JACK - Jack In The Box: Transitioning Towards Long-Term Growth

2023-06-09 12:10:14 ET

Summary

• Jack In The Box's revenue growth is expected to benefit from recent and upcoming price increases, improved restaurant-level execution, customer satisfaction, and portfolio restructuring.
• Margins should also benefit from price increases, moderating inflation, and cost-saving measures.
• Valuation is lower than historical averages.

Investment Thesis

Jack In The Box Inc's ( JACK ) revenue growth is expected to benefit from the carryover impact of recent price increases, as well as additional price increases. Furthermore, management has been focused on transforming the business by improving restaurant-level execution, customer satisfaction, and the restaurant portfolio. This transition is expected to position the company for long-term revenue growth. Additionally, I anticipate that the company will be able to withstand macro headwinds and concerns regarding declining consumer financial health in an inflationary environment, supported by the general trend of consumers trading down to less expensive food options, which will benefit the Quick Service Restaurant ((QSR)) industry, including JACK's promotional efforts.

On the margin front, the company should experience benefits from price increases, moderating inflation, and cost-saving initiatives. Moreover, the company is currently trading at a discount to its historical valuation based on forward P/E. Taking into account the prospects of revenue and margin growth, I rate the company as a buy.

Revenue Analysis and Outlook

Jack in the Box has seen strong revenue growth in the last few quarters. The company’s revenue growth gained momentum following its acquisition of Del Taco in the second quarter of fiscal 2022. Furthermore, same-store sales also benefited from price increases in the latter half of the last year.

In the second quarter of fiscal 2023, same-store sales growth continued to benefit from price increases. Additionally, the company experienced an improvement in menu mix and overall staffing at its restaurants. As a result, Jack in the Box's system-wide same-store sales grew by 9.5% year-over-year (YoY), with price increases contributing 9.1 percentage points and a favorable menu mix contributing 1.2 percentage points, partially offset by a 0.8 percentage point decline in transactions. Del Taco's system-wide same-store sales grew by 3.2%, driven by a 9.9 percentage point benefit from price increases, partially offset by a 3.8 percentage point decline in transactions and a 2.6 percentage point negative impact from an unfavorable mix. Overall, consolidated revenue increased by 22.8% to $396 million.

Looking ahead, I believe the company should be able to achieve same-store sales growth by capitalizing on price increases, enhancing the guest experience through improved execution, and expanding digital channels.

Similar to others in the industry, the company has also benefitted from menu price increases to offset inflationary costs in the current macro environment. This strategy has contributed to same-store growth in recent quarters. The company anticipates implementing high single-digit price increases system-wide for the full year, indicating further price adjustments for both brands in the upcoming quarters. Therefore, I expect the recent price increases as well as upcoming price increases to continue supporting the momentum of same-store sales growth in the coming quarters.

In addition to pricing, the company has also been focused on transforming the company for long-term growth through improving customer experience at both brands. The main driver for enhancing guest experience is improving staffing levels and operating hours at restaurants. At the beginning of 2022, JACK strengthened its training program, which was not being used or monitored properly before, and implemented a manager and team member certification requirement in which all the team members are trained up to the industry standards and as per the need of the company in boosting sales. Since then, more than 93% of restaurant-level employees have been certified. This has resulted in faster guest service, fewer complaint alerts, and an increase in overall dining room operating hours to just over 13 hours per day on average. These operational improvements have helped the company in increasing overall guest satisfaction. Since implementing these guest experience standards a year ago, the company has seen a 20% improvement in standard execution from third-party assessments. The franchise restaurants are still behind the company-owned restaurants on most of these operational improvements. However , according to the company, they are working hard in implementing these training programs and catching up to the improved standards. So, as the franchises also enhance customer experience, I expect system-wide sales growth to further benefit from increased transactions and guest traffic.

Moreover, in order to increase the operating hours and further capture the demand for food services, the company has also been focused on increasing its operations late at night. The company believes that late-night sales represent an important and growing opportunity, supported by the trends of late-night food cravings of young consumers, and opening restaurants and drive-thru’s late-night could help JACK in gaining market from other large burger chains. This should also help in increasing transactions and support sales growth moving forward.

Additionally, JACK's digital and delivery channels have also shown improvement. Digital sales now account for 12% of the company's total sales, a significant increase from less than 1% in 2019. The company generates over $500 million in digital sales annually, combining both Jack in the Box and Del Taco. To further boost digital sales, the company launched a new app and web ordering platform in the first quarter of 2023. These platforms allow guests to conveniently place orders from any device, provide secure payment options, select favorite locations, and easily earn and redeem loyalty points through the Jack Pack rewards program. The introduction of these digital platforms has resulted in higher average check values, a sequential increase in transactions, and a 30% growth in web and app sales during the second quarter of fiscal 2023. Additionally, Jack Pack Rewards membership has increased by 45%. The recent launch of the digital app and website, coupled with the utilization of third-party delivery apps, is expected to further boost digital sales and support overall revenue growth.

Furthermore, the company is strategically positioning itself for long-term growth by restructuring its restaurant portfolio. This involves exiting lower-performing markets and closing underperforming restaurant units. As a result, the total unit count has decreased since 2019, as closures of poor-performing restaurants have exceeded new openings. However, despite the reduction in restaurant units, sales have improved as the restaurant portfolio now consists of higher-quality establishments. The company believes that the portfolio restructuring is nearly complete and anticipates positive net unit growth in fiscal 2023, aligning with its long-term target of 4% annual net new restaurant growth. Currently, the company has 61 restaurants in various stages of permitting, design, or construction. Moreover, JACK is expanding into new markets, with plans to open its first Jack restaurant in Salt Lake City next month, followed by three more in 2023 and at least seven in 2024, both as company-owned and franchise locations. Additionally, the company will open restaurants in Louisville later this summer, initially starting with company-owned establishments. The newest Jack drive-through, which opened in Q4FY22 in Tulsa, Oklahoma, has displayed strong early performance, surpassing expectations with average weekly sales of approximately $43,000 and demonstrating robust demand across different geographies.

The company has secured 76 new agreements, totalling 335 restaurants, in the last couple of quarters. These commitments include the addition of new Jack franchisees, as well as market launches in Florida and Arkansas. Furthermore, a Del Taco franchisee has made commitments to build both Jack and Del Taco restaurants in new markets in Montana and Wyoming, which is a significant expansion for the company. Additionally, a franchise agreement for 22 restaurants in Mexico has been obtained, taking advantage of the brand's recognition among Mexicans due to its proximity to many US restaurants. This growing restaurant pipeline is expected to drive long-term sales growth for the company.

While these development agreements may take time to be completed, it provides a good visibility for unit expansion over the next couple of years. So, I am optimistic about the company’s long-term growth prospects.

Margin Analysis and Outlook

Over the past year, the company's margins have been negatively affected by inflationary pressures on commodity and labor costs, as well as supply challenges, mirroring the challenges faced by the rest of the industry.

In the second quarter of 2023, these inflationary headwinds continued to impact restaurant and franchise-level margins at both brands, as well as the adjusted EBITDA margin. However, Jack in the Box was able to counteract these headwinds through price increases, sales leverage, and a favorable menu mix, resulting in a 640 basis points (bps) year-over-year (YoY) increase in restaurant-level margin to 21.4% and a 180 bps YoY increase in franchise-level margin to 41.2%. Conversely, Del Taco faced higher costs associated with repair and maintenance, leading to a 50 bps YoY decline in restaurant margins to 17.3% and a 440 bps YoY decrease in franchise-level margin to 37.3%. On a consolidated basis, the adjusted EBITDA margin declined by 10 bps YoY to 19.9% due to higher SG&A expenses as a percentage of sales.

Looking ahead, I believe the company is poised to achieve margin growth in the coming years. JACK has implemented price increases to offset inflationary headwinds, and management expects to continue with high single-digit price increases for the full year, which should help mitigate inflationary costs. Additionally, the company experienced a sequential decline in commodity inflation from 15.5% in Q1 FY22 to 7.7% in Q2 FY23. As inflation comparisons become more favorable in the latter half of fiscal 2023, the year-over-year inflationary pressures should further moderate. This, combined with price increases, will support margin growth.

Furthermore, the company is actively focused on driving cost-saving measures to protect margins. JACK anticipates achieving cost savings of $55,000 per restaurant per year by the end of fiscal year 2023. Examples of these cost-saving measures include standardized product builds, which will save $2,900 per restaurant while enhancing ease of execution for team members. Other examples include cheese pumps, resulting in a $7,500 savings per restaurant by reducing prep and waste, as well as hydro rents, which will save $5,000 per restaurant through reduced labor and waste, along with improved shake machine uptime and a 3-in-1 toaster to enhance service speed. These measures aim to reduce complexity and drive efficiencies amidst cost pressures. Additionally, the implementation of a new POS system in company-owned restaurants in Q3 FY23 and franchise restaurants in FY24 should further optimize costs and improve the guest experience through advanced tools such as automation and AI. The completion of this system upgrade by the end of fiscal 2025 is expected to contribute to margin improvement.

Considering these factors, I hold an optimistic outlook regarding the company's margin growth prospects in the coming years.

Valuation and Conclusion

Jack in the Box is currently trading at a forward P/E ratio of 14.97x based on the FY23 consensus EPS estimate of $6.08, and a forward P/E ratio of 13.41x based on the FY24 consensus EPS estimate of $6.79. These valuations are lower than the historical 5-year average forward P/E ratio of 16.66x.

I believe that management's ongoing transformation plan to establish a business for long-term profitable growth is yielding positive results. As the company resumes net unit expansion in both existing and new markets, sales growth is expected to accelerate in the coming years. The company is well-positioned to benefit from the consumer trend of trading down, which is advantageous for the Quick Service Restaurant industry. Additionally, JACK's promotional efforts are likely to drive demand in a challenging macroeconomic environment.

Furthermore, as inflation moderates and cost-saving measures take effect, I expect margins to return to pre-pandemic levels over time. Considering the long-term prospects for margin and revenue growth, as well as the lower valuation compared to historical levels, I recommend a buy rating on the stock.

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