This week's Value Investing Congress has had a heavy hint of restaurant in the mix, with David Einhorn calling out Chipotle Mexican Grill (CMG 2.51%) and Ryan Fusaro putting in a plug for Jack in the Box (JACK 2.19%). While I railed against Einhorn the other day, he's probably right. I also think Fusaro might be on to something. He pointed out the strength that Jack in the Box has shown recently, and highlighted the company's business model shift that should generate more income for it in the very near future. Let's take a look at the points in Jack's favor, and see if Fusaro's pick is right for investors.
The Jack in the Box model
Jack in the Box was a very traditional restaurant company, focusing on building a network of company-owned and franchise stores under the Jack in the Box and Qdoba brands. Over the last five years, Jack has actually seen revenue fall 24% with earnings per share down 21% over the same time period. All this was happening while the company was undergoing a transformation, moving away from corporate stores to a franchise model more like McDonald's (MCD 0.83%).
With the sell-off taking place since 2005, the company now operates just 24% of its stores, with franchisees running the vast majority. One of Fusaro's main points as a value guy was that "the market hasn't fully appreciated this transformation." He argues that franchise models should sport higher multiples than normal, corporate businesses due to the higher margins.
But oddly, margins have been decreasing at Jack in the Box. Operating margins have fallen from 7.6% in 2009 to just 6.5% last year. Fusaro says that this is because the company has not addressed its selling and general administrative costs the way it should have. To highlight this, he points out that Burger King (BKW +0.00%), which spends 63% more on SG&A, has 4.5 times as many stores.
The continued transformation
Fusaro thinks that if the company can get its costs in line, then it will be able to generate a lot more for investors. He also theorizes that the company may be able to spin off Qdoba, which Jack in the Box has grown from 85 stores in 2003 to almost 600 stores today. That could release a huge amount of value for investors, especially since only 56% of the stores are currently franchised.
With the increase in franchising, the company should also be able to release some of the value it currently holds in real estate. By selling off those assets, and allowing the franchises to rent from the new owners, Jack in the Box can generate additional capital. While this sell-off would create temporary cash, and not long term value, it would relieve the company of some tax burdens, while allowing additional capital to be freed up for research, expansion, and marketing. That last one, marketing, is where Fusaro thinks the company needs work.
The small drop in SG&A has come largely through the company cutting back on marketing at a time when it's desperately needed to drive new revenue. If instead Jack in the Box can trim its operational costs, then it can realize wider margins, and start spending again on marketing to draw in new customers.
The bottom line
I went into Fusaro's work expecting to be underwhelmed, but I think I've been swayed. Jack in the Box clearly has some hurdles, the biggest being management's inability to get costs under control, but once those are cleared it should be smooth sailing. Fusaro authored his thesis earlier in the year, and argues that Jack in the Box has a fair value of $39. Right now, it's trading around $28, so if he's right, the stock has an upside of about 40%.
I think this one is worth testing out. The company doesn't pay a dividend, so you have to believe in the growth story. If you want more information, you can get Fusaro's work online, and check out the details for yourself. You can also check out the Fool's report "Middle-Class Millionaire-Makers: 3 Stocks Wall Street's Too Rich to Notice." It gives all the details about these three companies that are hidden in plain view. Get your free copy today.
