Life is getting tougher for casual dining restaurants.
Rising energy prices not only affect the costs of running a business, but probably cut customers' discretionary funds. Because of this, competition is heating up all over, as many restaurants try to differentiate themselves further in an attempt to draw consumers. Some are handling it fairly well; others are not.
In the second half of 2004, Applebee's kicked up its expansion efforts. In fact, expansion continues as management plans to add about 135 new stores this year, compared with 133 last year and only 91 and 89 in the two years before that. This can cause problems, such as finding and training good management and employees, as fellow Fool John Bluis pointed out.
At the same time, total debt began to increase significantly, climbing from about $25 million at the beginning of Q2 2005 to about $200 million currently. Of course, this means higher interest payments and less net income. However, the company can afford to do this.
Most notably during the same period, Applebee's quarterly year-over-year free cash flow has been dropping. In fact, last quarter, free cash flow was actually negative $4 million, the first time that has happened since at least the beginning of 2003.
In the recent quarter's earnings release, Lloyd Hill, chairman and chief executive officer, said, "We are disappointed that our efforts to broaden our reach have been masked by the challenging consumer spending environment." While the consumer environment might be contributing to the company's problems, the issues outlined above are not necessarily helping. Going forward, investors should watch the interest coverage ratio (earnings before interest and taxes divided by interest). For the most recent quarter, the ratio is about 11.6, so that is all right (five or greater is considered healthy). Keep an eye on net margin as well, because the company seems to be adding restaurants faster than it can realize the benefits from doing so.
For investors looking to buy an expanding restaurant company, there are probably tastier choices elsewhere.
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