DineEquity (NYSE:DIN) delighted investors and analysts with its recent year-over-year improvements, but it's important to understand what's driving the headline figures. The company behind national chains Applebee's and IHOP delivered a big beat over analyst estimates and lifted some crucial guidance figures, helping the stock drive toward its 52-week high. DineEquity looks especially sweet in light of the fact that most casual full-service plays have struggled in recent periods due to a tepid consumer spending environment and increasing competition from the QSRs. After going basically nowhere for the first nine months of the year, the stock is now trading nearly 20% higher. The question now is, where can the stock go from here?
DineEquity posted an adjusted EPS of $1.10 -- a solid $0.19 per share over Wall Street's average estimate. Sales dipped down nearly 25%, as expected, due to the company's refranchising efforts that resulted in a short-term dip in the top line (more on this below). Still, analysts were expecting an even greater sales dip, allowing the company to outperform by nearly $5 million on the top line.
Same-store sells fell marginally at Applebee's, but grew by 3.4% at the seemingly more popular IHOP. Looking ahead, management bumped up guidance for same-store sales at IHOP and adjusted EPS gains. Now, investors can expect the company to earn $4.14 to $4.24 per share. Analysts had an average estimate of $3.98 per share.
So, how was the company able to drive earnings higher while sales fell by a quarter? Franchising. More and more, fast-casual restaurant operators are putting the focus on franchising their businesses for obvious reasons: lower costs, fatter margins, and attractive cash flow.
Similar to peers such as Texas Roadhouse and, of course, many of the lower-price-point fast-food options, DineEquity is a franchise-centric business. In this role, the company becomes a supporting factor -- one that creates effective, systemwide marketing material for its franchisees to use, along with training, performance standards, menu testing, and more. This allows the company to focus less on day-to-day restaurant operations and instead ensure the longevity of the business.
DineEquity is also a focused play, with just two big chains to manage. Both are price-conscious, full-service dining options with a definable, similar demographic. While some may complain that this is a limiting factor for the company, or perhaps a diversification risk, it's proving to be a more favorable strategy.
Take a look at Darden Restaurants (NYSE:DRI), for comparison. Darden has eight national chains to operate, and they serve vastly different groups. On the low end, the company has Red Lobster and Olive Garden. In the middle it has Yard House and Longhorn Steakhouse, among others. And then the company has a high-end operation: The Capital Grille. Darden can't initiate a companywide strategy to improve its operations (which have been hurting lately), and instead is in a perpetual game of lever-pulling so that its higher-earning brands can compensate for its underperformers. On the surface, it may seem like a safer play -- the cheaper options performing better in rough economic times, while the high end grabs the opposite trend. But in reality, the company seems to lack an overall vision beyond a multi-brand presence.
DineEquity is a superior business for investors to look at today because of its focused, cash-flow-friendly strategy. At 18 times forward earnings, the stock isn't particularly cheap, but free cash flow is a more important number than EPS in this case. Keep an eye on dividend growth and buybacks as the company continues its leaner operating model.
Fool contributor Michael Lewis has no position in any stocks mentioned. The Motley Fool recommends Texas Roadhouse. The Motley Fool owns shares of Darden Restaurants. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.