Glendale, California-based DineEquity Inc (NYSE:DIN) has nearly completed an ambitious and unprecedented restructuring project that has seen it relinquish its position as one of the largest owner-operators in the casual dining space. With the recent sale of its remaining Applebee’s locations in the Upper Midwest, the company has transformed itself into a franchise-only operation.
Going forward, its revenues will come primarily from franchise sales and ongoing royalty payments from its third-party operators. Although this will prevent DineEquity from reaping the full rewards of a significant upturn in the casual-dining business, it will also add some stability to its finances and insulate it from the whims of the notoriously fickle American consumer. Since its franchisees will shoulder a significant amount of the risk associated with operating the company’s Applebee’s and IHOP restaurants, DineEquity will enjoy reduced exposure to fluctuating food and labor costs as well. For shareholders, DineEquity’s restructuring also provides a tantalizing bonus: a reinstated quarterly dividend of 75 cents per share.
About DineEquity Inc (NYSE:DIN)
DineEquity is a food service company that owns, operates and franchises Applebee’s and IHOP locations in the United States and several key international markets. The company is the sole license-holder of both restaurant concepts. Applebee’s is a middle-market restaurant chain that offers a full lunch, dinner and drink menu at all of its standalone and mall-based locations. IHOP is a full-service restaurant chain that focuses on breakfast offerings like pancakes, waffles and egg-based meals as well as burgers, fries and other classic American fare. DineEquity Inc (NYSE:DIN) earned about $122.5 million on gross revenues of $849.9 million in 2012.
What the Company Is Doing
Since purchasing the Applebee’s concept outright in 2007, DineEquity Inc (NYSE:DIN) has embarked on a campaign to offload the chain’s restaurants to various franchise operators. Aside from 23 “test” locations that it will continue to operate for the purposes of testing new systems, procedures, menu items and decor choices, the company has now franchised all of its company-operated locations.
For shareholders, the most pertinent aspect of this restructuring will involve DineEquity’s decision to pay a healthy dividend. In effect, the company will return the bulk of the cash flow that it receives in the form of royalties and franchise fees to its shareholders as a $3 annual dividend. At DineEquity’s current share price of about $70, this represents a 4.3 percent annual yield. By comparison, the company’s main competitors offer yields of between 1.5 and 4.5 percent. This alone should make the company attractive to long-term investors.
Other Competitors in the Space
It is impossible to talk about DineEquity’s future prospects without mentioning a major competitor like Darden Restaurants, Inc. (NYSE:DRI). Given Darden’s lackluster financial performance, as well as its recent announcement that it would revamp its flagship Olive Garden chain, DineEquity’s risk-averse restructuring is especially noteworthy. Darden Restaurants, Inc. (NYSE:DRI) has had quarter after quarter of diminishing sales and net income. In terms of efficiency within the company, DineEquity has a profit margin of about 3 times that of Darden Restaurants, Inc. (NYSE:DRI), and DineEquity’s profit margin could increase with the restructuring. In fact, DineEquity seems to have decided that it cannot afford to make capital-intensive structural changes to its businesses on its own. Going forward, it will rely on its franchisees for such support.
It must also be noted that DineEquity Inc (NYSE:DIN) and other casual-dining chains have been and will continue to be disproportionately affected by the Affordable Care Act. Public companies like Papa John’s Int’l, Inc. (NASDAQ:PZZA) have adopted various strategies to deal with the coverage mandate for full-time employees, including price increases and working-hour cuts. Papa John’s strategy could lower unit sales due to the higher prices and increase training costs since more workers will need to be hired to fill the cut hours of many workers. While it is unclear if the new law will harm food service companies to the extent that many management teams have claimed, DineEquity’s decision to franchise the bulk of its locations will allow it to avoid adopting any new healthcare-related structural costs. Under the company’s new franchise model, its franchisees will be financially responsible for providing healthcare coverage for their hourly “full-time” employees.
Potential Complications and Long-Term Outlook
There are few established precedents for DineEquity’s new franchising strategy. It will certainly be one of the largest publicly-traded restaurant companies ever to adopt an all-franchise model for one of its core concepts. While there are plenty of privately-held food service corporations that maintain lean corporate structures and derive the bulk of their revenues from royalties and franchise fees, it will be interesting to see whether or not DineEquity can remain competitive as a public franchisor.
At the moment, there is no reason to doubt the company’s strategy. Although DineEquity’s most recent quarterly report had plenty of encouraging attributes, the company also reported a decline in revenue and customer traffic at both of its concepts.
While a lot of the revenue decrease can be attributed to the company’s ongoing operational divestiture, the organic component of the decline provides clear evidence that the company’s franchising strategy is prudent. In the future, DineEquity’s franchisees will be forced to absorb the lion’s share of such decreases. Of course, they will also be responsible for making the investments and capital improvements necessary to drive the chain’s organic growth. As such, DineEquity will be able to eliminate a significant drain on its bottom line by slimming down its centralized corporate structure.
In sum, DineEquity Inc (NYSE:DIN) is embarking upon an interesting experiment that may allow it to shrink its overall revenues while returning a significant amount of capital to its shareholders. It will be insulated from the volatility that characterizes the American casual-dining industry and rely on franchisees to drive its growth. As such, it may serve as a compelling component of consumer-focused investors’ medium-term and long-term portfolios.
The article Restructuring Could Lead to a Large Payoff originally appeared on Fool.com and is written by Mike Thiessen.
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