After I looked at Applebee's (NASDAQ:APPB) press release yesterday, I started thinking of all the imagery I could use in the title of this piece. A few worthy candidates included rancid, rotten, spoiled, and mushy. But after listening to this morning's conference call, I found CEO Lloyd Hill's opening comment much more powerful. He said, "The best thing I can say about last year is that it's over."
Looking back, evidence of poor performance in 2005 is scattered throughout the financial statements: more long-term debt, lower free cash flow, falling margins at every level. Instead of rehashing all those numbers, most of which can be seen here, I'd rather focus on how the company got to where it is and what it may be able to do to fix things.
The main cause for concern seems to be the very aggressive expansion approach. After opening 25 or 26 company-owned stores in each of the years from 2000 through 2003, a total of 84 new stores were opened the last two years. Acquisitions of franchisee stores and their associated markets have also increased at a rapid pace, as $68.8 million has been spent over the same time period to gather another 34 more stores under the corporate banner. Franchisees opened 169 new franchise stores over the last two years, as well. It's already difficult to find good management and employees for new stores, but when a company has to find that many people for more than 100 stores a year, the task becomes monumental. A number of quality restaurants have been boiled in their own oil by expanding too quickly.
Excessive growth can put a strain on the balance sheet, as well. The long-term debt-to-cash ratio was just 1.2 at the end of 2003 but has since escalated to 13.9 with $180.2 million in long-term debt and $13.0 million in cash (although a healthy interest coverage ratio of 15 for the most recent quarter indicates that Applebee's can easily meet its interest expenses). Combine increasing debt with the declining same-store sales in the second half of 2005, and investors may have cause for concern.
The good news is that the company does have a plan. Management did its research and had more than 40,000 customers fill out those oft-annoying tell-us-what-you-think cards. They discovered that loyal guests are still loyal and pleased, but in the case of "light users," it was all about the food. They often craved other things that Applebee's didn't offer, including higher quality, more expensive items. The company has taken this to heart and will be rolling out higher quality items throughout the year and believes they can live side by side with the value items. That would keep loyal customers happy while enticing other patrons.
I think this is a great move. Every time I've ever thought about Applebee's as an investment, I kept going back to the fact that the food was mediocre. What will keep the stock growing once the market has been saturated? Along with supporting my local restaurants that I love, I'll still be going to Red Robin (NASDAQ:RRGB) to get my burgers, Outback (NYSE:OSI) to get my steaks, and Motley Fool Hidden Gems recommendation Buffalo Wild Wings (NASDAQ:BWLD) for my wings. When my wife and I have different cravings, Applebee's should be perfect for us, yet it usually isn't. However, if the new fare sounds interesting, we may have to check it out. And if future reports show a slowdown to expansion, I may even consider ordering up a few shares. But right now, neither the food nor the stock seems very palatable.
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Everything in moderation is a good philosophy for life, but it's tough to live by when there's a bucket of wings staring at you. That's one reason why Fool contributor John Bluis owns shares of Buffalo Wild Wings, but no other company mentioned in this article. The Fool has an ironclad disclosure policy.
