Following the release of third-quarter 2013 results on Oct 28, Spartanburg, South Carolina-based restaurant chain, Denny’s Corporation’s (DENN - Free Report) share price has declined 3.8%. We believe lower-than-expected revenues, higher costs and reduced margins are responsible for such disappointing results.
In the third quarter, Denny’s adjusted earnings of 8 cents per share were in line with the Zacks Consensus Estimate but above the year-ago quarter’s earnings of 6 cents by 33.3%. Earnings in the quarter received a boost from lower interest expenses and reduced share count in the quarter.
Total revenue was nearly $117.3 million missing the Zacks Consensus Estimate of $119 million by 1.4% and the year-ago quarter’s revenues of $121 million by 3.1%. Lower company restaurant sales pulled down the revenues during the quarter.
Performance Highlights in the Quarter
During the quarter, sales at the company-operated restaurants declined 3.7% year over year to $83.4 million, due to the decline in the number of company restaurants resulting from the company’s refranchising activities. Same-restaurant sales (comps) at company restaurants were up 0.7% on the back of an increase in the same-store average check, offset by lower traffic.
Franchise and license revenues decreased 1.4% year over year to $33.9 million owing to lower occupancy revenues and reduced initial fees. Comps at franchised restaurants were up 1.3% with the rise in guest check average offsetting the decline in same-store traffic.
Domestic system-wide comps nudged up 1.2%, higher than a 0.5% growth in the year-earlier quarter.
Company-operated restaurants’ operating margin contracted 240 basis points (bps) year over year to 12.3% due to a rise in the product cost, higher payroll and benefits costs, and increased other operating costs. Franchise operating margin expanded 90 bps year over year to 65.8%, driven by higher royalty and licensing margin. Total operating margin reduced 120 bps year over year to 27.8% due to lower company restaurant operating margin.
During the quarter, the company unveiled nine franchised unit and shut down 13 franchised restaurants. At quarter-end, the company had 164 company-owned and 1,522 franchised and licensed restaurants. Apart from this, Denny’s acquired a restaurant in Columbus, Ohio.
The company remains steadfast in its goal to expand internationally. It has recently added a restaurant to its Latin American portfolio by opening a unit each in El Salvador and Chile.
The company now expects the number of openings to be at the lower end of its previous guidance of 40–45 franchised restaurants in 2013. The restaurateur also intends to shut down 35–40 restaurants in 2013.
Denny’s ended the third quarter with cash and cash equivalents of $6.3 million versus $2.0 million in the prior quarter. Long-term debt, at quarter-end, came in at $152.5 million as compared with $153.8 million at the end of the second quarter.
During the third quarter, the company bought back 1.8 million shares worth $10.2 million. Currently, 9.7 million shares remain under the company’s existing share repurchase program. Since the beginning of its share repurchase in 2010 the company has repurchased 15.3 million shares worth $69.2 million.
For 2013, Denny’s reiterated its comps guidance. The company continues to expect that its domestic system-wide comps growth will be within the range of 0%–1%.
In 2013, commodity cost is expected to be 2.5%, within the company’s prior guidance range of 2%-3%. The company continues to expect its franchise margin to be at the higher end of its prior estimate of 65%–66%. However, Denny’s believes that its restaurant margin will be lower than its initial guidance range of 14%–15%.
The company continues to believe that capital expenditure will be within $20 million–$22 million.
Denny’s has undertaken several initiatives such as menu innovation and aggressive expansion to significantly drive revenues. The company is increasingly focusing on refranchising to generate more free cash flow.
Although, Denny’s’ earnings were in line with the Zack Consensus Estimate in the third quarter, we remain concerned about the lower top line and muted comps growth.
The Zacks Rank #4 (Sell) company is still at the transitional stage and will take some time to stabilize the operation both at company-owned and franchised units. Continuous decline in margin in the past few quarters also remains an overhang.
Other Stocks to Consider
Some other players in the restaurant industry which look attractive at the current level include Red Robin Gourmet Burgers Inc. (RRGB - Free Report) , Cracker Barrel Old Country Store, Inc. (CBRL - Free Report) and Bob Evans Farms, Inc. (BOBE - Free Report) . While Red Robin holds a Zacks Rank #1 (Strong Buy), Cracker Barrel and Bob Evans Farms carry a Zacks Rank #2 (Buy).