DineEquity (DIN), the $1.4 billion owner of chains like Applebee’s and IHOP, is on the Hedgeye Restaurants Best Ideas list as a short. Why? The company is currently grappling with struggling business fundamentals and the precarious nature of its balance sheet.
The cracks in the company's foundation are beginning to show.
Yesterday, DineEquity announced the closure of two locations, including an Applebee's opened 30-years ago in Kansas City, when the budding restaurant chain had just eight units in Atlanta, two in Dallas and one in Houston.
As you may remember from our December Black Book, we highlighted our belief that recent franchisee hardship would ultimately lead to unit closures. Overall, our key points included:
- Business Fundamentals Are Deteriorating: The issues with the casual dining space are well documented. That being said, there are some brands in casual dining that are doing well and there are those that are failing. Applebee's is one of the old line brands that is failing and its food offering is stale and uncompetitive in the marketplace. Significant market share losses, little re-investment in the brand, strategic operational errors and vacant executive positions are only some of the issues the company faces. We believe the company's ability to fix these issues are limited and it will be expensive to execute.
- Franchisees Are Struggling: The heart and soul of the DIN business model is the health of the Applebee's franchisees. To this end, there are significant issues and a number of franchisees are rumored to be in significant trouble. Years of market share losses and mismanagement have finally taken its toll on the company. Franchise profitability has been declining for years and the latest decline in same-store sales could be the tipping point for some franchisees.
- Financials Are Strained/Significant Balance Sheet Liabilities: Today, DIN finds itself in a precarious financial position. Given the decline in the profitability of the franchisees, the company needs to invest in the business, but it had limited financial resources to do so. The company’s significant leverage, off balance sheet liabilities and 62% dividend payout ratio are only the start of the issues. As franchisee profitability continues to decline and the need for incremental investment grows, the pressure on the company's financials will be significant.
Well it now appears that the chickens have come home to roost, as struggling sales, aggressive discounting, and continued weak traffic have forced Applebees to permanently close its doors at multiple locations.
In a recent development, the Company reported yesterday that it has closed two locations, including the first unit to open in the Kansas City market, which opened its doors 30 years ago at The Watts Mill Plaza. The other unit closed was the Olathe, KS location on the outskirts of the Great Mall of the Great Plains, a mall that closed its door in mid-2015.
An Applebees spokesperson did not disclose the specific reason for the closures, only stating that:
“From time to time, like other brands with large, national footprints, locations close. Restaurant closures occur for many reasons ranging from change in trade areas to lease and franchise agreement expirations.”
However, it is safe to deduce that the brand’s recent struggles played a significant role, as franchisees are among those that have been hit the hardest.
Editor's Note
This is from an institutional research note written by Restaurants analysts Howard Penney and Shayne Laidlaw. To learn more about our institutional research ping sales@hedgeye.com.
