Over the past five days JACK has been the second best performing restaurant stock that we monitor. Commodity costs are rampant and the hikes in inflation guidance are concerning. However, given the commentary from other management teams that have been reporting for the past few weeks, the commentary on food costs was somewhat expected and not new news. The top-line improvement that manifested itself in the 2QFY11 results, on the other hand, is new and therefore took center stage. From that perspective, JACK had a good quarter. While two-year trends remain soft, the upward revision in FY11 guidance is a positive. With the stock trading at 6x EV/NTM EBITDA, the short thesis is losing credibility.
JACK 2QFY11 EPS came in light at $0.12 ex-items versus consensus at $0.20. EPS guidance for fiscal 2011 remains unchanged despite a significantly more positive top-line outlook. We’ve been highlighting improving unemployment trends in the young male demographic as being positive for QSR and, it seems, JACK has seen some benefit from that.
On the negative side, commodity costs are clearly weighing heavily on profitability. While this is not new, it will be important to monitor commodity prices closely going forward to gauge the potential risk of further margin pressure from food costs. Below, we detail 2Q results as well as management’s outlook and earnings call commentary.
Jack in the box company comparable-restaurant sales increased +0.8% year-over-year in 2QFY11 versus consensus of -0.5% and guidance of flat to -2%. Jack in the box franchise comparable-restaurant sales declined -0.3%, in line with consensus expectations. Qdoba system comparable-restaurant sales increased +6% versus consensus of +4.2% and guidance of +3-5%. Food and packaging costs came in at 33.4% for the quarter versus consensus at 32.7% of sales. Commodity costs are impacting JACK’s profitability meaningfully.
Jack in the box company same-store sales are expected to increase 2-4% versus a -9.4% decline in the year-ago quarter. Qdoba system same-store sales are expected to increase approximately 4-6% versus a 4.6% increase in the year-ago quarter. Commodity costs are expected to increase by 6-7% and refranchising gains are expected to decline from 3QFY10.
The company raised top-line guidance significantly for FY11 following the better-than-expected 2QFY11 numbers and the trend in April which, we assume, also brought robust sales growth versus prior expectations. Company same-store sales for Jack in the box restaurants are now expected to grow by 1-3% in FY11 versus prior guidance -2% to +2%. Qdoba system same-store sales are expected to increase by 4-6% versus prior guidance of 3-5%.
Consolidated restaurant operating margin is now projected to come in at 12.5% to 13.5% for the fiscal year versus prior guidance of 13% to 14%. The company raised its commodity costs growth expectations to +4.5% to 5.5% (from 3% to 4% prior) for FY11 including +6-7% for 3QFY11.
In terms of unit growth, 30 to 35 Jack in the box stores are projected to open in FY11 (in line with prior guidance) along with 60 to 70 Qdoba restaurants (versus prior guidance for 50 to 60 openings).
Management struck a positive tone on the earnings call, underlining the importance of same-store sales for the longer-term profitability of the company. Commodity costs pose a strong threat to profitability and will likely continue to weigh on earnings for the foreseeable future. Below is a selection of (paraphrased) incremental comments from management regarding the quarter and the company’s future prospects:
- 1.5% of pricing was taken last week in company stores. Breakfast continues to be strong and the company also saw gains during the dinner day part.
- CA and TX continue to have positive same-store sales with CA the best performing market on a two-year basis. AZ quarterly comparable store sales were positive for the second consecutive quarter.
- The All-American Jack Burger has successfully driven sales as a $4.99 combo meal. However, there was a negative impact on mix from the popularity of this promotion.
- New menu boards are being rolled out (a “before and after” will be shown at the Wells Fargo conference next week) that management expects to improve the customer experience and encourage trial and sales of higher mix items.
- The reimaging program (70-80% of Jack in the Box system now franchised) is nearing completion is focused on producing better sales and satisfaction scores as well as more efficient operations within the four walls.
- Qdoba is performing well with transaction growth driving performance.
- Management is not noticing any meaningful change in the competitive discounting environment.
- Improved margin in the back half of FY2011 includes the sale of underperforming restaurants. That benefit remains part of margin guidance but commodity costs being as elevated as they are, overall margins are still expected to rise.
- Food costs are expected to remain elevated. Tellingly, while emphasizing the lack of visibility on this issue, management stated that they are seeing no sign of abatement in food costs looking past FY11. The recent decline in food costs did not spur the company to make a bullish statement on this subject.
- Labor costs were higher in the quarter due to higher levels of staffing designed to approve the guest experience as well as increases in unemployment taxes in several states.
- The company expects restaurant operating margin will be above 16% at the conclusion of the refranchising strategy in a “normalized environment”.
- Qdoba is expected to have a positive impact on restaurant operating margins in the back half of FY11. Qdoba now accounts for 21% of the company restaurant base versus 12% a year ago as Qdoba stores are opened and the refranchising program continues.
- The refranchising program is progressing ahead of schedule – 70-80% of the Jack in the Box system is now franchise-operated.
- Reimage contribution payments to franchisees impacted EPS significantly. Additionally, guidance for impairment and other charges of 70-80 basis points of sales in 2011 represents approximately $0.20 of EPS.
- Impairment costs are expected to continue to impact earnings but, while difficult to forecast, management expects this item to have a lesser impact going forward.