn-A-Stack a few weeks ago, I'm not very surprised.
The current weak spot is that revenues only increased 3%. Since a company can only cut costs so much, IHOP has to make sure that revenue growth gets back on track soon. Fortunately, there are currently commitments for 445 new franchise restaurants to be built in the U.S. over the next several years, representing a 36% increase in store count. Plans for as many as 21 new restaurants in Mexico are under way as well.
What investors should look at most closely is the current amount of free cash flow. The company no longer needs to make large capital expenditures to grow, which allows cash to be used for buying back shares, increasing the dividend, or paying back debt when it needs to. Even if you have no interest in buying shares of the company, much can be learned about IHOP's transformation by reading its last few annual reports. That is, if you're one of those Foolish geeks who's into that sort of thing.
Although IHOP is currently valued in line with many of its peers -- such as CBRL Group's (NASDAQ:CBRL) Cracker Barrel and Bob Evans (NASDAQ:BOBE) -- on an earnings basis, its healthy free cash flow and improving margins makes it look much better prepared for the future. What you should be asking now is whether IHOP is undervalued or its competitors are overvalued.
Foolish contributor John Bluis does not own shares of any company mentioned in this article. The Motley Fool is investors writing for investors.
