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Jack in the Box (JACK) Rides on Franchising Amid Competition

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Jack in the Box Inc.’s (JACK - Free Report) premium and value offerings, along with the increased focus on menu innovation, franchising and delivery are key growth drivers. The strategic sell-out of the Qdoba brand is also expected to reap benefits, going forward.

However, decelerating comps growth, rising costs, along with the stiff competition in breakfast and lunch day parts raise caution. In the second quarter of fiscal 2018, the company’s earnings and revenues not only missed the Zacks Consensus Estimate but also declined 7% and 21.1%, respectively, from the year-ago quarter. Also, system wide comps declined 0.1% in the first quarter while franchise comps dipped 0.2%.

Moreover, shares of Jack in the Box have declined 23.7% in the past year, widely underperforming the industry’s growth of 1.3%. Earnings estimates have also been revised downward over the past month, reflecting analysts’ concern surrounding the future earnings potential of the company.

Innovation in Menu & Delivery Services to Drive Sales

Jack in the Box, being one of the largest hamburger chains, makes regular menu innovations and also provides limited period offers (LPO) to drive long-term customer loyalty. With focused menu inventions around premium products like Buttery Jack Burgers, the company witnessed increased comps in the second quarter of fiscal 2018. At its restaurants, the company continues to combat heightened competitive activity around breakfast day part, and carry out aggressive value deals across the industry by menu innovations and value offerings.

The company is also increasingly focusing on delivery channels, which is a growing area for the industry. Given the high demand for this service, management has undertaken third-party delivery channels to boost transactions and sales. Currently, two-third of the restaurant system is served by major delivery companies like DoorDash and Grubhub. Jack in the Box is currently testing a mobile application in a few markets that support order-ahead functionality and payment. Management is reaping benefits in terms of higher ticket from the mobile orders.

Gains From Franchising & Qdoba Sell-Out

Jack in the Box restaurants are currently 90% franchised and the company plans to increase the number to around 95% by the end of fiscal 2018. We believe, franchising a large chunk of its system will lower its general and administrative expenses, and thereby boost earnings. Moreover, over the long term, it would generate a higher return on equity by lowering capital requirements. This would also boost free cash flow, thereby enhancing its shareholders’ return.  Notably, the company believes that the majority of Jack in the Box’s new unit growth will be through franchise restaurants. In fact, in the second quarter of fiscal 2018, the company sold 53 Jack in the Box restaurants to franchisees. Management has roughly 17 restaurants with signed LOIs, having a current 93% franchise mix.

Also, with the strategic sell-out of the Qdoba brand, management is expecting to gradually witness a reduction in SG&A in the second half of the fiscal. The Qdoba brand had become more of a drag in the past few quarters, given the poor restaurant-level execution and a choppy sales environment. In fact, it generated a net loss of $0.6 million in the first quarter of fiscal 2018 against net earnings of $1.4 million in the prior-year quarter.

Limited International Presence & Stiff Competition Raise Concerns

The American dining brands are keen on expanding in the fast-growing emerging markets. While several other restaurateurs including Yum! Brands (YUM - Free Report) , McDonald’s (MCD - Free Report) and Domino’s Pizza (DPZ - Free Report) have opened their outlets in the emerging markets; Jack in the Box seems to be slow on this front. Thus, limited international presence might be a big disadvantage for the company and hurt its competitive position. Moreover, the company is experiencing increased competitive pressure in breakfast and lunch day parts, as many other restaurateurs have introduced aggressive value offers.

The company operates in the retail restaurant space that is highly dependent on consumer discretionary spending. Consumers’ propensity to spend largely depends on the overall macro-economic scenario. Although higher disposable income and increased wages are favoring the industry right now, it can change with the slightest disruption in the economy. This Zacks Rank #3 (Hold) company, therefore, is highly vulnerable to the inconsistent nature of consumer discretionary spending. If it does not make pragmatic use of advanced technologies to innovate across value chains, it has high chances of fading out like many other restaurant retailers. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

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