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Jack In The Box (JACK): An Undervalued Stock Set To Witness Earnings Upside

 June 01, 2012 11:40 AM


( By Mani) Jack in the Box, Inc. (NASDAQ:JACK) could witness earnings growth, driven by improving store level economics at its leading brands, enabling the restaurant operator to post earnings ahead of Wall Street expectations.

Jack in the Box (JIB) restaurants, which accounts for 85 percent of profits, continues to turn around due structural enhancements. Meanwhile, Qdoba (15 percent of profits) appears to be on the right path by enhancing unit returns and lifting  investor confidence.

"We believe the Street underappreciates improving store level economics at both brands which could enable JACK's earnings trajectory to outpace expectations, Oppenheimer analyst Brian Bittner wrote in a note to clients.

[Related -Top Restaurant Stock Picks For 2013]

Positive comp momentum at JIB appears structural and is the result of successful turnaround initiatives such as food quality upgrades, new service-related initiatives and the completion of its store reimaging campaign.

"The two year trend continues to accelerate, and we estimate +8.4% for F3Q12, which would represent the highest level in five years," Bittner noted.

In addition, JIB store-level margin expansion is trending ahead of expectations owing to operating leverage from positive comps, easing commodity costs and accretive re-franchising benefits. There has been much debate about whether JIB margins can expand to levels that exceed 16 percent by fiscal 2014. The analyst expects this margin levels are achievable by fiscal 2013.

[Related -Jack In The Box: A Short And Long-Term Top Idea]

Store-level margins in the latest quarter expanded 320 basis points year-over-year to 15.5 percent. However, the store base still included 150 plus lower margin stores that will soon be re-franchised; a dynamic that is highly accretive to store-level margins.

Meanwhile, Qdoba should represent the company's vehicle for growth as company-owned Qdoba units expand 15-20 percent per year. Recent disclosure of new store margins and cash returns at the company's February 2012 analyst day were poor and cautioned investors on Qdoba's future growth strategy.

However, the analyst believes Qdoba store-level margins are showing early signs of improvement and the company appears committed to repurchasing accretive franchisee markets.

"Qdoba expectations are relatively constrained and could be a source of upside if core margin improvement continues, accretive franchisee acquisitions occur or new unit profits benefit from expansion into healthier newly acquired markets that remain underpenetrated," Bittner added.

On May 16, the company raised its fiscal 2012 operating EPS forecast to $1.00-$1.15, from 95 cents to $1.10, and bumped its restaurant margin guidance by 50 basis points. Both still appear conservative, especially as comps remain in line, food commodity inflation does not accelerate, and restaurant margins do not contract sequentially.

Meanwhile, the company long-term guidance of "at least $2" of EPS by fiscal 2015 versus estimated EPS of $1.00-$1.15 in fiscal 2012 looks conservative owing to potential for accelerating margin improvements and management's assumption for no share repurchases.

For the second quarter, San Diego, California-based company reported net earnings of $21.6 million or 48 cents per share, higher than $6.8 million or 13 cents per share last year. Excluding items, it earned 27 cents a share, which came in below Street expectations of 32 cents per share. Quarterly revenues rose $506.36 million from $505 million last year. Analysts estimated revenue of $502.86 million for the quarter.

"We believe JACK's earnings trajectory could build above-Street expectations as 1) JIB execution remains strong, 2) store-level margins at both brands expand, 3) Qdoba's overall unit economics improve and 4) JIB's re-franchising concludes," said Bittner.

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