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Marcato Capital Goes For Some Applebee’s With DineEquity

At the end of September, Marcato Capital had owned about 770,000 shares of DineEquity Inc (NYSE:DIN), a $1.2 billion market cap restaurant company which owns the Applebee’s and IHOP brands (check out more stocks that Marcato owned). The fund has since increased that stake to just over 1 million shares, giving it ownership of 5.5% of the shares outstanding. Marcato is managed by Richard McGuire, who had previously worked at Bill Ackman’s Pershing Square.

Mick McGuire

DineEquity Inc is in the process of converting part of its restaurant portfolio to franchises. As a result, its revenue was down 18% in the third quarter of 2012 versus a year earlier, and had also been down in the first half of the year, but gross profits were only narrowly lower as the company was also able to cut down on its restaurant expenses. General and administrative expenses did rise, and so net income fell substantially if we strip out gains from sale of DineEquity’s assets, but in theory the shift to franchising should give DineEquity more stability in its financials in the long term. Given that the stock’s beta based on historical results is 2.1, it’s possible that investors will benefit from more consistent performance at the company. DineEquity currently trades at 15 times analyst consensus for 2013 earnings- a lower multiple than at many other restaurants, though DineEquity is comparatively small in terms of market cap and looks to have a lower earnings growth rate than many of its peers. The most recent data shows that 12% of the outstanding shares were held short, so a number of market players are bearish on the stock. On the other side, Southeastern Asset Management, managed by Mason Hawkins, reported owning 3.1 million shares of the stock at the end of September (find more stocks owned by Southeastern Asset Management).

DineEquity is best compared to other restaurant companies which are focused on table-service restaurants. These companies tend to be seeing lower growth rates than quick service restaurants, but also as a rule have lower earnings multiples as the market expects less growth in the future. Denny’s Corporation (NASDAQ:DENN) and Cracker Barrel Old Country Store, Inc. (NASDAQ:CBRL) make for good peers. These companies trade at discounts to DineEquity in terms of their forward earnings, with P/E multiples of 14 and 12, respectively. Cracker Barrel can also boast improved revenue and earnings numbers in its most recent quarter compared to the same period in the previous year. We think that we’d avoid Denny’s, as that company seems to be struggling, but Cracker Barrel seems to be a more attractive value stock than DineEquity.

We can also compare DineEquity to Brinker International, Inc. (NYSE:EAT), which owns Chili’s and Maggiano’s Little Italy, and to Darden Restaurants, Inc. (NYSE:DRI), whose restaurants include among others Red Lobster and Olive Garden. Interestingly, these restaurants also have lower forward earnings multiples than DineEquity does, in the 11-12 range, even though they operate comparable- and, in the case of Darden, arguably better-performing- brands. Brinker has been seeing good earnings growth over the last year, and also made our list of the most popular restaurant stocks among hedge funds for the third quarter of the year (find more restaurant stocks that hedge funds liked), though these investors tended to prefer quick service restaurants. Darden’s recent performance has been more modest but it pays a 3.8% dividend yield at current prices and has a beta of 0.7. As a result it might be a good income pick, and wouldn’t be as exposed to the broader economy as might be expected of a table-service restaurant. At its current multiple it, as well as Brinker, is also a candidate for value stock status.

We think there are better picks in the restaurant industry than DineEquity. Perhaps once it has a couple more quarters under its belt we can see how the franchising plan is developing, but for now we see cheaper restaurants whose businesses are performing better.

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