Get to Know JACK

 | Sep 19, 2012 | 2:00 PM EDT  | Comments
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Unless you live in the western half of the U.S., Jack in the Box (JACK) is not a name that comes to mind when you think of fast food burger chains. For investors, it may be time to look closer at this restaurant chain. Even though the shares are sitting near a 52-week high of $28, there are layers of value that could manifest very nicely over the coming year or two.

Many consumers may be giving JACK a lot a business without even knowing it as the company also owns fast-growing Mexican brand Qdoba, which sells freshly made burritos, tacos and the like. In addition to its 2,242 Jack in the Box restaurants, the company operates more than 600 Qdoba locations nationwide. Of those, approximately 50% are franchised. The company breaks out the earnings of each segment in its financial reporting, which is a positive sign that one day Qdoba could be spun out to shareholders. Looking closely at the valuation of JACK as a whole, it's clear that the parts are worth more than the whole.

JACK currently has a market cap of $1.2 billion and an enterprise value (EV) of $1.7 billion. The company currently trades for 8x EV/earnings before interest, taxes, depreciation and amortization (EBITDA). The company's growth plan involves doubling the Qdoba restaurant count by 2015 and a long-term growth target of 2,000 units of which about 30% to 40% will be franchised. For the nine months ending July 8, 2012, the company-owned Qdoba restaurants generated around $210 million in sales, or an annual run-rate of nearly $300 million when you consider that same-store sales are increasing by 3% to 5% each year. So by the end 2015 with 1,200 Qdoba locations, assuming a 50/50 split between owned and franchised, the owned Qdoba's could be generating in excess of $700 million in sales. Chipotle Mexican Grill (CMG), which is currently the most successful U.S. Mexican restaurant concept (by far), trades for 4x sales -- and one can easily argue that its valuation is inflated due to Chipotle's phenomenal growth.

I'll give Qdoba a P/S ratio of 1.0, so the Qdoba operation is worth $700 million. But I'm not even counting the value of the other 500-600 franchisees that could be in existence by 2015 and that will subsequently be spinning off high-margin franchise fees. Chipotle, with over 1,300 locations, is being valued at $10 billion, which is perhaps not a realistic valuation. Therefore, if you value Qdoba's 1,200 restaurants in the next three years at 15% of the Chipotle figure, you get a value of $1.5 billion. In other words, the anticipated Qdoba growth means you are getting more than 2,000 Jack in the Box locations for free. Those locations, 75% which are franchised, pull in around $1 billion in annual revenues and over $70 million in operating income. 

JACK's strategy is seeking to increase the number of franchise locations. The reason is obvious: Franchisees are equivalent to annuity like cash flows. From fiscal 2006 to fiscal  2011, JACK has grown its consolidated franchise revenues from $110 million to $280 million. EBITDA from those revenues in fiscal 2011 was $170 million -- a margin of over 60%. As the company continues to reduce owned locations in favor of franchised ones, margins increase, which tends to lead to higher valuation multiples.

Because JACK currently has all these moving parts, the true valuation picture gets confusing. But that will clear up over the coming years and, as it does, investors could potentially have a total share price above $50 compared with $28 today.

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