2023-12-28 13:00:46 ET
Summary
- Dine Brands has significantly underperformed its peer group in the restaurant industry over the past two months.
- The underperformance isn't surprising with comp sales lagging its peers at both brands (Applebee's/IHOP) and annual EPS set to come in well below 2019 levels.
- In this update, we'll dig into the Q3 results, recent developments, and where the stock's updated buy zone lies.
Just over two months ago, I wrote on Dine Brands ( DIN ), noting that there was no reason to rush into the stock ahead of its Q3 results with weak industry-wide traffic and no margin of safety present in the stock. Since then, Dine Brands has massively underperformed its peer group (2% return vs. a ~20% gain for the restaurant industry group), and suffered a 15% drawdown from the $50.00 level into its Q2 report. And while the company noted that it "demonstrated solid performance" , I would argue that this is a generous assessment of the results with same-restaurant sales lagging its peer group despite heavy promotions in the period.
In this update we'll dig into the Q3 results, recent developments, and where the stock's updated buy zone sits.
Q3 Results
Dine Brands released its Q3 results in November, reporting quarterly revenue of $202.5 million, a 13% decline from the year-ago period. The sharp decline in revenue was related to re-franchising of 69 Applebee's restaurants, resulting in a significant increase in franchise revenue ($172.5 million vs. $164.9 million), offset by a sharp decline in company-owned store revenue ($0.3 million vs. $38.2 million). However, while this explains the softer Q3 sales performance, the comp sales performance was underwhelming, with comp sales down 2.4% at Applebee's (2-year stacked growth of 1.4% despite significant pricing actions) and just 2.0% comp sales growth at IHOP or 2-year stacked comp sales growth of just 3.9%. Notably, this was despite promotions like All You Can Eat Wings and Kids Eat Free/All You Can Eat Pancakes at IHOP.
The lower comp sales growth was despite ~4% price increases at Applebee's and ~8% at IHOP, implying significant traffic declines.
Dine Brands Quarterly Revenue - Company Filings, Author's Chart
Digging into the results a little closer, Dine Brands clearly saw some impact from the tough macro environment and promotional activity, with the company noting that "guests are limiting discretionary spending and have become more selective where they choose to spend" . This is not an entirely new development and other casual dining brands have warned of early signs of check management and consumers being more judicious as early as Q1 2023. Still, companies like First Watch ( FWRG ) are finding ways to grow dining room traffic, and it certainly isn't ideal from a margin standpoint for its franchisees that ~16% guests are ordering from limited time and value menus year-to-date. Additionally, it's not encouraging to see that despite being more promotional, Applebee's/IHOP still underperformed its family dining peers according to Black Box, with the only outperformance coming during heavily promotional periods intra-quarter like its All You Can Eat Pancakes in August.
As for the company's financial results, Dine Brands reported net income of $18.5 million (Q3 2022: $20.9 million), with higher interest expense and G&A costs. Meanwhile, adjusted earnings per share [EPS] came in at $1.46 (Q3 2022: $1.66), and adjusted EBITDA slipped to $60.6 million vs. $63.6 million. Finally, the company ended the quarter with $160 million in cash and over $1.0 billion in net debt, placing its net debt/EBITDA ratio above 4.0x on a forward basis and far more leveraged than its peers.
Recent Developments & Industry Trends
Starting with positive developments, the strength in the stock market/cryptocurrencies and tick up in housing prices could have a positive impact on consumer sentiment and provide a tailwind from the wealth effect after a brutal year in 2022 and the first half of 2023. In addition, gas prices have remained well off their highs for an extended period and are sitting at ~$3.10/gallon, which is often positive for restaurants as consumers are at least getting relief in some areas to counteract rising mortgage/rent, grocery, and utility costs, among other general inflation. In addition, we saw seated diners growth in the back half of December for the first time in nearly six months according to OpenTable, but it will be interesting to see if this was only seasonal or remains past the holiday season.
National Gas Prices - AAA Gas Prices
Seated Diners Growth - OpenTable
As for the negatives, there were several. For starters, Dine Brands continues to be one of the few brands in the restaurant space with a steadily declining store count at Applebee's, meaning it's entirely reliant on comp sales growth to grow sales unlike peers such as Restaurant Brands International ( QSR ), Chipotle ( CMG ) and others that are growing units at or above 5% per year. Second, the company shared on its Q3 Call that the tougher macro environment is leading consumers to not only choose between Dine Brands and other restaurants, but also cooking at home, and this isn't overly surprising with Dine Brands skewing to less affluent customers vs. some of its peers, with low personal savings rates currently and elevated credit card debt. On the opposite side, Brinker ( EAT ) shared that it's seeing a little less impact as it's gotten away from deep discounting and is now averaging a higher income consumer, with these consumers less sensitive to price.
"At the same time, we believe the decreased personal budgets are leading guests to ask, where should we go to eat less and should we just cook at home more. This means we're not only competing with other restaurant brands, but also with home-cooked meals."
- Dine Brands, Q3 2023 Conference Call
Looking at the other negatives, IHOP may have had a decent quarter with the benefit of Chicken and Waffles and Pancake Tacos, but it still underperformed peers in the period and Applebee's appears to be struggling to compete when comparing its comp sales growth against peers. Plus, while planned store refreshes and continued deep discounting might help to reverse this eventually, I'm less optimistic about its ability to continue raising menu prices and grow its store count with its main lever for growing traffic being deep discounting. Therefore, while the industry group might see slightly higher comp sales in 2024 despite macro headwinds with the benefit of pricing actions, Applebee's may have to be more careful with pricing given that traffic remains lower and lagging its peers. This is not ideal from a restaurant-level margin (franchisee health) or comp sales standpoint, and this could continue to weigh on sentiment and appetite for the stock.
Valuation
Based on ~15.5 million shares and a share price of $51.00, Dine Brands trades at a market cap of ~$800 million and an enterprise value of ~$2.2 billion. This makes it one of the lower capitalization names sector-wide, behind other casual dining brands like Darden ( DRI ), Texas Roadhouse ( TXRH ), and Bloomin' Brands ( BLMN ). However, while the stock may have underperformed its peer group and trades at a far lower valuation despite being 99% franchised, much of this can be attributed to the disappointing sales performance from its brands (primarily Applebee's), and its much higher leverage relative to peers. In fact, Dine Brands trades at one of the highest net debt/EBITDA ratios sector-wide and has some of the weakest comp sales growth, with IHOP and Applebee's underperforming the family dining segment in both Q3 and year-to-date.
Dine Brands - Forward EV/EBITDA Multiple - TIKR.com
Dine Brands vs. Peers - Valuation, Revenue Growth & Leverage - FinBox
So, what's a fair value for the stock?
Using what I believe to be a more conservative multiple of 9.0x EV/EBITDA (15-year average: 10.3x), and FY2024 estimates of ~$253 million, I see a fair value for the stock of $56.40. This points to an 11% upside from current levels (15% when including its industry-leading dividend yield), but I am looking for a minimum 25% discount to fair value when it comes to sector laggards even if they have a relatively low-risk and franchised business model. And after applying this discount, DIN's ideal buy zone comes in at $42.30, suggesting that the stock is nowhere near a low-risk buy zone after its recent rally. Hence, I continue to see DIN as a name that remains cheap for a reason (underperformance vs. other casual dining brands). Plus, while a ~4% dividend may be attractive to some investors, there are more attractive yields in other sectors with higher undervaluation, such as B2Gold ( BTG ) with a ~4.9% yield trading at barely 4.0x EV/EBITDA with significant growth on deck from its development-stage Goose Project (~60% operating margins).
Summary
Dine Brands had another disappointing quarter in Q3, and traffic was far weaker than I expected given the level of promotional activity in the period. And while a potential return to the wealth effect and the benefit of lower gas prices could provide minor tailwinds, it's still difficult to be overly optimistic about sales performance in 2024 for the industry after years of rising prices and many consumers (especially those that are less affluent) being pinched with personal savings rates remaining near multi-decade lows.
This doesn't mean that DIN can't rally after a year of underperformance, and a rising tide (overall market near all-time highs, with retail stocks perking up) could lift all boats. Still, I don't see any reason to pay over 9x forward EV/EBITDA for a company with flat to declining unit growth and underperforming comp sales performance even if investors are being paid to wait with a decent dividend yield. In summary, I continue to see more attractive bets elsewhere in the market, and I would need a pullback below $42.35 on DIN to become more interested in the stock as a potential turnaround story.
For further details see:
Dine Brands: Another Disappointing Quarter