Adopting a value investment philosophy and implementing it effectively can be a powerful strategy for generating strong risk-adjusted returns. However, this approach is not without risks.
One significant pitfall is relying too much on a company’s current value while ignoring certain risk factors. A case in point is Denny’s Corporation (DENN), a restaurant chain whose stock performance has been less than stellar.
Since November 2022, Denny’s stock has plummeted 33.8%, while the S&P 500 has risen 32.5%.
Despite the stock’s significant drop, which could make it seem more attractive from a valuation perspective, the ongoing decline in location count remains a critical issue.
Financial Performance
Over the past few years, Denny’s financial performance has been mixed. From 2022 to 2023, the company’s revenue increased by 1.6% from $456.4 million to $463.9 million. This growth was driven by a 2.7% increase in same-store sales and the full-year revenue contribution from the newly acquired Keke’s chain.
However, franchise and license revenue dropped by 3.2%, primarily due to a decline in the number of franchised Denny’s locations from 1,536 to 1,508. Although same-store sales increased by 3.6%, this was offset by the decline in franchise locations and a 4.4% decrease in same-store revenue for Keke’s franchised locations.
Profitability also suffered, with net income falling from $74.7 million to $19.9 million. This decline was largely due to a significant change in income from cash flow hedges, from $55 million in 2022 to a $10.6 million expense in 2023.
Other profitability metrics improved, with operating cash flow rising from $39.5 million to $72.1 million, adjusted operating cash flow increasing slightly from $61.2 million to $62.1 million, and EBITDA growing from $77.5 million to $81.5 million.
First Quarter 2024
The financial picture for the first quarter of 2024 appears worse. Revenue dropped to $110 million, down from $117.5 million in the same period the previous year.
Company restaurant sales fell from $53.5 million to $52.3 million, despite a stable number of company-owned Denny’s restaurants and a slight increase in company-owned Keke’s locations.
The decline was driven by a 3% drop in same-store sales. Franchise and license revenue also decreased, from $64 million to $57.6 million, due to a 1.2% drop in domestic franchised Denny’s restaurants and a 4% decline in same-store revenue for domestic franchised Keke’s locations. Initial and other fees were hit hardest, dropping 63.6% from $5 million to $1.8 million.
While net income increased from $0.6 million to $4.7 million, other profitability metrics worsened. Operating cash flow plunged from $16.2 million to $0.2 million, and adjusted operating cash flow fell from $17 million to $10.3 million. EBITDA decreased from $22.1 million to $18.4 million, partly due to changes in cash flow hedges.
Future Outlook
For 2024, Denny’s management has provided some guidance. The company expects to open 40 to 50 new restaurants, with 12 to 16 of these under the Keke’s name. However, the total location count is still expected to fall by 10 to 20.
Despite this, EBITDA is projected to be between $87 million and $91 million, up from $81.5 million in 2023. This suggests that adjusted operating cash flow should be around $67.8 million for the year.
Using these figures, the company can be valued on a forward basis. Although the company trades at attractive multiples relative to cash flows, the continued decline in location count is a significant concern. This decline overshadows the company’s current low valuation multiples compared to similar companies.
Concerns Remain
Denny’s has demonstrated resilience in increasing cash flows despite challenges with location count and revenue. However, the persistent decline in the number of locations remains a major concern.
If the location count stabilizes, the company could be viewed more favorably. Until then, and unless the stock price drops significantly, investors may want to watch from the sidelines.
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Faith is an enthusiastic freelancer and regular contributor to numerous finance blogs, creating valuable pieces to educate individuals on finance and fintech options. As a skilled writer, Faith has created content for diverse industries—if it exists, she’s likely written about it!
