DENN - Denny's Corporation: A Tale Of 2 Brands

2023-07-24 15:47:29 ET

Summary

• Inflationary pressures and market share loss to limited-service restaurants have led to a decrease in the number of Denny's brand restaurants in the US over the years.
• DENN's newly-acquired Keke's brand is expected to be a key short-term growth driver for the company, taking into account the brand's pipeline of new restaurant openings.
• I have a Hold rating for DENN, as I consider both the potential closures for Denny's brand restaurants and the new restaurant openings for the Keke's brand.

Elevator Pitch

I award a Hold investment rating to Denny's Corporation ( DENN ) stock. It is a tale of two brands for DENN; the number of restaurants for the legacy Denny's brand in the US has been on the decline, while the company has found a new growth driver in the form of Keke's, a business that it acquired last year.

Business Profile

In the company's media releases , DENN describes itself as "one of America's largest full-service restaurant chains" with 1,594 and 54 of its restaurants under the Denny's and Keke's brands, respectively as of March 29, 2023. Denny's Corporation is largely a franchisor, as less than 5% of its restaurants are directly operated by DENN.

Denny's Brand

The number of domestic restaurants for the Denny's brand has been decreasing in recent years.

DENN's restaurants branded as Denny's in the US rose by +0.7% from 1,599 at the end of 2015 to 1,610 as of end-2016, but things went downhill subsequently. The company saw the number of its domestic Denny's brand restaurants decline for six consecutive years for the 2017-2022 period based on my review of DENN's historical 10-K filings. Specifically, DENN had a much lower number of restaurants at 1,445 (versus 1,610 in 2016) under the Denny's brand in the US at the end of last year as per its FY 2022 10-K filing . To make things worse, the domestic restaurant count for the Denny's brand contracted further by -0.8% QoQ to 1,433 as of end-Q1 2023 as indicated in the company's Q1 2023 earnings presentation .

It is no surprise that DENN's top line growth for the past few years has been negatively affected by the decrease in domestic unit count for the Denny's brand. The FY 2016-2022 revenue CAGR for Denny's Corporation was a negative -1.7% as per S&P Capital IQ data.

DENN acknowledged at the company's prior Q4 2022 earnings briefing in mid-February this year that it had witnessed "a higher than average number of Denny's franchise closures" for 2H 2022 due to "the persistent inflationary environment." It appears that consumers have a preference for wallet-friendly limited-service restaurants over their full-service counterparts like the Denny's brand. According to research published by the American Farm Bureau Federation, full-service restaurants' share of US consumers' away-from-home food expenditures have stayed stagnant at 34% in 2022, which is the same market share it achieved for 2017. In contrast, limited-service restaurants have increased their share of away-from-home food spending in the US from 33% in 2017 to 35% in 2022.

It is worthy of note that Denny's Corporation has guided at its Q4 2022 results call that it expects "a similar closure rate" for 2023 vis-a-vis 2022. As such, it is reasonable to assume that DENN won't be able to achieve a net increase in the number of domestic Denny's brand restaurants in this year or anytime soon.

Keke's Brand

In the preceding section, I highlighted the full-service restaurants' market share loss to limited-service restaurants could be one of the key reasons for the poor performance of Denny's brand in the US in terms of network expansion in the last couple of years.

Another factor that might have affected the growth of Denny's brand is that this particular dining concept might have already reached its saturation point in the US with more than a thousand restaurants. In the middle of last year, DENN bought over Keke's Breakfast Cafe, which it referred to as a restaurant operator that "offers handmade breakfast and lunch entrees with fresh fruits and vegetables."

Keke's appears to be in the early innings of growth. There were only 54 restaurants branded as Keke's in the US, or more specifically Florida, at the end of the first quarter of this year as highlighted in DENN's Q1 2023 results presentation.

The Keke's brand has meaningful growth potential, considering its favorable diner profile and its focus on the attractive breakfast segment. At the company's Q1 2022 earnings call , Denny's Corporation highlighted that Keke's restaurants operate in "a category frequently used by millennials and Gen-Z families with kids whose household income levels skew above $75,000." Separately, there is lots of room for more people to eat breakfast outside of home, which points to a bright future for Keke's. I previously noted in my earlier July 20, 2023 article for First Watch Restaurant Group ( FWRG ) that "70% of breakfast occasions (in the US) are eaten at home."

DENN stressed at its Q1 2023 results briefing that it is targeting to "accelerate growth (for Keke's) in the back half of 2023 and into 2024", as it tries its best to "build a pipeline of both developers and site locations" for new Keke's restaurants.

The current sell-side consensus FY 2022-2027 revenue CAGR (Source: S&P Capital IQ ) for Denny's Corporation is +3.0%, which is a decent albeit unexciting rate of growth. In the short term, DENN's future top line expansion is expected to be largely driven by new restaurant openings for the Keke's brand. For the long run, there is still uncertainty over whether Keke's will be successful in new markets outside Florida when it eventually expands across the country.

Concluding Thoughts

DENN is in transition now, which justifies a Hold rating. On one hand, the company is trying to keep the performance of its legacy Denny's brand restaurants steady and limit restaurant closures. On the other hand, Denny's Corporation is planning for new Keke's brand restaurants to be opened in the months ahead, as the Keke's brand is still at the early part of its corporate lifecycle as evidenced by its current restaurant count at 54.

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