Applebee's and IHOP Shine While Competitors Continue to Suffer

Applebee's and IHOP Shine While Competitors Continue to Suffer

Earlier today, shares of DineEquity ,the parent company of both Applebees and IHOP rose as much as 12% on news that its earnings far outpaced analyst expectations for its third fiscal quarter. In what follows, we will look at what this means for the company and its shareholders moving forward as such a large share price appreciation indicates one of two things; either the company's future prospects should be better than they have been, or all of the "easy money" that came about as a result of owning shares has already been claimed.

Blowout Earnings!
For the third quarter of this year, analysts expected DineEquity, the parent company of Applebee's and IHOP, to earn $0.92 per share. However, the company presented investors with favorable results as its earnings per share came in at $1.10 after adding back certain transactions such as the amortization of intangible assets. Before adding back these charges, the company saw earnings per share of $0.97, 5.4% higher than expected. Though such a large surprise is good for shareholders, it's far lower than the $3.14 per share the company saw in the same period a year ago (but higher after you take out the $73.65 million it booked as a gain on the disposition of assets last year, which would bring its earnings per share in the third quarter of last year to $0.48).

Looking at the first three quarters of this year and comparing it to the same three quarters a year ago, we can see that the company's performance has shown continued improvement. After taking out the company's 9-month gain from the disposition of assets of $89.64 million, its earnings per share last year came in at $2.61. This implies a net profit margin of 8.3%, which is fairly attractive. But, it pales in comparison to the company's 9-month earnings per share of $2.76 (an increase of 5.7%) and a net profit margin of nearly 11% that it hit this year.

The reason behind DineEquity's recent improvement can be chalked up to two factors. The first is that the company has been seeing some attractive same-store growth in its IHOP restaurants, which, in this quarter compared to the same quarter a year ago, rose by 3.6% as the average guest check rose but was partially offset by a decline in traffic. On the other hand, the company's Applebee's restaurants saw a marginal decline of 0.4% in same-store sales as the chain has been unable to keep more customers coming in as prices rise.

The second factor has to do with the company's decision to increase the percentage of restaurants it franchises out from 91% of total locations last year to 94% this year. Although the increase isn't necessarily significant and has actually aided in the company's revenue declining, it has allowed management to cut franchise and restaurant expenses by 53.9% this quarter compared to last year's quarter, and by an even more impressive 58.2% for its first three quarters this year.

Is DineEquity eating alone?
Lately, shares of some casual dining companies have been underperforming the market. For instance, Darden Restaurants , the parent company of Olive Garden, Red Lobster, and LongHorn Steakhouse, has been struggling as its Olive Garden and Red Lobster chains have been hammered from same-store sales declining by 4% and 5.2%, respectively.

As a result of Darden Restaurant's lackluster performance, Barington Capital Group, LP, a private equity firm, acquired 2.8% of the company and has since been pressuring management to engage in a spinoff. Barington's proposal would include the company ridding itself of its underperforming assets so that the spun off entity could focus its efforts on cost-cutting and attracting new customers, while Darden's other chains could focus on growth.

Another underperforming restaurant chain recently has been Yum! Brands , which has seen its net income fall by 68% during its most recent quarter compared to the same quarter a year ago. In all fairness, a good portion of its decrease in net income can be attributed to a writedown of intangible assets pertaining to its Little Sheep acquisition it made in China last year, but even after taking out the company's one-time charge, sales trends have been disconcerting to say the least.

In addition to same-store sales declining by 16% year-to-date in China, the company's largest market, it has also seen its revenue in the United States fall by 13.2% as competitors like Chipotle Mexican Grill and Panera Bread Company are taking up market share through the advent of the quick-casual dining space. Even in the company's international segment, its revenue declined by 6.5% for the year, with only its India segment helping to offset its business.

Foolish takeaway
Moving forward, it's difficult to tell what is in store for DineEquity. The company has improved lately, but it would likely be irrational to expect any significant increase in margins as it is almost entirely franchised out (only 6% capacity remains). Furthermore, it appears as though its Applebee's operations may be at risk for lower profitability in the future if it can't justify its value proposition to both franchisees and customers. On the other hand, it appears as though its IHOP operations may continue to drive the company's future growth so, for those of you interested in acquiring shares of DineEquity (or trying to decide whether or not to keep your existing shares) and who consequently enjoy pancakes, now may be the time to go out and kick the tires by eating there a couple times.

On the plus side, it appears as though the company likely shouldn't collapse anytime soon, but I doubt that further share price appreciation is warranted in the near future since the company already trades at an expensive 19+ times 2013 earnings. So, with that being said, it may not be a terrible idea to sit by the sidelines and be picky about a purchase price if you like the idea of owning shares of this restaurant conglomerate.

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The article Applebee's and IHOP Shine While Competitors Continue to Suffer originally appeared on

Daniel Jones has no position in any stocks mentioned. The Motley Fool owns shares of Darden Restaurants. 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.

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