A Yummier Investment than Jack?

Dan is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Jack in the Box's (NASDAQ: JACK) stock has gone up more than 100% over the past three years, yet revenue has declined four years in a row. Jack delivered profits in each of the past four years, but overall, its EPS trend is down.

A fickle consumer is the biggest reason for its revenue decline and high commodity costs have helped to hurt its bottom line.  Strategic moves have aided the stock's ascent, but any sustainable stock price improvement is questionable.  In fact one of the company’s peers might offer a more logical investment.

The situation

Jack in the Box's current strategy is to cut costs to improve efficiency, which should then lead to earnings growth.  It's also moving more toward a franchise-based model. This will lead to margin improvement and improved cash flow, and since Jack will rely on fixed revenue from fees, risk will be reduced. Other focuses include emerging market expansion and brand recognition improvement.

As Jack in the Box works to improve, it continues to return cash to shareholders via share buybacks. With a debt-to-equity ratio of 0.86 versus an industry average of 0.9, management shows fiscal responsibility.  Not being crushed by a pile of debt also means it is free to return cash to investors in the future.

Jack in the Box will close 67 underperforming Qdoba locations by the end of the year, but will add 60-70 more Qdoba locations by the end of 2014. This might seem unusual, but it’s simply a matter of placing stores in higher-traffic areas. For now, these closings will reduce overhead, which should lead to stronger profits.

It should also be noted that these store closings will likely benefit Chipotle Mexican Grill (NYSE: CMG). Even if Qdoba locations were underperforming, they still had their fair share of loyal customers. Without Qdoba, customers are likely to get their Mexican fix from Chipotle.

Comps and guidance

In the second quarter, same store sales were flat at Jack in the Box, while comps at Qdoba slid 1.5%. Not surprisingly, management cited bad weather as the primary reason for lower comps at Qdoba.  Isn't the weather a universal reason for poor performance?  Some good news included an improved cash position, a decline in food packaging costs, and reduced payroll and employee benefit costs.

For the third quarter, Jack in the Box stores are expected to increase by 1% - 3%, and comps at Qdoba should be flat. Full year sales at Jack in the Box restaurants are expected to come in at 1.5% - 2.5%, and while at Qdoba sales are expected to be flat or slightly negative.

Management has also upped its full year guidance to $1.55-$1.65 from $1.48-$1.63. Commodity cost declines are said to be the primary reason.

Jack vs. peers

While share buybacks and cost-cutting are positives for investors, organic growth is what we're really looking for. With consistent declines in same store revenue, investors should be on notice.  While a true turnaround is still possible, better options, with growing sales, exist.

For instance, Chipotle’s revenue and earnings have consistently improved on an annual basis. With 67 Qdoba locations closing, top-line growth for many Chipotle locations may improve. Chipotle is also a cash-rich business with over $500 million available and no long-term debt.

Chipotle's management also demonstrates solid efficiency with a profit margin north of 10%. The only real negative for Chipotle is that it’s trading at 42 times earnings, which is very expensive for a restaurant chain.  Another potential negative is that the stock isn’t likely to be resilient if the broader market were to suffer a steep correction.

Yum! Brands (NYSE: YUM), owner and operator of Taco Bell, might not be as exciting as Chipotle from an investing standpoint, but it’s a safer option thanks to its massive brand and geographic diversification. Yum! has seen revenue increases for three consecutive years and earnings increases for four consecutive years. Yum! also yields 1.90%.

Its debt-to-equity ratio stands at 1.22 -- not great, but good enough to maintain dividend payments. Yum! is similar to Chipotle in efficiency, sporting a profit margin of 11%.  It's also a more mature company that offers better value, trading at 23 times earnings.

Yum! recently had some negative publicity in China, (related to the potential use of low-quality chicken at Kentucky Fried Chicken), as well as a decline in foot traffic due to an outbreak of the Avian flu.  When this smoke blows over, its business in China should rebound. 

Conclusion

Chipotle and Yum! have greatly outperformed Jack in the Box over the years, indicating stronger brands and better management. Jack in the Box is also the only company with consistent revenue declines and no organic growth, making it the riskiest investment of the group.  While Chipotle is a solid company, you're going to pay up for its quality.  So if you want a decent business, backed by steady growth at a fair price, consider looking into Yum!.

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Dan Moskowitz has no position in any stocks mentioned. The Motley Fool recommends Chipotle Mexican Grill. The Motley Fool owns shares of Chipotle Mexican Grill. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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