Can These Quick-Service Restaurant Chains Serve Long-Term Profits?

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Avid consumers of burgers and fries may call them fast-food joints, but the industry prefers the term "quick service restaurant," or QSR. In its January 2013 edition, trade publication QSR magazine predicted trends for 2013 including continued economic headwinds -- although the National Restaurant Association expects that the quick-service sector will grow faster than the industry as a whole. 

When we review the results for three prominent quick service chains, you can definitely feel the headwinds, but we also see a rigorous effort to operate more efficiently. These companies are also striving to keep competitors from stealing market share, by understanding what consumers want from the quick service experience and delivering it to them. Quickly.

Not exactly a Sonic boom

For the third fiscal quarter ended May 31, Sonic (NASDAQ: SONC) reported net income of $14.8 million, a tiny percentage increase over the $14.4 million earned during the same period last year. Same store sales increased only 0.1%, with results somewhat better at franchise drive-ins compared to their company owned drive-ins.

In the company's press release, management cited bad weather as a factor for the slow sales growth. This negative effect was partially offset by its national advertising campaign yielding positive results; bad weather can't completely trump good marketing.  

In its fiscal 2013 outlook, Sonic anticipates margins will improve 50-75 basis points, as sales rebound and the company's investment in technologies shows results in terms of operational efficiencies. They expect to grow their chain by adding 25 to 30 new franchises.

Sonic's franchise-oriented business model allows the company to harvest cash earned from royalties and not have capital tied up in buildings and equipment. This cash can in turn be used to pay down debt, repurchase shares of common stock and continue capital expenditures in new technologies and their supply chain management system.

Revenues not so jacked up

Franchising -- or more precisely, turning company-owned stores into franchises -- is also a strategic theme for Jack in the Box (NASDAQ: JACK). Of the 2,256 Jack in the Box restaurants at the end of the quarter, 1,710 of 75% were franchise locations. For its second quarter ending April 14, the company reported income from continuing operations of $13.4 million, seemingly a large drop from the $21.6 million earned the previous year. The results were skewed by a $14 million gain on the sale of company-owned stores in the second quarter of 2012. With that taken out, the company performed better than the previous year.

During the quarter, same-store sales for combined company- and franchise-owned stores rose 0.1%. The company said this was 1.9% higher than the results for the QSR sandwich group as a whole, as reported in NPD Group's Sales Track Weekly.

The company expects third-quarter sales results to slightly underperform last year's results. The transition to the franchise model allows the company to gradually lower its costs as a percentage of sales. This was reflected in operating margins for the Jack in the Box stores being up 160 basis points in the 2nd quarter.

More than just a morning show

Dunkin' Brands (NASDAQ: DNKN) had a very satisfactory first quarter of 2013, with U.S. comparable-store sales for their Dunkin' Donuts locations up 1.7% and adjusted operating income growing 12.2%. The company has now achieved 45 consecutive quarters of comparable-store sales growth. Keys to their growth strategies in the last several years have included menu innovations to move the company out of donuts-and-coffee mode. For example, in 2012 they introduced an Angus steak sandwich and breakfast burritos. In its investor presentation, management cited the benefits of offering "high margin differentiated beverage and food products."

This company seeks to capture customers well into the afternoon hours. To that end, more than 1,800 franchise locations have been remodeled in the last four years. They recently introduced a strikingly modern update to their restaurant design. Features include a refrigerated "Grab N' Go" cooler -- presumably, the customer stays long enough to pay -- and electrical outlets for customers who want to sit down, relax and use their smartphones and computers. 

This is an excellent idea on the part of Dunkin' Brands to utilize its space for a bigger portion of the day. After all, the company or the franchisee is paying rent for the full day. In my view, they could do a little better job of promoting this aspect of their strategy. They start off behind in the mid-day sandwich race by virtue of the name of their company. 

Quickly serving up my choice

My favorite of these three companies is Dunkin' Brands. Although they have expanded their menu, they haven't gone overboard and added more items than they can execute well. As industry observer Carol Tice pointed out in, large menus translate into having to manage the costs of more ingredients and offer more employee training to execute all of these choices.

Consistently increasing same-store sales each quarter is the hallmark of a restaurant chain that understands its customer base extremely well. Dunkin also expanded aggressively despite industry-wide concerns about the economy. They added 108 new restaurants worldwide during the quarter. This shows management's confidence in the future of its brand. And in view of the company's excellent same-store sales growth performance, the market is definitely receptive to more Dunkin' locations opening. 

Brian Hill has no position in any stocks mentioned. The Motley Fool recommends McDonald's and Starbucks. The Motley Fool owns shares of McDonald's and Starbucks. 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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