Yesterday, CKE rose 13% on the back of Jim Cramer recommending it as a turnaround play. His case was based on the premise that CKE is "the worst of breed" and therefore has the most upside potential. He noted that the company's operating margins of 5.7% lag behind its peers, like Burger King (BKC), with margins of 14.5% and Jack-In-The Box (JACK), with 8.5% margins.
I have some issues with his analysis. First, BKC is primarily a franchised company, while CKE is a company-owned operation; as a result comparing operating margins is a useless exercise. Although, it's relevant when looking at JACK, the analysis is still misguided.
When looking at any restaurant company, restaurant level margins are the best barometer of how a company is performing and on this metric CKR is the "best of breed."
Looking at restaurant level margins, CKE has better margins than both JACK and BKC. In the most recent quarter FY2Q09 JACK reported restaurant level margins of 16.5% versus my estimate of 19.9% for CKE restaurants (FY1Q10.) In FY3Q09 Burger King's restaurant level margins are 11.4% - ouch! So any turnaround in CKR margins is not going to come from better sales trends and/or lower food costs, but from management getting religion cutting fat from the company's bloated cost structure. Thus the difference in operating margins cited by Cramer
Having analyzed this company for years, management is not going to give up the Cessna Citation or the other perks that keep the company cost structure bloated. As a side note JACK's senior management flies commercial and the market value of JACK is $1.8 billion and CKR's is $750 million.
Today, CKR reported that its Carl's Jr. Restaurant reported a decline of 6.2% in the period ending May 18th. Assuming 2-3% pricing, this suggests that traffic trends at Carl's Jr. are down 8-9% -- that is a problem! CKR management cites the poor economic conditions in California as the main reason for the decline in traffic trends, but the competition is significantly outperforming in that market.
Recently, JACK reported that 2Q09 same-store sales for its Jack in the Box company-owned restaurants were up 0.4%. Importantly, they said on a regional basis, same-store sales remained positive in California, Texas, and Las Vegas.
CKR takes the high road as it relates to maintaining the company's profitability and brand image, therefore significant discounting is not an option. Maintaining the company's industry leading margins is a higher priority than generating short-term positive same-store sales!
If there is a turnaround in top line sales at Carl's Jr. concept, it will come from increased discounting, which carry lower margins. This is not the type of turnaround I would be looking for!