JACK - Jack in the Box: Good Growth Prospects At A Reasonable Valuation

2023-08-16 12:28:20 ET

Summary

• Jack in The Box is well positioned for revenue growth with recent price increases, improving staffing levels, and growing digital channels.
• The company reported better-than-expected Q3 earnings with increased same-store sales and adjusted EPS.
• Price increases, promotional efforts, and new unit development are expected to drive future sales growth, while cost-saving measures and moderating inflation should support margin growth.

Investment Thesis

Jack in The Box Inc. ( JACK ) is well positioned to deliver revenue growth moving forward, benefiting from the carryover impact of recent price increases, as well as incremental price increases. In addition, the company should also benefit from improving staffing levels and the speed of services which is resulting in faster table turns. Further, good demand in the late night daypart and growing digital channels should also support the revenue growth.

Moreover, I expect that the company should be able to navigate macro headwinds and concerns regarding declining consumer financial health in an inflationary environment with the help of increasing promotional efforts and value offerings. In the medium to long term sales growth should benefit from acceleration of new unit development. On the margin front, the company should benefit from price increases, moderating inflation, and cost-saving and productivity initiatives. So, the company has a good medium to long-term growth prospects ahead, and given the lower-than-historical valuation, I continue to have a buy rating on the stock.

Q3 FY2023 Earnings

Recently, Jack in The Box Inc reported better-than-expected results for its third quarter of fiscal 2023. While consolidated net revenue decreased 0.3% Y/Y to $397 million, it beat the consensus estimate by ~$3 million. On a same-store sales basis, revenue increased by 7.9% at Jack in the Box restaurants and 1.7% at the Del Taco restaurants. Adjusted EPS increased by 5.07% Y/Y to $1.45, beating the consensus estimate by $0.11. The adjusted EBITDA margin increased 160 bps to 20%. The decline in consolidated revenue was due to lower transactions and tough comparisons, while same-store sales growth was driven by price increases. EPS and Margins benefited from price increases, moderating inflation, and cost-saving measures.

Revenue Analysis And Outlook

In my previous article , I discussed the company’s good growth prospects as a result of price increases, improving execution, and new restaurant openings. The company reported earnings for its third quarter of fiscal 2023 and similar dynamics were seen there.

In the third quarter of fiscal 2023, the company’s same-store sales growth continued to benefit from price increases. Moreover, the company experienced an improvement in staffing levels and operating hours which also contributed to same-store sales. However, this was partially offset by a decline in transactions (guest traffic growth). As a result, Jack in the Box's system-wide same-store sales grew by 7.9% year-over-year (YoY), with price increases contributing 8.7 percentage points and a favorable menu mix contributing 0.2 percentage points, partially offset by a 1 percentage point decline in transactions. Del Taco's system-wide same-store sales grew by 1.7%, driven by an 8.1 percentage point benefit from price increases, partially offset by a 2.4 percentage point decline in transactions and a 3.8 percentage point negative impact from an unfavorable mix. As a result, consolidated revenue decreased by 0.3% to $397 million.

Looking forward, I believe the company should be able to deliver sales growth as it benefits from price increases, increasing promotional offerings, improvement in restaurant-level execution, and new unit developments.

Over the last year, the company has raised its prices in order to protect its margins. This has been helping it increase same-store sales growth. I believe the company should keep benefiting from the carryover impact of price increases over the last few quarters. Moreover, the company also plans to take additional price increases (although not at a significant rate) moving forward. This should also help the company’s same-store sales growth moving forward.

While there are some concerns regarding lower consumer sentiments in an inflationary environment, I believe the company should be able to overcome it. With moderating inflation, the company does not plan to take significant across-the-board price increases like it did over the last several quarters. For the incremental price increases in the coming quarters, the management plans to take price increases as per the region or only in specific markets or stores, rather than implementing company-wide price increases. So, this should diminish the impact of price increases on customers.

Moreover, the company also plans to lean more towards the value side of menu offerings in the coming quarters and increase promotional activities. This should also attract consumers in an inflationary environment. Over the last couple of quarters, the company has launched various value meal offerings like 20 under $20 at Del Taco restaurants or $6 jack pack at Jack in the Box restaurants. These promotional meals have gained good traction among value-seeking customers and help offset demand headwinds from lower consumer sentiment for the company. I expect as the company further increases its promotional efforts and focuses on providing good value at those promotional prices, it should be able to attract guest traffic to its restaurants.

In addition, the company is also focused on improving its restaurant-level execution by increasing staffing levels to pre-pandemic levels and also improving the training process. In 2022, JACK strengthened its training program, which had previously been underutilized and unmonitored, and implemented a manager and team member certification requirement, in which all team members are trained to industry standards and as needed by the company to boost sales. In its Q3 FY23 earnings call , management mentioned that over 95% of the company staff has been trained as per the program and got certified since then. This is a progression from Q2FY23 where 93% of restaurant-level staff were trained and contributed to a 12-second improvement in the speed of service in Q3. I believe as the company continues increasing its staffing and more and more restaurant employees get properly trained, the speed of service should further increase and improve table turnovers. So, improving restaurant-level execution and customer service should help continued recovery in transaction growth.

Furthermore, the company is also doing a good job in growing its late-night daypart where demand for its food services is good. During the third quarter, the transactions grew by 3.1 percentage points YoY in the late-night daypart, which helped partially offset the overall decline in transactions. Late-night hours are becoming increasingly significant for the food industry. This is because many young consumers have a strong desire for food services during late hours. So, with an increase in operating hours and opening more restaurants late at night, JACK should be able to capture this growing demand and also gain market share gain from other burger chains. Additionally, the growing demand in the late-night daypart is also boosting the growth of digital channels as ordering from digital platforms is more convenient during late hours. This led to a 54% increase in web and app sales compared to Q3 last year. So, as the late-night daypart further grows with the increasing demand, it should also boost digital and delivery sales, supporting the overall transaction growth.

Lastly, for long-term growth, the company is also focused on restructuring its restaurant portfolio by exiting the lower-performing restaurants. Management believes that the restructuring is almost complete and is giving them the confidence to post positive net unit development in 2023 for the first time in 5 years (the total unit count has decreased since 2019, as closures of poor-performing restaurants have exceeded new openings). In Q3, the company opened 6 Jack in the Box restaurants, with 2 in Texas, 2 in California, 1 in Arizona, and its first in Salt Lake City. Speaking of firsts, the company is also progressing well in expanding its footprint in new markets. The company saw increasing traction for its brand in salt lake city as the new restaurant opening in salt lake city posted 66% higher sales in the first full operational month than the previous new market record at Jack.

The company is planning to open 3 additional Salt Lake City locations by the end of the fiscal year, which should further help the company gain market in the region and drive sales growth. Moreover, the company also has new market development agreements for Florida, Arkansas, Montana, Mexico, and Wyoming. This should also help the company strengthen its market position for long-term sales growth. Currently, the company has 82 Jack in the Box restaurants in the permitting, design, or construction phases, giving good visibility for the upcoming new unit development and a total of 77 new agreements for 340 new restaurant openings in the years to come. Similarly, for Del Taco the company has signed 20 agreements for a total of 153 restaurant openings in the coming years.

Hence, I believe the continuing staffing to pre-pandemic levels, increasing table turns, good demand at late night daypart, and acceleration of new unit development should help the company’s sales growth in the medium to longer term. So, I remain optimistic about the company’s medium to long-term sales growth prospects.

Margin Analysis And Outlook

In the third quarter of 2023, the company continued to battle inflationary headwinds and costs associated with its repair and maintenance program. This continued to impact restaurant and franchise-level margins at both the brands and the adjusted EBITDA margin. However, company-owned Jack in the Box was able to offset these headwinds through price increases, and a favorable menu mix, which resulted in a 600 bps YoY increase in restaurant-level margin to 21.8%, while the franchise business margin decreased by 30 bps YoY to 41.1% due to more pronounced inflationary headwinds.

Coming to Del Taco, the restaurants faced higher costs associated with repair and maintenance, which led to a 20 bps YoY decline in restaurant margins to 17.4% and an 800 bps YoY decrease in the franchise-level margin to 36.7%.

On the contrary, the adjusted EBITDA margin on a consolidated basis increased by 160 bps YoY to 20% due to lower SG&A expenses as a percentage of sales compared to the previous year and price increases.

Looking forward, I believe the company should be able to recover its margin as it gets benefits from the carryover impact of price increases and potential price increases in the coming quarters. Moreover, inflation is also moderating as the company is seeing the majority of commodity costs declining as compared to the previous year. In the third quarter of FY2023, commodity inflation was 5.2% Y/Y, which was sequentially lower than the 7.7% Y/Y commodity inflation in the second quarter of FY2023. So, this moderating inflation should become less of a drag on both restaurant-level and franchise-level margins moving forward.

Moreover, the company is also focused on driving cost-saving and productivity measures with an aim to gain annualized savings of $55,000 per restaurant or approximately 200 basis points improvement of restaurant-level margins. Standardized product builds are one example of a cost-cutting measure that should save a restaurant $2,900 per year while improving the ease of execution for team members. Other examples include cheese pumps saving $7,500 per restaurant annually by reducing prep and waste, and hydro rents which save $5,000 per restaurant annually by reducing labor and waste. Furthermore, the company is in the process of implementing a new POS system in company-owned restaurants in the coming quarters and franchise restaurants in FY24, helping in further reducing costs. These cost-saving initiatives should also support margin growth

Further, the company is also progressing well towards pre-pandemic levels of staffing in all of its restaurants. So, this should reduce the costs associated with hiring and training new employees. Moreover, as the company further certifies its restaurant-level staff with proper training, productivity should increase which should also help margin growth moving forward. Hence, I am optimistic about margin growth prospects in the coming years.

Valuation and Conclusion

Jack in the Box is currently trading at a forward P/E ratio of 13.22x based on the FY23 consensus EPS estimate of $6.10, and a forward P/E ratio of 11.81x based on the FY24 consensus EPS estimate of $6.83. These valuations are lower than the historical 5-year average forward P/E ratio of 16.39x. While there are near-term uncertainties regarding lower consumer sentiments, I believe the company is executing well to navigate those headwinds and sustain the top-line momentum even during adverse macroeconomic challenges.

Moreover, the medium to long-term growth prospects are also encouraging as the company should benefit from improving restaurant execution, increasing staffing levels, and new unit development. In addition, margins should also recover as the cost-saving and productivity measures take hold in the coming year along with moderating inflation. Hence, given the medium to long-term growth prospects and favorable valuation, I continue to have a buy rating on the stock.

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