The Motley Fool, 10/16/97: The Daily Double

Thursday, October 16, 1997

CKE Restaurants, Inc.
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Phone: 714-774-5796
Website: http://www.ckr.com
Price (10/15/97): $43 1/2

HOW DID IT DOUBLE?

CKE Restaurants has been on a roll. Since 1995, the stock of this fast-food company has risen from just over $4 per share. That's a cool nine-bagger.

Last spring when McDonald's announced bargain basement pricing for the Big Mac, CKE's rise was interrupted and the shares fell to just over $18 per share. All fast-food concerns suffered on fears of a price war and the resulting margin squeeze.

In late spring CKE announced it would buy the Hardee's restaurant chain from IMASCO. Investors smelled another turnaround in the making and started bidding up the stock. CKE had already successfully revived the Carl's Jr. chain and had also taken a stake in Rally's and Checkers burger chains. Hardee's is the fourth-largest burger chain in the nation, but is losing money -- CKE hopes to change that.

In addition to adding the 3,000-restaurant Hardee's chain, the company has been surpassing analysts' expectations on the earnings front. The past three quarters earnings estimates were exceeded by 6%, 31%, and 17%, respectively. A new business opportunity and estimate-beating performances have lead to a double for CKE.

BUSINESS DESCRIPTION

CKE Restaurants is the operator of the Carl's Jr. hamburger chain. This chain operates primarily on the West Coast. The company also owns the Green Burrito chain of Tex-Mex restaurants, a large stake in the Rally's chain, the Taco Bueno Mexican fast-food chain, and now Hardee's.

CKE ousted founder Carl Karchner in 1994 and William Foley took over. Since that time the company has found a successful formula, which is to revive the old restaurants with a new, fresh look, improve service, and change the menus. CKE also uses a cross-branding strategy in which the most successful products of one chain are offered at another. This strategy is one that the company hopes to employ at Hardee's.

FINANCIAL FACTS

Income Statement
12-month sales: $810.8 million
12-month income: $32.9 million
12-month EPS: $0.94
Profit Margin: 4.1%
Market Cap: $1650.4 million

Balance Sheet
Cash: $37.9 million
Current Assets: $97.5 million
Current Liabilities: $176.3 million
Long-term Debt: $129.5 million

Ratios
Price-to-earnings: 46.3
Price-to-sales: 2.0

HOW COULD YOU HAVE FOUND THIS DOUBLE?

There were several opportunities to latch on to CKE shares. During the entire time the stock price has doubled, Value Line has given it a #1 rating for timeliness. Value Line's #1 ranked stocks have a history of outperformance. Looking at the #1 ranked stocks is a fertile field for finding potential doubles.

When the stock was trading at $20 in April, the PEG was right around 1.0. However, the YPEG valuation was a much more compelling $35 per share. This was before the Hardee's deal and prior to a big estimate-beating first quarter earnings report.

One of the best ways to get a big profit investing is to focus on companies that are the victims of "collateral damage" when a similar company has problems. The announcement of reduced Big Mac prices shook the entire sector for what amounted to a minimal piece of news. That provided a dip in CKE's shares. When Ascend has problems, Cisco drops. When Aetna has problems, Oxford Health Plans drops. As long as the problems are company specific, these events are buying opportunities for savvy Fools.

In late spring when the company announced earnings 31% ahead of estimates and the acquisition of Hardee's, it began to move toward fair value and a double.

WHERE TO FROM HERE?

CKE's stock is not the bargain it was last spring. The PEG stands at 1.33 and the YPEG valuation is $44, right near the current quote. However, at $44 you own a fairly valued stock with a projected 30% long-term growth rate, not a bad proposition. Earnings estimates have been raised five times in the past month.

Value Line continues to place a #1 rating for timeliness on these shares.

Interestingly, the long-term earnings growth estimate recorded in Zack's hasn't changed since the Hardee's deal was announced. If the company can pull off a turnaround at Hardee's similar to the one it managed at Carl's Jr., I would expect the company to continue to exceed estimates.

Management seems exceptionally skilled and has an impressive record for expanding margins and improving sales in the fast food business. CEO William Foley was profiled for his exceptional management skills in Investor's Business Daily last spring.

On the side of caution, a Foolish investor would like to see a better balance sheet. As of the last quarterly earnings report, the company had negative working capital. However, the company stated in its 10-Q that between cash on hand and cash flow from operations (which was $38 million last quarter), it has adequate cash to fund operations.

This stock is worth a look for a Foolish investor. If estimates continue to climb and the company continues to exceed them, there may be further upside. That said, it may take a bit longer for the shares to double again.

- Mark Weaver, MD, [email protected]

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