Jack in the Box Inc. (NASDAQ:JACK) stock was up nearly 3% in trading Thursday — but from here it looks like a relief rally. Jack in the Box stock had fallen 26% just between early December and mid-February. The JACK stock price had hit a 20-month low as a result.
Coming out of Wednesday evening’s fiscal first-quarter earnings report, JACK has bounced about 13% off those lows. But Q1 earnings don’t look quite good enough to keep that rally going back to $100 and beyond. JACK posted a nice consensus earnings-per-share beat in Q1, but same-restaurant sales are weak and full-year guidance was maintained.
There is a bull case here if Jack can get sales, in particular, moving in the right direction. Refranchising efforts have lifted peers like McDonald’s Corporation (NYSE:MCD), and Jack has more restaurants to refranchise this year. With a more stable revenue stream of franchise fees, JACK can add leverage to its balance sheet and return substantial amounts of capital to shareholders.
But the franchise model is based solely on franchise-level sales — and it’s there that Jack in the Box needs to improve. If the company can fix its sales trend, its multiples will rise toward those of other franchisers, and JACK stock will rally. What Q1 shows is that the company still has work left to do on that front.
Jack’s Q1 looks like a strong quarter relative to analyst expectations. Revenue declined 16.6% year over year, 3 points better than Street estimates. Jack’s restaurant sales aren’t plunging double-digits, of course. Rather, refranchising over the last 12 months means Jack only recognizes revenue from franchise fees in those restaurants — instead of all of the dollar sales booked under its ownership.
Adjusted EPS of $1.23 rose 4% YOY, and beat analyst estimates by 17 cents. But some of that beat appears to have come from poor modeling; Jack’s adjusted EBITDA declined almost 6% YOY, with a better tax rate of 24.5% driving most of the EPS increase.
Expectations aside, it’s not a particularly impressive report. Same-restaurant sales at company-owned restaurants increased just 0.2% in the 16 weeks ended Jan. 21. Franchise same-restaurant sales dropped 0.3%, driving a system-wide 0.2% decline.
That’s a disappointing performance.
McDonald’s grew US same-restaurant sales 4.5% in its fourth quarter. Restaurant Brands International Inc (NYSE:QSR) Burger King unit saw ~4% growth (globally) in the same period. Jack in the Box admittedly has struggled with the aggressive promotions from McDonald’s, in particular, and has tried to aim both high (via its ribeye burger) and low (via its own value menu) in terms of pricing.
But sales have to improve, because, again, franchiser revenues are based solely on sales. In a market where labor costs are rising and input costs are seeing some inflation as well, that’s why investors like the model so much. That model, though, doesn’t work all that well if comps are flat.
The Bull Case for Jack in the Box Stock
To be sure, one quarter, even after a relatively disappointing FY17, doesn’t mean the JACK stock price can’t rally. And there is substantial upside here — if those comps can strengthen.
After all, Jack in the Box stock looks relatively cheap compared to other franchise plays. The midpoint of FY18 EBITDA guidance suggests a roughly 13 multiple. Wendys Co (NASDAQ:WEN) trades at about 16x. McDonalds is in the 17x range, as is QSR, and Yum! Brands, Inc. (NYSE:YUM) trades around 19x.
Simply getting valuation closer to QSR/MCD would move JACK higher — a 15 multiple would add about 20% to the stock price and get the JACK stock price back toward 2017 highs. Debt-fueled share repurchases could drive more value.
But Jack has to get sales growth going to get there. And it needs to dodge the key concern I noted about the space in an article on YUM last month. It needs to keep those franchisees happy. With costs rising, that, too, will require growth.
From that standpoint, the muted reaction to Q1 makes some sense. The quarter wasn’t bad enough to kill Jack’s chances, but it wasn’t good enough to believe that a turnaround is imminent.
If that turnaround comes, the JACK stock price will rise, and likely sharply so. If not, Jack in the Box stock is dead money — at best.
As of this writing, Vince Martin has no positions in any securities mentioned.