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April 27, 1999
IHOP for Mom
by Warren Gump ([email protected])
Trading at $42 1/2 as of April 26, 1999
In appreciation for all the great meals that you've given me over the years, Mom, I'm going to take you out to eat. Why don't we go over to that tasty pancake place with the nice blue roof? The food's almost always good, the prices are reasonable, and visiting IHOP <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: IHOP)") else Response.Write("(Nasdaq: IHOP)") end if %>, also known as International House of Pancakes, brings back good memories from when I was a kid. To help keep you nourished for more than a day, I'm also going to throw a few shares of IHOP into your investment portfolio.
Hold it... IHOP as an investment? You never really thought about it? Well, you wouldn't be alone. This nice little company based in California doesn't get a lot of press on Wall Street. Even though millions of people stop by the restaurants each year, not too many of them have taken the time to check out the corporate owner. It's really a shame, because management has gone to great lengths to create a terrific company.
One of the most interesting aspects of IHOP is its franchise system. The company had 835 restaurants open at the end of last year, only 66 of which were owned and operated by IHOP. The rest were operated by franchisees or area developers. A vast majority of the franchised restaurants are operated by managers who work in the restaurants. IHOP believes that these owners provide a quality of management and dedication that is generally unmatched by salaried employees. Of all the company's franchisees, only 12 own more than 6 restaurants. This system of empowerment seems to work and engender loyalty. In the past five years, 85% of new franchise sales have been to current franchisees, IHOP employees, or their immediate family members.
You might be wondering how someone who works in an IHOP restaurant would be able to afford to own a restaurant franchise. IHOP's development strategy makes it relatively easy. Instead of having the franchisee develop and build his or her own restaurant, the company develops most of its new sites itself. Once the site is built and equipped, the company then leases the restaurant to the new franchisee. Because the restaurant is ready to go, the company is able to charge a substantial franchise fee of $200,000 to $350,000. About 80% of this fee is usually financed by the company over five to eight years.
With this franchise structure, IHOP has four primary sources of revenue from franchisees: (1) ongoing royalty payments of about 4.5% of restaurant sales, (2) income from leasing the restaurants and equipment, (3) income from loans to finance new franchisees, and (4) revenue from the sale of proprietary products (mostly pancake mix). That's a pretty hefty stream of income. You might also notice that these streams should be fairly steady since they are tied to sales rather than profitability. A restaurant's profitability can fluctuate substantially due to changing labor markets, food costs, or operating inefficiencies. Sales, on the other hand, tend to be fairly consistent. While the company certainly wants its franchisees to succeed, it doesn't suffer economically when a unit's profitability decreases (as long as it doesn't default).
What kind of results has this strategy produced? Pretty darn good ones. Corporate earnings have increased every year for the past four years. From $1.60 in 1994, earnings per share rose steadily to $2.61 in 1998, representing growth of 13% per year. The First Call analyst consensus calls for the company to grow earnings at 15% over the next few years. For those of you keeping track, that's even with or higher than the growth expected from General Electric <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: GE)") else Response.Write("(NYSE: GE)") end if %> and Coca-Cola <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: KO)") else Response.Write("(NYSE: KO)") end if %>. Because little ol' IHOP isn't closely followed on the Street, however, you can buy into IHOP at a much lower multiple to earnings than with those two companies. Instead of paying 30x to 45x earnings, IHOP is trading at a lowly 14x earnings estimates for the current year.
Now, I don't expect IHOP to boast the full-priced multiples of the big boys just mentioned. More than likely, it will continue to push ahead with steady growth, increasing its value about 15% or so a year. While that may not sound like anything spectacular relative to the performance of the high-octane stocks of the past few years, you'll still double your money every five years. That's not so bad when you're investing in a company with a strong brand identity and solid finances. My hope is that this addition to your portfolio will help you sleep a little easier and retire much wealthier. Happy Mother's Day!
IHOP Company Information:
Trades on Nasqaq under symbol IHOP
IHOP's website: www.ihop.com
Current Quote
IHOP's Chart
Other Related Links:
IHOP Message Board
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