Sector financial performance:

This company, who is the franchiser of Applebee's (bar& grill) and IHOP (family dining), has been grouped into bar& grill - casual dining restaurants sector in foodservice industry.

It seems that significantly slowing down traffic is the major reason contributing to downturn in comparable sales of casual dining restaurants between 2015 and 2017. Data indicates the average increase in comparable sales all across this sector went down from around 1.7% of 2015 to around -0.6% of 2017: the average growth in comparable sales for bar& grill-sub sector went down from -0.9% to -2.4%, from 5% to -0.2% for American family sub sector, from 1.6% to 0.5% for Italian sub-sector, from 3% to -0.7% for Mexican sub-sector, from 1.7% to -0.7% for pizza sub-sector.  Correspondingly, what accompanied with declining sales is the decreasing traffic all across the sector during this period. For example, our data of casual dining sector indicates that the average growth in traffic for 2015, 2016 and 2017 was -1.1, -2.3, and -2.4% respectively including: 2%, -1.3%, and -1.3% for family dining restaurants; -1.6%, -3%, and -3.1% for bar& grill restaurants; -1.3%, -1.7% and -1.6% for Italian restaurants; -0.7%, -1%, and -2.3% for Mexican restaurants, -1.4%, -2.6%, and -2.7% for pizza restaurants.

Since 2017, it seems the downward trend in comparable sales (up by average 1.3% in first half of 2018 as compared with -0.6% of 2017) has been halted driven by slower decrease in traffic with rising price among almost all of sectors. In fat, for sectors experiencing continuing decrease in traffic, it has been increasingly difficult by rising price to offset the faster decreasing traffic/transaction. For example, in family dining sector, the average growth in comparable sales down to -0.4% in 2018 from -0.2% of 2017 as traffic went down further; For sectors experiencing recovery of traffic, we see increase in sales with slower rise in price. For example,  in Italian & steak sector, the average growth in comparable sales up to 1.3% in 2018 from 0.5% of 2017; in Mexican food sector, the average growth in comparable sales up to 0.3% in 2018 from -0.7% of 2017; in Pizza sector, the average growth in comparable sales up to 5% in 2018 from -0.7% of 2017; in Pizza sector, the average growth in comparable sales up to 5% in 2018 from -0.7% of 2017; in bar& grill sector, the average growth in comparable sales up to 0.7% in 2018 from -2.4% of 2017;

It seems, unlike in fast-casual restaurants, the difference in performance in terms of comparable sales and thus the traffic in this sector presents much smaller variations.

Generally, impacts of unfavourable climate of restaurants industry to traffic since 2015 seem to be less significant to casual dining than to fast-casual restaurants but bigger than QSR as indicated by changes in their growth in traffic. However, probably because there are more powers for casual restaurants than another two restaurants to raise menu price since their menu prices a higher, their sales have been better offset by increased menu price or product mix.

For companies in this industry, franchising seems not to be popularly accepted as compared with QSRs. Except for some bar& grill and family restaurants chains, most of companies are operating their own restaurants and their gross margins vary in similar range as those fast-casual restaurants.

However, due to less spending in G&A of casual restaurants ( average 5.5% compared with 10%)  the average operating margins are higher (above 7.5%) than fast-casual restaurants (3%): bar& grill casual dining sector - 5.5% with a G&A as percentage of sales of 7.5%; family sector - 11% with a G&A as percentage of sales of 5%; Italian sector -  8% with a G&A as percentage of sales of 6%; pizza - 5% with a G&A as percentage of sales of 5%; Mexican - 6.5% with a G&A as percentage of sales of 5%.

Unlike in QSR where companies use franchise as buffer, companies’ margins in this sector declined as traffic and thus sales slowing down. However, with higher menu price the typical average gross margin of restaurants in this sector decreased by smaller percentage than those in fast-casual sector, which is about 100 basis points less since 2015.

The average cash flow/share of companies in this sector presents decrease of 8% and 4% for 2017 and 2018.

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Company performance:

It seems that the demand for bar/grill service/products of this company has been declining between 2015 and 2017 as indicated by decreasing traffic and this company’s limited ability to raise the price to offset the decrease cash flow. However, since the second half of 2017, traffic seems to be coming quickly probably driven by large spending on ad. Relatively, its family dining products/services has experienced less impact in terms of decrease in traffic between 2015 and 2017 and also presented rebounding trend in sales in 2018.

For first six months of The Fiscal 2018 compared with the same period of 2017(ended 20180630)

Applebee’s (US market)

Comparable sales increased by about 4.5% (5.7% for 2Q) attributable to increase in traffic and slight increase in check size.

IHOP (US market)

Comparable sales increased by about 0.9% (0.7% for 2Q) attributable to increase in check size offset by decrease in traffic.

 The Fiscal 2017 compared with the 2016

Applebee’s (US market)

Comparable sales decreased by about 5.3% attributable to decrease in traffic and decrease in check size.

IHOP (US market)

Comparable sales decreased by about 1.9% attributable to decrease in traffic offset by increase in check size.

Fiscal 2016 compared with 2015

Applebee’s (US market)

Comparable sales decreased by about 5.0% attributable to decrease in traffic offset by increase in check size.

IHOP (US market)

Comparable sales decreased by about 0.1% attributable to decrease in traffic offset by increase in check size.

Fiscal 2015 compared with 2014

Applebee’s (US market)

Comparable sales increased by about 0.2% attributable to increase in check size offset by decrease in traffic.

IHOP (US market)

Comparable sales increased by about 4.5% attributable to increase in traffic and increase in check size.

Its gross margin (franchise expenses mainly) was down from 57% of 2015 to 55% of 2017due to increased franchises expenses ( bad debt expenses probably as a result of massive closure of restaurants and franchisor’s contribution to NAF). Its G&A as percentage of sales has been up to about 27% in 2017 from about 22% of 2014 as a result of increase in G&A expenses (marketing and consulting costs) and decrease the sales, its operating margin went down from 31% to 28% in 2017. Due to huge input in franchise ad, we have seen that this company’s gross margin (including franchise expenses) went down largely to about 51% in 2018 and caused its operating margin down to about 25% in 2018.

Stock price

This stock currently has an enterprise price/EBI ratio of 27. We think that its stock is being relatively fairly valued considering that its large spending in ad bring back traffic for this company while hurt its margin.