DineEquity Has Run It’s Course

Owner of casual dining restaurants Applebee’s and IHOP DineEquity (DIN) reported first quarter results on Tuesday morning and the stock is trading down almost 11% in reaction to the news. The sell off was not due to disappointing earnings as the company reported net income of $19.7 million or $.75 per share, but when excluding one-time charges the results improved to $1.08 per share. Even though the company made $1.80 per share in the quarter a year ago, these results surpassed analyst’s expectations for $.78 per share. Unfortunately top-line results of $358 million declined by 4.7% and trailed expectations. Same-restaurant sales at IHOP slipped just .4% as Applebee’s fared worse declining 2.7%.

Turning around poor performance from Applebee’s has been a focal point for DineEquity management of late, and they are not finished yet. Applebee’s has introduced new under 550 calorie menu items with heavy advertising in order to set itself apart from the crowded space of neighborhood bar and grill restaurants. IHOP has also offered significant promotions to attract customers like it’s all you can eat pancakes, and sales at the breakfast focused chain have held up better than at Applebee’s. Sequentially, sales at both chains perked up in the quarter after far worse sale performance in the fourth quarter.

Operating performance improved in the quarter as DineEquity reduced general and administrative costs by 14.8%, although margins did fall due to promotional activities. The company continues to pay down debt as quickly as possible, as they reduced securitized debt by $55 million in the quarter, and they plan to reduce debt by between $118 million and $128 million for the full year. We believe that is the proper course of action as the company still has a considerable long term debt load in an environment where sales are slowing. In our view, debt should be used to fuel growth and when there is no growth debt can hang like an anchor on results. Until they start seeing more favorable sales trends year over year, we like to see them aggressively reducing debt.

As you can see from our Ockham historical ratings chart we liked DIN from a valuation perspective until recently. We actually downgraded DineEquity from Undervalued to Overvalued as of this week’s report, and though it was not our intent to time this move, it seems right thus far. The price-to-cash earnings and price-to-sales valuations are not particularly distressing at this time, and fundamentals are improving sequentially. However, we have become uneasy about a stock that had nearly doubled in the last three months coming into this week, and yet is seeing continued sales difficulty. Furthermore, the debt load is improving but debt reduction may restrict future growth as they devote resources to lessening leverage. Our advice to investors is to take profits if possible and look to stocks with more appealing long term value.

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