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While Jack-in-the-Box is outperforming some of its competition (Carl's Jr.) on a same-store sales basis, it's underperforming the industry-behemoth McDonald's.


Generally, I like the direction management is headed by concentrating on the core business by selling underperforming, low return assets. While it's not new news that JACK has agreed to sell 55 of its 61 Quick Stuff convenience stores and gas stations, it is a statement as to where management is taking the company. The re-franchising strategy is also a long-term net positive, but the dilutive nature of each transaction is less of a positive.


The biggest negative for JACK has been the rapid growth in capital spending over the past two years, which has contributed to the decline in JACK's return on incremental invesed capital (ROIIC). Over the past two years capital spending has grown 10% and 16% faster than revenues, respectively.

JACK - FOLLOWING THE CASH - jackroiic

Management doubled its new Qdoba company-operated openings in 2008 just as same-store sales started to slow. The company plans to increase Qdoba company openings to 30-40 per year from its prior 10-15 run rate (21 in FY08 and 25 planned for FY09). In this environment, it's unlikely that the company will get paid for an accelerating rate of growth. With Chipotle growing at 125+ stores a year, the heat in on Qdoba not to fall too far behind, a situation that is not necessarily good for shareholders.


The company is increasing its Jack in the Box company openings in FY09 at the same time it is accelerating the refranchising program. Increasing company new unit development is clearly inconsistent with the company's refranchising goal of operating less company restaurants.
The company has attributed part of the increase in capital spending each year since at least FY06 to its ongoing reimage program at Jack in the Box so it is spending incrementally more on these reimages each year. In FY08, the capital spending increase was also attributed to a kitchen enhancement program at Jack in the Box (a program to increase restaurant capacity for new product introductions while reducing utility expense using energy-efficient equipment) and the purchase of smoothie equipment.


While these non customer-facing initiatives, such as the kitchen enhancement program and the purchase of smoothie equipment, are important, they do not typically generate incremental returns. Based on my estimates, with the number of new company units coming down in FY08, these non customer-facing initiatives grew as percent of overall capital spending at the same time capital spending grew 17% YOY, thereby explaining the decline in returns. The company plans to maintain the same level of capital spending over the balance of FY09 but with new company unit growth accelerating in FY09 relative to the prior year and the kitchen enhancement spending wrapped up in FY08, a greater level of the spending should be allocated to more customer-facing and typically higher return initiatives.


The real turnaround in returns could come in 2010. The company's exterior reimage program is expected to be complete by the end of fiscal 2009 and the interior reimage program finished by 2011 so the level of capital spending associated with these reimages should be less going forward. If the company keeps its new unit growth in check and more prudently manages its capital spending, cash flows can be redeployed to shareholders, thereby providing a positive catalyst for the stock.