Jack in the Box Plagued With Declining Comps & High Costs

Jack in the Box Inc.JACK has been grappling with declining sales for quite some time. A challenging sales environment in the U.S. restaurant space has resulted in constant deceleration of comps whereas high costs associated with restaurant operations have been potential headwinds for the company.

However, Jack in the Box recently reported better-than-expected results in the first quarter of fiscal 2018. Adjusted earnings of $1.23 per share surpassed the Zacks Consensus Estimate by 16% and increased nearly 15% year over year on margin improvement, driven by refranchising.

Notably, shares of the company have underperformed the industry in the past year. While the industry gained 13.1%, Jack in the Box's shares fell 7.6%. Moreover, earnings estimates for fiscal 2018 have gone down 11.2% over the past two months, reflecting ongoing pessimism in the stock's prospects.

Declining Comps Pose Concern

Owing to soft consumer demand, the company's sales have come under pressure. Comps at Jack in the Box company stores inched up 0.2% in the first quarter of fiscal 2018, comparing unfavorably with the prior-year quarter's rise of 0.6%. Same-store sales at franchised stores dipped 0.3%, comparing unfavorably with a gain of 3.9% in the year-ago quarter. Moreover, system-wide same-store sales fell 0.2% against a rise of 3.1% in the comparable period last year.

Qdoba generated a net loss of $0.6 million in the quarter against net earnings of $1.4 million in the prior-year quarter.

High Costs Amid Stiff Competition is Challenging

Jack in the Box has been bearing the brunt of high costs associated with restaurant operations. Costs related to marketing initiatives, unit expansion and opening of catering call centers are keeping the company's profits under pressure. Moreover, the company is also shouldering higher labor costs due to the implementation of The Affordable Care Act, commonly known as Obamacare, which is expected to have an adverse impact on margins, going forward.

Meanwhile, American dining brands are keen on expanding in the fast-growing emerging markets. While several other restaurateurs including Yum! Brands YUM , McDonald's MCD and Domino's DPZ have opened outlets in the emerging markets; Jack in the Box seems to be slow on this front.

Thus, limited international presence might be a big disadvantage for the company and hurt its competitive position. Moreover, the company is experiencing increased competitive pressure in breakfast and lunch day parts as many other restaurateurs have introduced aggressive value offers.

Franchise Business & Strategic Sell Out of Qdoba are Respites

Jack in the Box restaurants are currently 89% franchised, which the company plans to increase to around 95% by the end of fiscal 2018. We believe, franchising a large chunk of its system will lower its general and administrative expenses and thereby boost earnings. Moreover, over the long term, it would generate a higher return on equity by lowering capital requirements. This would also boost free cash flow, thereby enhancing shareholder return.

Also, given poor restaurant level execution at the company's legendary Qdoba chain, management made a strategic decision to sell the brand. In the fiscal first quarter, the company signed an agreement to sell Qdoba to Apollo Global Management, LLC. The transaction, however, is expected to close by April 2018.

We believe that by selling the brand, the company will free itself from the burden of operating under two business models, which have been more of a drag in the recent past.

Zacks Rank

Jack in the Box carries a Zacks Rank #4 (Sell).

You can see the complete list of today's Zacks #1 Rank (Strong Buy) stocks here.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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