JIB is a huge chain, in fact, it's one of the largest hamburger chains in the US with more than 2,200 locations. However, many investors have probably never visited one. That's because they are very geographically concentrated. About 70% of JIB's are in California (the company is based in San Diego) and Texas. So if you live on the East Coast or Midwest, there's a good chance you may have never even seen one but they are huge in California and Texas. Altogether, JIB has a presence in just 20 states, mostly in the Western and Southern US. As such, management believes that the JIB brand has significant growth potential in new markets. In FY11, JIB opened 31 new locations, about half were franchises. In FY12, the goal is top open 25-30 more. As a side note, their mascot is a guy with a ping pong ball for a head which is a little scary if you ask us but we digress.
Qdoba Mexican Grill: If you've never been to a Qdoba, it's very similar to Chipotle but with more variety and a bit more expensive. While both offer staples such as burritos, tacos and salads, Qdoba's menu includes a number of additional items including meat quesadillas, meat nachos and a number of signature queso sauces. The restaurants look a lot like Chipotle's restaurants, modern and clean. Most of its restaurants have a seating capacity of 60-80 and the average check in FY11 was $9.74. There are currently about 600 locations but management believes there is long term potential for 1,800-2,000 locations in the US. In FY11, JACK opened 67 Qdoba restaurants, including 42 franchise locations. In FY12, the goal is to open 70-90 restaurants.
Changing the Model
JACK has been undergoing a significant transition over the last several years. It is turning its core JIB business from a company-owned model to a franchise model and it's building out its key growth vehicle, Qdoba, which is moving to a company-owned model from a franchise model.
Let's get into the details a bit. Several years ago, the JIB segment was an 80% company-owned business with about 20% franchise. That's getting completely flipped as it's now about 70% franchise and the goal is to get it to 80%. The thinking here is that franchise dollars are much higher margin and less risky than operating the restaurants. The main benefit is that it allows JIB to transfer the capital and operating costs to franchisees. JIB's sales numbers will take a hit as it will record only the royalties and upfront fees as revenue but this will be much higher margin revenue. At the end of day, when the refranchising strategy is complete with an 80% target, JIB will run about 500 restaurants around that time.
On the Qdoba side, JACK has been moving the other way: from a franchise model to a company-owned model. Currently, the split is about 52-48 franchise/owned but the goal is to not only significantly grow the overall store count to 1,800-2,000 from 600 but the large majority of them will be company-owned (CMG currently has 1,250 locations). The transition is not going to happen tomorrow but JACK is making progress as company-owned is up to 48% from 40% a year ago. Also, JACK recently announced plans to rather significantly increase the rate of growth for new Qdoba stores to +15-20% per year. Part of that is being done by acquiring franchised locations. For example, in MarQ, JACK bought a set of 25 franchised locations from a single franchisee for $33 million. The rationale behind the shift to a company-owned model is that Qdoba has stronger margins and a much higher average ticket ($9.74 vs. $6.25) relative to JIB.
On a final note, here are some of the details on the franchise fees. The JIB franchise agreement generally provides for an initial franchise fee of $50,000. Then franchisees typically pay a 5% annual marketing fee plus a royalty fee usually around 5% although it can range from 2-15%. For a Qdoba franchise, it's usually a $30,000 initial fee. Then there is a 2% annual marketing fee plus a minimum 2% marketing fee that franchisees must spend on local advertising. Royalty rates are then typically 5% of gross sales.
Re-Imaging and Other Improvements
Shifting its owned/franchise model as discussed above is not the only change going on at JACK. A big initiative over the past couple of years has been to re-image and modernize JIB restaurants. Qdoba is a newer concept and was in good shape, but many JIB locations were dated. As such, JIB and its franchisees spent about $150-160k per store to make a number of improvements in order to become more current and contemporary. This included new signage, new logos, installing eco-friendly lighting, remodeling the dining areas and restrooms. New floors, ceiling tiles, wall coverings, light fixtures, plumbing fixtures etc. were installed. Also, its ADA violations were brought up to code inside and out. The remodel program was essentially wrapped up in January 2012 and early results have been encouraging.
It hasn't just been the remodeling. The company also improved the menu and improved its customer service. In terms of the menu, JIB is using higher quality beef and bacon. It also made improvements to its french fries and coffee.
On the customer service side, as anyone who has eaten at a JIB can tell you, it used to take a long time to complete an order. JIB had been notorious for taking longer than McDonald's or Burger King. Part of the problem is that JIB offers a much more varied menu, including tacos and breakfast can be ordered anytime of the day. To help solve this, JIB has worked with franchisees to rely more on time-of-day forecasting. Rather than waiting for customers to enter the restaurant, JIB relies more on historical data for sales patterns to start cooking when history shows that a lot of a certain type of food is sold during certain hours even if the restaurant is not crowded. This has resulted in higher food waste but it also has improved overall sales and margins. Franchisees have started to buy into the concept. They still lag competitors in terms of speed but that have made progress in closing the gap. Another customer service improvement has been better order accuracy.
Another focus, which started in 1H12 and is expected to continue in 2H12, has been a comprehensive review of the overhead structure, including evaluating opportunities for outsourcing, restructuring of certain functions and workforce reductions. Some steps were taken in 1H12 and management expects more restructuring charges in 2H12.
On May 16, JACK reported 2Q12 (Mar) non-GAAP EPS of $0.27, which was a $0.04 beat while revenue was roughly flat at $506.6 million vs. the $503.0 million consensus. The stock has rallied about 15% since this report. It was a good solid beat on the EPS line and a nice improvement from the penny beat in DecQ. The metric that stands out to us is the margins as operating margin improved to 15.5% from 12.3% a year ago. Management cites higher selling prices and a favorable product mix which suggests to us that the remodeling of the JIB stores appears to at least be partly responsible. Customers are simply willing to pay more for a nicer environment in which to eat.
However, it was not just that as management also cited the fact that Qdoba is becoming a larger part of the overall business. And this speaks to the increasing focus on quickly building out the Qdoba brand, which has a higher average ticket and higher margins. As JIB becomes more of a franchise fee collector (higher margin than operating the restaurant) and as Qdoba, which has higher margins, becomes a larger part of the business overall, that is having a meaningful impact on margins. Sales growth may not be that great because as JIB becomes more of a franchisor, sales will decline. The upside is that the sales that are collected will be much higher margin. On a final note, management noted that company-owned Qdoba restaurant operating margin improved substantially during MarQ, which is a good sign going forward.
Besides margins, the other standout metric from the MarQ report is same store sales: JIB was a nice performer, up +4.2% vs. +0.1% a year ago and vs. +3.6% in DecQ. Of note, the company-owned stores outperformed the franchise restaurants by a good margin: +5.6% vs. +3.6%. On the Qdoba side, even management concedes they were not up to expectations at +3.0% but that was against a tough +6.0% comp a year ago and owned outpaced franchise: +3.8% vs. +2.2%. On the call, management said this was due to fewer promotions in MarQ, so while revenue was hurt, margins were better. More promotions are expected though in JunQ and SepQ.