This week’s overvalued company of the week is Applebee’s International Inc. (APPB). Applebee’s business is the operation and franchising of casual dining restaurants featuring moderately priced entrees with a neighborhood feel to the establishment. We will analyze this company using Warren Buffett’s approach for the Business and Management Review, and use Benjamin Graham’s methods for equity valuation.
Business and Management Review
1) Is the business simple and understandable?
Applebee’s is a restaurant chain, and in that respect the business is fairly simple. They prepare and serve food (lunch and dinner only) to customers by offering the greatest value for the food received. Applebee’s currently operates 1,813 freestanding restaurants in 49 states, and in 14 countries (data as of 2-8-06). Applebee’s is not a complicated business to understand, it is in the food industry which incorporates a simple business model for laymen to understand.
2) Does the business have a consistent operating history?
Applebee’s does not have a consistent operating history with quarterly earnings fluctuating substantial at times. Second quarter 2005, the EPS was $1.36 versus this year of only $1.19, or a decline of 12.50%. Another concern we see is the Accounts Receivable/Days ratio has steadily increased from 10.86 in 2001 to 13.22 in 2005. Also, Applebee’s does not seem to be turning its inventory as quickly as it had in years past, as inventories days held has increased from 7.89 in 2001 to 11.42 in 2005. The dividend payout rate has fluctuated over the years as well, further increasing the uncertainty of this company.
3) Does the business have favorable long term prospects?
With the continued uncertainty of discretionary spending by consumers, we feel that Applebee’s will suffer in the future from this alongside other factors. The earnings estimates have dropped eight cents per share over the past three months. Same store sales as well fell in August dropping 2.70%. We feel as well that the growing competition in middle-income restaurants is increasing, and will continue to do so in the future.
4) Is management rationale?
It is questionable whether management is acting in the best interests of the shareholders. There is, however, no agency problems as the Chairman and CEO are two different individuals so that is positive for the shareholders. We think that the company should try to re-create itself and further distinguish itself from its competitors in any form necessary. Perhaps slowing the growth of opening new stores, or closing non-performing stores may help the company long term. They should try to saturate the markets of each individual restaurant and have regional and individual store management be held responsible for continued growth of their respected territories.
5) Is management candid with its shareholders
Applebee’s has a very informative website for investors (investor relations). With the advent of the internet it is much easier for companies to have a more direct communication route to all investors than before. Applebee’s site has all the basic and even some nice touches including audio files of conference calls.
6) Does management resist the institutional imperative
Applebee’s does resist this urge of many professionals. We find no reason to have concern of this company.
Financial and Value Review
After reviewing Applebee’s we find that the company is currently overpriced significantly and is unsuitable for either the defensive or enterprising investor. We find the P/E ratio at 18.21 too high for this given company as we are paying too much for the small earnings they are producing (see our methods). The current price of $21.51 is valued at 144.78% of the company’s intrinsic value. At 6.96% we also find that the Return on Invested Capital (ROIC) too low given the risk of the company.
We would not feel comfortable paying any more than $11.00/share for this stock.
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