Sometimes, you can find good investment ideas by looking at the myriad of restaurants in your neighborhood. They may not all rank with huge global restaurant chains such as McDonald’s Corporation (NYSE:MCD); however, they may still be worth some of your research time. The three restaurant chains below reside in a turnaround situation that can profit the long-term shareholder.
From pancakes and steaks
Full service restaurant chain DineEquity Inc (NYSE:DIN) and its franchisees operate Applebee’s and the International House of Pancakes, or IHOP.
The company stands just shy of completing a move toward a 100% franchised system, a process that began five years ago. Last year, the company sold 154 IHOPs and Applebee’s each to franchisees, sacrificing short-term revenue for long-term gains in profit margins with franchisees doing most of the heavy lifting in terms of overhead.
DineEquity Inc (NYSE:DIN)’s revenue and free cash flow declined 21% and 62%, respectively, due to the significantly lower number of stores owned by the company. However, its net profit margins doubled from 7% in 2011 to 14% in 2012.
DineEquity Inc (NYSE:DIN) made strides in improving its balance sheet. Cash to stockholder’s equity stands at 21%. Its long-term debt to equity ratio stands at a monstrous 389%; however, DineEquity paid its long-term debt down $200 million last year.
With the future depending so much on its franchisees, it established a purchasing cooperative where the company’s franchisees can participate in the purchasing power of the company’s more than 3,600 restaurants. This better enables it to profitably sell to restaurant patrons at a value price.
The drive-in chain
National drive-in chain Sonic Corporation (NASDAQ:SONC) sells hamburgers, hot dogs, and ice cream. This chain probably appeals to you on a nostalgic level. Pulling into one of those drive-ins certainly provides an experience difficult to find elsewhere.
In recent years, Sonic Corporation (NASDAQ:SONC) experienced difficulty with product quality and the lack of a uniform national marketing campaign. The company made moves to invest in its national marketing efforts and improve product quality. Moreover, like DineEquity Inc (NYSE:DIN), Sonic is moving more to a franchised system and paying down debt. In addition, Sonic wants to build smaller store formats to better attract franchisees and to expand into smaller markets that wouldn’t necessarily support a larger restaurant.
In 2012, Sonic Corporation (NASDAQ:SONC)’s revenue declined 41 basis points due to the re-franchising of 34 restaurants. Its free cash flow increased 17%. Long-term debt declined 3% last year, but still comprises 788% of stockholder’s equity.
The company still needs to pay down significant amounts of debt before achieving a decent margin of safety. Last year, operating income only exceeded interest expense three times. A good rule of thumb calls for at least five times interest expense.
Sonic Corporation (NASDAQ:SONC)’s investment in marketing, product quality, and a smaller store format may prove beneficial to the company and its shareholders.
Hamburger deluxe
Casual dining chain Red Robin Gourmet Burgers, Inc. (NASDAQ:RRGB) defines itself on a pleasant dining experience. Interestingly, “Unbridled Acts” serves as part of the company’s culture where company employees can delight the customer with random acts of kindness.
Red Robin Gourmet Burgers, Inc. (NASDAQ:RRGB) sports the strongest fundamentals of the three companies discussed here. The company’s revenue increased 7% last year. However, its free cash flow declined 34%, stemming from lower operating cash flow and higher capital expenditures.
