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.
On a final note, JIB increased its market share in MarQ despite aggressive couponing by "a big competitor who is trying to make a resurgence." JIB same-store sales growth exceeded trends for the quick-service sandwich segment overall. The chain's promotion of bundled meals, which have favorable margins, rather than an emphasis on coupons helped in this regard.
When people think of Jack in the Box, they think boring burger chain. However, what you have here is a company that is undergoing a major change for the better that most investors are probably not aware of. By switching to a franchise model for JIB, that reduces a lot of capital and operating costs. And it's all high margin revenue. At the same time, the company sounds pretty optimistic about Qdoba's unit growth prospects (current 600 could eventually reach 1,800-2,000). They are going with a company-owned model there because it's higher margin.
There are risks here as JIB and Qdoba both have high exposure to commodities like beef and chicken. Also, while Chipotle appears to be the model, they are not in that league yet and may never be. However, they clearly are going in that direction (we would not be surprised if they changed their name to Qdoba at some point) and the store economics are similar. There will likely be bumps along the way but we think management is making the right decisions in terms of their JIB and Qdoba segments.
In terms of the standout valuation metric, its shareholder yield (dividends & share buybacks) rank is extremely high. JACK does not pay a dividend but it has been very aggressive buying back stock. For example, in MarQ, JACK had 44.9 million shares outstanding. While this is roughly flat with DecQ, it's below the nearly 51 million shares from the year ago period. That's a 12% decline, which is quite large in just a year.