In the Value Investing Challenge, over 100 contestants submitted investment ideas to a panel of judges, who then selected three proposals to be voted on. The winner of that vote was Ryan Fusaro’s pitch for Jack in the Box Inc. (NASDAQ:JACK), which he then delivered at the Value Investing Congress this month. Jack in the Box Inc. is a $1.2 billion market cap restaurant brand which also owns Mexican quick service restaurant Qdoba, and both operates and franchises locations under these names.
The company recently issued its 10-Q for the third quarter of its fiscal year (the fiscal year ended at the end of September) and in the first nine months its revenue was slightly down from the same period a year ago. Franchise fees were up as Jack in the Box Inc. continued a slow transition in the makeup of its locations to a model heavier on franchising, and but restaurant operations at its flagship brand were down 15%. The company is seeing good growth at Qdoba- revenues there were up 36%- but this has primarily been driven by an opening of new locations. With costs about even versus the same period a year earlier, net income was down 22%. However, heavy buybacks (shares outstanding dropped by 12%) caused earnings per share to only fall from $1.13 to $1.01. We’re not sure about the company’s plan for future buybacks; in the 10-Q it noted that the company had not yet touched its $100 million repurchasing program approved in November 2011. So we will assume that Jack in the Box will not get much, if any, growth in EPS from there. The company currently trades at 18 times trailing earnings, and with the sell-side expecting some growth next year the forward P/E is 17.
Hedge funds had been showing interest for some time: according to our rankings of the most popular restaurant stocks among hedge funds (see the full list) ownership of Jack in the Box rose from 11 filers in our database at the end of the first quarter to 16 by the end of the second quarter. This made it one of the few companies on the list to become more widely held by hedge funds and other major investors during the quarter. Positions generally were not large in dollar terms- this is only a $1.2 billion market cap company, after all- but had been increasing. Nantahala Capital Management, managed by Wilmot Harkey and Daniel Mack, more than doubled its stake to about 700,000 shares (find more stocks owned by Nantahala Capital Management). Canyon Capital Advisors initiated a position in Jack in the Box during the second quarter, closing June with about 650,000 shares (see more of their stock picks).
We would consider Burger King Worldwide Inc (NYSE:BKW), McDonald’s Corporation (NYSE:MCD), Yum! Brands, Inc. (NYSE:YUM), and The Wendy’s Company (NASDAQ:WEN) to be a good peer group for Jack in the Box, though we would note that all of these other restaurants are larger in terms of market cap and McDonald’s and Yum are much larger. All of these companies except for Burger King also joined Jack in the Box as popular restaurant picks among hedge funds. McDonalds and Yum are priced at about the same multiple, with trailing P/Es of 17 and 21 respectively, and offer welcome dividend yields (3.3% in the case of the Golden Arches). McDonald’s business is about stagnant, while Yum is seeing low growth. Given the larger size of these companies and their better record of returning cash to shareholders we actually think they may be relative buys compared to Jack in the Box, and certainly don’t see much of a value case for the smaller company on the surface. Burger King and Wendy’s are a bit more odd, with Wall Street growth expectations pulling them down to forward earnings multiples in the low 20s. Wendy’s in particular is barely profitable and it looks a bit overvalued compared to Jack in the Box. Burger King is at least seeing good earnings growth, but we still aren’t ready to buy a restaurant so high-priced on a forward basis until we can be convinced that the growth is sustainable.
Jack in the Box’s relatively low market cap means that it is under the radar for many investors. However, we don’t think that the company is a hidden gem- it trades at about the same P/Es as franchising-heavy McDonald’s and the market leader also offers a good dividend.