Jack In The Box: Poor Q2 Results, Outlook Remains Positive (NASDAQ:JACK)

Investment Conclusion

Jack In The Box (NASDAQ:JACK) reported disappointing F2Q2022 financial results. Although, on a year-over-year basis system sales were higher driven by the inclusion of Del Taco’s sales, Jack In the Box’s system sales were flattish and same-store sales declined. The shortfall in sales growth was driven by tough comparables, as Americans received their stimulus checks in the prior year’s same quarter, staffing constraints leading to limited operating hours, and reduced customer demand due to the surge in Omicron cases in January.

Moreover, margins contracted significantly, as revenue leverage suffered due to weak sales growth, cost inflation related to labor and commodities surged, and failing restaurants JACK acquired last year from franchisees continued to underperform. As a flow-through of poor margins and increase in interest expense associated with the long-term debt secured to facilitate the Del Taco buyout, earnings and free cash flows decreased substantially on a year-over-year basis. During the quarter, the company opened five new restaurants and shuttered six that were struggling, ending the period with a global footprint of 2,207 units. In addition, JACK completed the acquisition of Del Taco which was announced in December 2021.

In regard to upcoming quarters, we are less upbeat than company management. In our opinion, the significant boost in sales growth that unfolded during the pandemic will be difficult to sustain, as customer demand has shifted away from drive-thrus (as social distancing is now unnecessary) and towards dine-in experiences. In addition, although the reopening of 50% of dining rooms that remained closed at the end of F2Q2022, rapid menu turnover, better staffing levels at franchisee led restaurants, and continued expansion of digital transactions, will support sales growth, we believe several factors including the effect of higher gas and food prices on JACK’s target customer, and that the end of the pandemic has invariably boosted the number of restaurant options available to guests, will further erode market share.

In our judgment, management is not oblivious to the reality of likely saturation in organic growth looking ahead, and efforts, such as remodeling of restaurants, rebranding of the group’s image, significant footprint expansion plans, and even the acquisition of Del Taco, appear to us as attempts to ignite sales growth. In addition, although given JACK’s expectations for: a dramatic improvement in sales, and easing of inflationary pressures towards the back half of the year, margins might improve from the dismal levels evidenced over F2Q2022, they are expected to remain ~1000 bps below those generated pre-pandemic, over the short to medium term. Considering slower sales growth and weaker margins, it would not be surprising if FY2022 earnings per share and free cash flows decline, on a year-over-year basis.

Conversely, we are substantially more optimistic about JACK’s long-term prospects. Even adjusting for low single-digit same-store sales growth, the company on geographic expansion plans for Jack In The Box and Del Taco could deliver reasonable growth, given the current consolidated footprint of ~2,800 stores. In that respect, the annual new unit development growth target of ~4% by FY2024, signifies considerable sales growth over the out years of the decade. In addition, we expect margins to adjust towards the historic rates of ~27%, as business dynamics associated with company stores (which are suffering due to the acquisition of failing franchisee led businesses) improve, a significant fraction of Del Taco restaurants are refranchised leading to higher margin royalty revenues, inflationary headwinds recede, and operational efficiencies from recent initiatives gather momentum. Further additional leverage will be derived from economies of scale associated with marketing, the digital platform, and corporate spending. Consequently, as a flow-through of the uptrend in sales and margins, profits and free cash flows are likely to surge over the long-term.

Although, we are lowering our secular sales growth estimates for Jack In The Box to account for short to medium-term challenges, given the expected expansion in sales related to the Del Taco acquisition, we are maintaining the overall 10-year revenue growth rate and 10-year operating cash flow margin factored in our 10-year discounted cash flow model. Therefore, there is no change to our 1-year Price Target of $129/share. Reiterate Buy Rating. (Please go through our initiation report “Jack in the Box: Positioned For Significant Business Development – Buy On Growth Plans” and associated notes for our long term opinion on the stock).

Key Takeaways From The Second Quarter

F2Q2022 Results Summary. For the quarter retail sales came in at ~$935 million (+0.1% compared to F2Q2021), revenues of ~$322 million (+25.3% on a year-over-year basis) missed consensus estimates of ~$341 million, and earnings per share of $0.37 (compared to $1.58 in F2Q2021) was below analyst projections of $1.37. In addition, on a year-over-year basis, same store sales declined by 0.8%, comprising company same store sales increase of 1.7%, and franchisee same store sales decrease of 1.1%, over the second quarter. Net income for the period was ~$7.8 million versus ~$35.9 million over the previous year’s same quarter. Restaurant margin for the period was 15%, reflecting a decline of 10.9% from F2Q2021. Operating cash flows at the end of F2Q2022 were ~$67.8 million.

Expanded The Menu To Encourage Customer Demand. JACK continued to deploy rapid menu innovation as a key growth strategy. During the quarter, Jack In the Box restaurants introduced Nacho Tiny Tacos, and relaunched Popcorn Chicken, which has been a fan favorite over the years, and loaded fries. In addition, the brand launched two shakes, a mini OREO shake and a pineapple based shake. Moreover, as an addition to late night food offerings, a premium priced munchie meal was introduced. As per management, the menu innovation, drove foot traffic to stores, reflecting in material growth in sales.

Further, the company has a strong pipeline of menu items, including changes to the core Jack In The Box menu offerings, planned for upcoming quarters. Considering that the launch of new and legacy menu items, attracts customers to stores, we are encouraged that JACK continues to focus on this key strategy of its business model.

Planned Digital Enhancement To Support Revenue Expansion. JACK expects to launch a web ordering platform for its Jack In the Box restaurants over the back half of the year. In addition, to the proprietary app and the Jack Pack loyalty program launched in response to the COVID outbreak, the firm believes, the endeavor will reflect in significant sales growth.

In that respect, management’s argument is bolstered by the element that digital sales expanded to ~10% of total sales during the second quarter, from 0%, prior to the pandemic. In addition, sales linked to the loyalty platform likely increased significantly since the implementation of an initiative to allow customers to enroll in the feature during their visits to the brand’s restaurants and drive-thrus, drove a 25% increase in the utilization of the rewards program. Given the feature’s potential to tailor promotions to customer tastes, the loyalty program will possibly reflect in substantial growth in sales, in our opinion.

Considering that digital platforms have opened up an additional leg of long-term growth across the restaurant industry, we are glad that JACK has increased focus on its digital initiatives. In our judgment, e-commerce sales are low hanging fruit, that the firm, now has the ability to access.

Store Remodels Underway To Fuel Sales Growth. Jack In The Box restaurants are undergoing a makeover as part of the company’s reimage program, that seeks to further develop the story around Jack, the iconic edgy mascot associated with the brand.

136 franchisee restaurants and 12 company restaurants have already been approved for remodeling. Management expects the updated stores to be ready for relaunch during FY2023. The extensive renovations will include remodeling of the building exteriors (widening of the drive-thrus, in some cases, even upgrading to double drive-thrus), and changes to dining rooms.

Considering that a remodeled Jack In the Box store in Yuma, Arizona is generating average sales/week of ~$100,000 to ~$130,000, which is 25% to 30% higher than non-renovated stores associated with the brand, we believe the additional spending the venture requires, is justified.

Overall, given that the remodeling effort is likely to substantially boost JACK’s top and bottom lines, we support the project.

Guidance Appears Reasonable. For FY2022, JACK projected EPS in a range of $5.80 to $6.10 which represents a decline of 23.8% on a year-over-year basis from the midpoint. The figure assumes same-store sales growth of flat to 1% for Jack In The Box, and between 3% and 4% for Del Taco, and a price increase of high single digits for the flagship brand.

In addition, the company lowered restaurant margin expectations for Jack In The Box to 17% from the previously announced 20% to 21%. The figure predicates commodity cost inflation in a range of 12% to 14% and wage inflation of between 12% to 13%, both on an annualized basis.

We believe JACK’s FY2022 estimates adequately account for the challenges the firm is facing on multiple levels, from cost inflation to staffing shortfall to the impact of higher gas prices on the discretionary spending habits of its target customer. Therefore, we expect actual financial outcomes for the fiscal year to either come in inline or ahead of guidance.

Balance Sheet Remains Strong. At the end of F2Q2022, the company had a cash and cash equivalents balance of ~$84.6 million and long term debt of $1.81 billion on its balance sheet. JACK has ~$58 million available under a variable note facility. Year-to-date FY2022, the firm has not repurchased shares. Therefore, the entire $200 million associated with the share buy-back program announced during November 2021 (which concludes in November 2023), is available for use. The company announced a dividend of $0.44/share for F2Q2022.

Bottom Line

Over the long-term, given JACK’s profile, with Jack In The Box as an established brand with a distinctive personality, a large footprint with plans for massive further expansion, and growing digital initiatives, and Del Taco as an additional cash cow through the expected refranchising of ~300 stores, prospects appear bright.

However, the firm will have to navigate near-term headwinds, in regards to slower growth due in some part to an upcoming recession, but generally because of the decline in the necessity of drive-thrus, as well as cost inflation and staffing shortfall.

Therefore, we don’t anticipate strong rallies in the stock any-time soon. Although, shares might somewhat appreciate from the current depressed levels, if quarterly revenues and earnings come in ahead of analyst expectations.