Jack in the Box
Valuation and Analysis
Developed by:
Grant Berg
Ash-Leah Chandler
Corey Donaway
Zachary Hall
Jordan Jones
TABLE OF CONTENTS
Executive Summary ............................................................................... 1
Business & Industry Analysis ................................................................... 7
COMPANY OVERVIEW ............................................................................... 7
INDUSTRY OVERVIEW............................................................................... 9
Five Forces Model.................................................................................... 11
THREAT OF NEW ENTRANTS ........................................................... 11
THREAT OF SUBSTITUTES .............................................................. 14
BARGAINING POWER OF BUYERS ..................................................... 15
BARGAINING POWER OF SUPPLIERS .................................................. 16
RIVALRY AMONG EXISTING FIRMS ................................................... 17
FIVE FORCES CONCLUSION ............................................................ 22
KEY SUCCESS FACTORS .......................................................................... 24
FIRM COMPETITIVE ADVANTAGE ANALYSIS ................................................... 26
Accounting Analysis ................................................................................ 31
Key Accounting Policies .......................................................................... 33
LEASE ACCOUNTING .............................................................................. 33
FRANCHISE ACCOUNTING ........................................................................ 35
SEGMENT DISCLOSURE ........................................................................... 36
Potential Accounting Flexibility.............................................................. 37
OPERATING VERSUS CAPITAL LEASES ......................................................... 37
INTANGIBLE ASSETS .............................................................................. 37
Actual Accounting Strategy .................................................................... 39
DISCLOSURE ....................................................................................... 39
ACCOUNTING POLICY STRATEGY ............................................................... 39
Qualitative Analysis of Disclosure .......................................................... 41
Quantitative Analysis of Disclosure........................................................ 42
ACCOUNTING DIAGNOSTIC RATIOS ........................................................... 42
SUMMARY OF ACCOUNTING DIAGNOSTIC RATIOS ................................. 43
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REVENUE DIAGNOSTIC RATIOS ................................................................ 44
NET SALES/CASH FROM SALES ....................................................... 44
NET SALES/NET ACCOUNTS RECEIVABLE ........................................... 45
NET SALES/INVENTORY ............................................................... 46
EXPENSE DIAGNOSTIC RATIOS .................................................................. 48
ASSET TURNOVER ...................................................................... 48
CFFO/OI ................................................................................ 49
Identify Potential Red Flags ................................................................... 51
Undo Accounting Distortions.................................................................. 52
RESTATING FINANCIALS ......................................................................... 52
Financial Analysis.................................................................................... 54
Liquidity Ratios ....................................................................................... 55
CURRENT RATIO ................................................................................... 55
QUICK ASSET RATIO .............................................................................. 56
INVENTORY TURNOVER ........................................................................... 57
DAYS’ SUPPLY OF INVENTORY ................................................................... 58
RECEIVABLES TURNOVER......................................................................... 59
DAYS’ SALES OUTSTANDING .................................................................... 60
WORKING CAPITAL TURNOVER ................................................................. 61
CASH-TO-CASH CYCLE ........................................................................... 62
Profitability Ratios .................................................................................. 64
GROSS PROFIT MARGIN ......................................................................... 64
OPERATING EXPENSE RATIO .................................................................... 65
NET PROFIT MARGIN ............................................................................. 66
ASSET TURNOVER ................................................................................. 67
RETURN ON ASSETS............................................................................... 68
RETURN ON EQUITY .............................................................................. 69
Capital Structure Ratios.......................................................................... 72
DEBT TO EQUITY RATIO ........................................................................ 72
TIMES INTEREST EARNED ....................................................................... 73
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DEBT SERVICE MARGIN .......................................................................... 74
IGR/SGR Analysis ................................................................................... 77
INTERNAL GROWTH RATE........................................................................ 77
SUSTAINABLE GROWTH RATE ................................................................... 78
Forecasting ............................................................................................ 79
YEAR 1 INCOME STATEMENT FORECAST ...................................................... 79
INCOME STATEMENT ............................................................................. 80
BALANCE SHEET ................................................................................... 81
RESTATED BALANCE SHEET ...................................................................... 81
STATEMENT OF CASH FLOWS.................................................................... 82
FINANCIAL STATEMENTS ......................................................................... 84
Cost of Financing..................................................................................... 92
COST OF EQUITY ................................................................................. 92
ESTIMATING BETA................................................................................. 92
BETA RESULTS .................................................................................... 93
OTHER FINDINGS FROM REGRESSION ANALYSIS ............................................ 93
COST OF DEBT .................................................................................... 95
WEIGHTED COST OF CAPITAL - WACC ...................................................... 97
Valuation Analysis................................................................................... 98
VALUATION: METHOD OF COMPARABLES ............................................................... 99
TRAILING PRICE/EARNINGS RATIO............................................................100
FORWARD PRICE/EARNINGS RATIO ..........................................................100
PRICE/BOOK RATIO..............................................................................101
DIVIDEND YIELD .................................................................................102
PEG RATIO .......................................................................................102
PRICE/EBITDA ....................................................................................102
PRICE/FREE CASH FLOW .......................................................................103
ENTERPRISE VALUE/EBITDA ....................................................................104
VALUATION: INTRINSIC VALUE .........................................................................106
DIVIDEND DISCOUNT MODEL ..................................................................106
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FREE CASH FLOW MODEL .......................................................................107
RESIDUAL INCOME MODEL......................................................................110
LONG RUN RESIDUAL INCOME PERPETUITY MODEL .......................................113
ABNORMAL EARNINGS GROWTH MODEL ....................................................116
CREDIT ANALYSIS .........................................................................................120
ANALYST RECOMMENDATION ............................................................................121
APPENDIX
...........................................................................................122
INCOME STATEMENT .............................................................................122
BALANCE SHEET ..................................................................................123
RESTATED BALANCE SHEET ....................................................................124
CASH FLOW STATEMENT ........................................................................125
COMMON SIZE INCOME STATEMENT ..........................................................126
COMMON SIZE BALANCE SHEET ...............................................................127
COMMON SIZE CASH FLOW ....................................................................128
INCOME STATEMENT QUARTERLY DATA .....................................................129
LIQUIDITY RATIOS ...............................................................................130
PROFITABILITY RATIOS .........................................................................131
CAPITAL STRUCTURE RATIOS ..................................................................132
VALUATION MODELS ............................................................................133
BETA ANALYSIS ...................................................................................135
COST OF DEBT ...................................................................................136
LEASE ADJUSTMENTS ...........................................................................137
References ...........................................................................................142
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Executive Summary
Investment Recommendation: SELL (11/1/2007)
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Executive Summary
Industry Analysis
Jack in the Box is a member of the fast food hamburger restaurant (FFHR)
industry. Jack in the Box, Inc. was founded in 1951 by Robert O. Peterson in
San Diego, California. The firm also owns and operates Qdoba Mexican Grill
restaurants and Quick Stuff convenience stores. Since 1951, Jack in the Box has
grown to more than 2,100 restaurants in 17 states. There are more than 370
Qdoba Mexican Grill restaurants in 39 states. In addition, the Quick Stuff
convenience stores have grown nation-wide with over 50 locations
(www.jackinthebox.com).
Jack in the Box’s direct competitors includes Sonic, Burger King, Wendy’s,
and McDonalds. In the FFHR industry, firms compete primarily on price, brand
image, and restaurant location. In the past five years, the stock performance
has been mixed for firms within this industry. Firms such as Jack in the Box,
Sonic, and McDonald’s have seen price appreciation over 100%, well above the
S&P 500’s return of 68%. However, Wendy’s and Burger King have been below
this benchmark.
From Porter’s Five Forces Model, we determined that the FFHR industry
has a high level of competitive pressures which should lead to heightened
pressures on firms to compete on the basis of price. The main determinants of
high competitive pressures for the FFHR industry are the 1) moderately high
threat of new entrants, 2) high bargaining power of buyers, 3) high threat of
substitute products, and, most importantly, 4) intense rivalry among existing
firms.
The key success factors for the FFHR industry are cost control,
convenience, brand image, and a diversified product portfolio. In order for a
firm to perform well within its industry, it must compete based on its key success
factors. Jack in the Box is striving to become a leader in the industry; however,
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the company needs to be compared against the industry’s key success factors to
determine its position within the industry.
Accounting Analysis
When analyzing the financial condition of a firm, it is important to conduct
an accounting analysis to uncover potential distortions in the financial
statements. The reason for distortions is the flexibility offered to managers by
GAAP. Firms have been given a level of flexibility so that they can better reflect
the nature of their business. However, since managers face pressure to meet
financial expectations, managers may utilize accounting flexibility to withhold or
manipulate information that is necessary to determine a firm’s financial position.
For the fast food hamburger restaurant industry, key accounting policies
include lease accounting, franchise accounting, and segment disclosure. Jack in
the Box, along with its competitors, reports most of its leases as operating leases
rather than capital leases. By reporting operating leases, firms are able to shift
these assets and obligations off their balance sheet. This practice is within the
guidelines of GAAP; however, this method may alter the true financial position of
the firm. With regards to franchise accounting, Jack in the Box is currently 29%
franchised (JBX 10-K 2006, 11). Franchising gives firms in the fast food
hamburger restaurant industry an opportunity to enter new markets while
decreasing investment risks and operating costs (JBX 10-K 2006, 11). Finally,
there are a few items that Jack in the Box discloses that may be valuable to the
user. These disclosure items include the number of franchised versus company
owned stores, sales of subsidiaries, and a detailed breakdown of revenues.
A firm may appear to be more or less attractive due to the flexibility in the
reporting of particular items within the firm’s financial statements. However,
Jack in the Box, utilizing a fairly aggressive accounting policy, does an average
job at disclosing its financial position. The two main accounting aspects that
Jack in the Box has flexibility in accounting are the recognition of leases and
intangible assets.
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In computing the diagnostic ratios, we concluded there are no ratios that
present a real “red flag”. The only item that may present a “red flag” is the
extensive use of operating leases instead of capital leases. For Jack in the Box, a
capital lease would be more appropriate than an operating lease because the
firm does not expect to leave the location once the lease term is up.
Financial Analysis, Forecast Financials, and Cost of Capital Estimation
The most common way of performing financial analysis is through the use
of ratios. The most commonly used can be broken down into three categories:
liquidity, profitability, and capital structure ratios. By using these ratios, we are
able to easily compare a firm’s performance with its competitors over time. In
order to value a firm, future performance must be forecasted. Beta is calculated
using a regression model. Once a Beta is found, we were then able to calculate
cost of equity. Then, using the cost of debt and equity the cost of capital can be
determined.
Jack in the Box improved its liquidity in recent years by accumulating cash
and cash equivalents. However, Jack in the Box’s competitor, McDonalds, leads
the fast food hamburger restaurant industry in regards to liquidity. Overall, Jack
in the Box is in keeping with the industry average in regards to liquidity. In
regards to the profitability ratios, Jack in the Box is performing below average
compared to its competitors in the industry. Jack in the Box appears to be
inefficient in controlling expenses as shown with operating expense margin and
net profit margin. However, it is performing fairly well with its asset efficiency,
return on assets, and return on equity. Finally, the capital structure ratios
indicate that the firms in the fast food hamburger restaurant industry are very
different in how they structure their debt and equity. The debt to equity ratio is
the only ratio that shows a trend for the industry.
Using the financial ratios and average growth rates, we were able to
forecast Jack in the Box’s financial statements for the next ten years. These
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forecasts show smooth, even growth over the next ten years, with net income
and assets doubling over this time period.
To find the cost of capital, we determined the cost of debt as well as the
cost of equity. To find the cost of equity, we first needed to determine beta for
Jack in the Box. Beta was found using multiple regression models over various
time horizons. This method allows us to determine stability of beta over time as
well as the investment time horizon. For Jack in the Box, we found a beta of
1.789 with an R2 of 20.3% based on a 10 year investment horizon. This beta
was very close to the Yahoo!’s published beta for JBX of 1.78. Using this beta,
we calculated a cost of equity of 16.9%. This cost of equity, combined with
JBX’s before and after tax cost of debt of 5.81% and 7.62% respectively, results
in a WACCBT of 11.25% and a WACCAT of 10.19%.
Valuations
The purpose of an equity valuation is to value the firm and determine if
the stock is over, under, or fairly valued. There are two primary methods of
valuing a firm: financial valuations and intrinsic valuations. Financial valuations
utilize the method of comparables where an analyst uses ratio averages from an
industry to estimate the share price for a specific firm. This can be done by
computing and averaging several different industry ratios individually and then
setting those averages and working backwards to find the target firm’s price per
share.
Of the seven applicable comparables, four comparables resulted in
showing that Jack in the Box is significantly undervalued with intrinsic values
ranging from $42.84 to $102.73 compared to JBX’s observed price of 29.83.
Lack of consistency is one of the main problems with the method of
comparables. These estimated prices do not show us anything because there is
no theory backing them up. They are merely numbers, some which are more
applicable to some firms than others.
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Intrinsic valuations are theory based models that produce an intrinsic
price for the firm. The free cash flow model was the only model that had JBX
priced under or even close to properly valued. In our opinion, this model should
be underweighted in our analysis since the free cash flows of JBX appear to be
difficult to forecast and the other models typically provide a more reliable
valuation. Therefore, we feel that more weight should be put on the residual
income, long run ROE residual income perpetuity, and the abnormal earnings
growth. All three of these models showed that JBX is consistently earning a ROE
significantly less than their KE, and thus JBX is forecasted to destroy value yearafter-year. This deterioration of value leads to the intrinsic value of JBX to be
significantly less than the observed price on November 1st, 2007 of $29.83.
Therefore, since these intrinsic valuations are less than the observed price, we
conclude that Jack in the Box is overvalued as of November 1st, 2007.
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Business & Industry Analysis
Company Overview
Jack in the Box, Inc. (JBX) is known as one of the nation’s top leaders in
the fast food hamburger restaurant industry (FFHR). The firm not only operates
and franchises Jack in the Box restaurants, but it also owns and operates Qdoba
Mexican Grill restaurants and Quick Stuff convenience stores. Jack in the Box,
Inc. was founded in 1951 by Robert O. Peterson in San Diego, California.
However, it was originally named San Diego Commissary Co. and then it was
renamed to Foodmaker Co. in 1960.
During this time, Peterson expanded into
Phoenix, Arizona, and then to the Houston and Dallas-Ft. Worth areas of Texas.
Needing an advertising campaign, Foodmaker came up with an innovative way to
attract customers by introducing Jack. Jack was featured in 1995 as the
company’s fictional founder, CEO, and ad pitchman. Since then, Jack has become
known all over the United States. “Acknowledging the strength and growth of the
Jack in the Box brand, the company changed its name to Jack in the Box Inc. in
1999.” (www.jackinthebox.com) Now, there are more than 2,100 Jack in the
Box restaurants in 17 states; in addition, there are more than 370 Qdoba
Mexican Grill restaurants in 39 states and over 50 Quick Stuff convenience stores
nation wide (www.jackinthebox.com).
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*Jack in the Box Coverage Area
(www.jackinthebox.com)
Jack in the Box was the “first major fast-food chain that started as a
drive-thru, and it was also the first to introduce menu items that are now staples
on most fast-food menu boards, including a breakfast sandwich and portable
salad. Today, Jack in the Box offers a broad selection of distinctive, innovative
products targeted at the adult fast-food consumer, including hamburgers,
specialty sandwiches, salads and real ice cream shakes”
(www.jackinthebox.com). Despite a broad selection of food options, Jack in the
Box menu focuses primarily on hamburgers.
There are many restaurants in the fast food industry; however, Jack in the
Box’s major competitors includes Sonic (SONC), Burger King (BCK), Wendy’s
(WEN), and McDonalds (MCD). Since September of 2002, firms in the FFHR
industry have seen an appreciation in their stock valuations ranging from
+41.35% to +381.68%. Over this time period, JBX has outperformed most of its
main competitors with a stock price appreciation of about 170%. SONC’s stock
performance has greatly outperformed the industry; where as, MCD surprisingly
is the laggard of the industry. The chart below illustrates the stock performance
of JBX and its competitors over the past five years.
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Industry Overview
The limited service restaurant industry can be broken down into several
sections: carryout, pizzerias, delis, fast food, and sandwich shops (U.S. Census
Bureau 2002). Jack in the Box is classified in fast food, a business model that
relies on limited menu items, quick preparation, and self-service. Fast food
restaurants, also known as quick service restaurants, “includes about 200,000
restaurants with combined annual revenue of about $120 billion” (Hoovers). Jack
in the Box’s main competitors in this industry are the national and regional
hamburger fast food chains of Sonic, Burger King, Wendy’s, and McDonald’s.
The fast food industry is constantly competing for growth and market
share. Firms must compete amongst themselves as well as “full service
restaurants, supermarkets, delis, convenience stores, snack shops, and
cafeterias. The industry is highly fragmented: the top 50 companies hold about
25 percent of industry sales” (Hoovers). Firms within the industry compete
primarily on price, as well as quality of food, brand, and location. An example of
price competition among fast food restaurants is the implementation of a “value
menu” to attract price conscious consumers.
The fast food industry can be further broken down into the type of entrée
served, such as “hamburgers, sandwiches, chicken, pizza/pasta, Mexican food,
Asian food, or snacks. Among the major fast food chains, hamburger
restaurants are 50 percent of the market; sandwich, pizza, chicken, and snack
shops are each 10 percent; and Mexican food is about 5 percent” (Hoovers). Fast
food companies are leaders of the overall restaurant industry.
Major Industry Trends
Recent industry trends of the fast food hamburger industry should be
noted in order to understand the competitive dynamics of the industry and the
direction the industry is going. Two major trends include firms focusing more
toward franchising restaurants and investing in advertising to develop their
respective brand.
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Franchising
Firms within the fast food hamburger industry have utilized franchised
restaurants in the past. However, the major recent trend is for firms to franchise
currently company owned stores or to grow into new markets through
franchises. One reason for this shift is stated best by Burger King in their 2006
10-k, “[w]e believe that our franchise restaurants will generate a consistent,
profitable royalty stream to us, with minimal associated capital expenditures or
incremental expense to us” (Burger King 10-k, pg 4). Shifting to the use of
franchising is a way in which firms can ensure themselves a guaranteed stream
of income with royalties of about $50,000 per restaurant and a percentage of the
sales while reducing the risk and exposure of the parent firm (JBX 10-k, pg 5).
Brand Development
A main strategy for almost all of the firms of the fast food hamburger
industry deals with brand development or redefining the company’s brand image.
In this highly competitive industry, firms are utilizing advertisement and
promotion in order to develop a distinct brand image in the minds of their
consumer. Firms hope that customers will dine at their restaurants for the
overall eating experience instead of viewing their food as a commodity.
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Five Forces Model
The Five Forces Model is a business unit strategy tool that can be utilized
to analyze an industry’s structure, degree of competitiveness, and profit
potential. The industry’s structure and degree of competitiveness are the main
determinants of the overall profit potential of an industry. Using the Five Forces
Model, we will be able to understand how the industry is structured and how to
be profitable inside the industry.
The Five Forces Model first examines the “[d]egree of actual and potential
competition” by analyzing three sources of competition (Palepu & Healy). These
three sources of competition are rivalry among existing firms, threat of new
entrants, and threat of substitute products. The Five Forces Model then analyzes
the “[b]argaining power in input and output markets” (Palepu & Healy). The
model also examines two sources that exist for bargaining power. The first is the
bargaining power of buyers or customers and the second is the bargaining power
of suppliers. In all, the Five Forces Model looks to discover the industry’s
potential profitability that exists based on assessing the competitive pressures
with in that industry.
Five Forces Summary
Threat of New
Entrants
Threat of
Substitute
Products
Bargaining
Power of Buyers
Bargaining
Power of
Suppliers
Rivalry Among
Existing Firms
Rating
7
9
9
3
10
Level of
Competition
Moderate
High
High
Low
High
Threat of New Entrants
As previously mentioned, the fast food industry has low concentration of
firms and is highly fragmented with over 200,000 restaurants with few firms
holding a large percentage of the market share (Hoovers). The five largest firms
in the FFHR industry operate only 26,109 of these 200,000+ restaurants (FFHR
10-ks). The market is diverse in that there are national chains, regional chains,
and even local firms. Although national and regional chains are able to capitalize
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on economies of scale and scope, there is room for local firms to attack niche
markets or steal market share in their respective markets.
Economies of Scale
Economies of scale allow the larger firms in this industry to reduce their
average cost per unit; thus, they are able to spread out their costs which should
in turn increase margins. Therefore, these economies of scale do give larger
chains a cost advantage over local firms. This advantage has not been strong
enough to keep out local fast food restaurants from opening up, however.
These local firms may use various marketing tools to differentiate their
restaurant from the national fast food chains in order to offset their cost
structure disadvantage. As seen in the following table, the average asset size for
the top five firms in the FFHR industry is about $7 to $7.5 billion. If McDonald’s
is excluded, the average asset size is about $2 billion. This large asset size will
allow these firms to spread out their costs which should lead to a cost advantage
over smaller firms. This is important in the FFHR industry since margins are
typically small; therefore, we expect firms with a cost advantage to be more
successful.
Total Asset Size
2003
Burger King Holdings Inc**
Jack in the Box, Inc.
McDonald's Corp
Sonic Corp.
Wendy's International, Inc.
Average
$1,176
$25,525
$486
$3,164
2004
$2,665
$1,285
$27,838
$519
$3,198
2005
$2,723
$1,338
$29,989
$563
$3,440
2006
$2,552
$1,520
$29,024
$638
$2,060
$7,587
$7,101
$7,610
$7,158
* in millions
**Information for Burger King was not available for 2003
Information was attained from each firms 10-k
First Mover Advantage
A first mover advantage is an advantage gained by a firm when it is the
first firm to move into a market or develop a product. If first mover advantages
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exist in an industry, a firm who achieves it may be able to restrict entrants into
the market and thus reduce competitive pressures. First mover advantages in
the fast food industry are relatively minute. Product offerings are fairly
standardized and product and menu innovations can be mimicked quickly. Since
there is a small incentive to be the first mover, competitive pressures are again
increased.
Capital Requirements
Capital requirements are the amount of capital needed to begin and
maintain operations within an industry. Barriers to entry into an industry are
increased as the amount of capital required increases. The capital required to
start up an individual fast food location is inexpensive with the major capital
outlays being the lease agreement, equipment, and labor costs. However, the
capital requirement to develop a chain is far more expensive requiring large
investments in distribution, advertising, and land. Jack in the Box reported that
it costs $1.5 to $2 million dollars to open up each individual location in addition
to the increased costs in developing a distribution system, national advertising,
and purchasing locations (JBX 10-k 2006). This high capital outlay to develop
and maintain a regional or national chain serves as a barrier to entry into the
FFHR industry. As mentioned, it is relatively inexpensive to start a single store;
however, to compete on the scale of the major regional and national firms within
the FFHR industry requires a large amount of capital.
Conclusion
The threat of new entrants into the fast food industry is moderate to high.
Factors that reduce the threat of new entrants are the economies of scale that
the larger chains possess and the large capital requirements for a large scale
operation. Alternatively, factors that increase the threat of new entrants are the
lack of a first mover advantage, the low capital requirement for a local
restaurant, the opportunity for niche restaurants, and very low barriers to exit.
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Overall, the threat of new entrants is moderately high and should lead to a
moderate increase in competitive pressures.
Threat of Substitute Products
Within the fast food industry there is a large threat of substitute products.
Consumers’ main motivation for eating at a fast food restaurant is a quick meal
at a low price. However, this low price is matched with low service, a factor
which drives away several potential customers. There are several potential
substitutes for fast food, such as full service restaurants, grocery stores, or
eating at home.
Relative Price and Performance
Relative price and performance refers to how well a substitute compares
to what the industry has to offer. Full service restaurants offer better food
quality and service, but at a higher price. Grocery stores now offer ready-to-eat
meals that can be enjoyed at home. These meals are usually in the same price
range as fast food meals, and are viewed as a healthier option. Eating at home
is also as expensive as eating fast food, but many consumers do not want to
take the time to cook and clean up. Though there are not exact matches in
relative price and performance in the industry, substitutes to fast food are very
common.
Buyer’s Willingness to Switch
Consumers’ willingness to switch is based on whether they perceive value
in staying where they are now. In the fast food industry, factors that influence a
buyer’s willingness to switch include age, income, and health consciousness.
The age of the consumer is very important to their willingness to switch. The
fast food industry has aggressively marketed to children, making them loyal to
the industry. Children do not want to go to a place they perceive as “boring,”
whereas mom and dad may prefer to dine at a full service restaurant.
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Additionally, higher income consumers are much more willing to switch than low
income consumers. Higher income consumers have more choices in where to
eat than low income consumers. Finally, health consciousness affects the
buyer’s willingness to switch. Even though the industry has attempted to add
more healthy entrées, many consumers still consider fast food too unhealthy. As
society becomes more health conscious, buyers will become more willing to
switch to other alternatives.
Conclusion
The threat of substitute products is high in the fast food industry due to
moderate relative price and performance and high willingness to switch. The fast
food industry is in constant competition with the restaurant industry for sales and
market share. In order for the industry to keep customers, the industry focuses
on a low price and quick, quality food.
Bargaining Power of Buyers
Business strategies are often determined by how much bargaining power
exists between the firm and its customers. A large part of a firm’s profits are
driven by the industry’s overall bargaining power with its customers. When
buyers have high bargaining power the firm is forced to compete on price. Since
the firm will have to focus on price, they will have to become efficient and focus
on their cost structure (ex. somewhere down the production line) in order to be
profitable. Factors that determine the bargain power of buyers are price
sensitivity and relative bargaining power.
Price Sensitivity
Price sensitivity measures the effect on demand for products given a
change in price. If customers are price sensitive, a marginal increase in price will
have a larger decrease in quantity demanded. Customers have a higher degree
of price sensitivity in the FFHR industry since products are undifferentiated and
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the buyer has low switching costs. Additionally, products from this industry
represent a small percentage of the customer’s income. Since customers are
sensitive to price, firms within the FFHR industry will have increased competitive
pressures and have to focus on cost leadership.
Relative Bargaining Power
Relative bargaining power depends on the cost that customers’ and the
firms’ face if they decided not to do business together (Palepu & Healy). The
higher the relative bargain power, the more influence that party has on price.
Customers of the FFHR industry appear to have bargaining power over the firms.
Factors that contribute to this high bargain power are low switching cost for
customers, the number of customers in the fast food industry significantly
outnumber the number of restaurants, and the number of substitute products
that customers can choose from are numerous. Since customers have bargain
power over the firms within this industry, firms face an increased pressure to
compete to compete on price.
Conclusion
As explained, there are several factors that contribute to the high
bargaining power that customers have over firms in the FFHR industry.
Customers are very sensitive to price and have relative bargain power over the
firms. Therefore firms in the FFHR will experience heighten competitive
pressures.
Bargaining Power of Suppliers
Bargaining power of suppliers is the pricing power that suppliers possess
over the firms in the FFHR industry. Whichever firm has this power, the firm or
the supplier, will have the ability to influence the price. Factors that determine
the bargaining power of supplier are price sensitivity and relative bargaining
power.
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Price Sensitivity
Price is the main component when this industry is making the decision on
suppliers. Since the inputs for the FFHR industry are largely undifferentiated and
are commodities, fast food firms are able to shop around for the lowest price.
This is important especially for firms that compete with each other on price to
gain customers. Firms must find a inputs at a low cost in order to maintain
margins.
Relative Bargaining Power
Again, bargaining power depends on the cost that customers’ and the
firms’ face if they decided not to do business together (Palepu & Healy). Firms
in the FFHR industry are able to set prices and create strict delivery schedules.
Firms are able to do this because they have low switching costs and are able to
switch to another supplier at a low cost. This low switching cost is an indicator of
low bargaining power for the suppliers.
Conclusion
In the fast food hamburger industry, suppliers have little bargaining
power. One of the reasons this industry holds the power in the relationship is
that most of the supplies bought in this industry are commodities, like meat,
bread, and vegetables. This, combined with a low switching cost, creates a very
little influence for the suppliers of fast food restaurants. Since the suppliers have
low power firms in the FFHR industry face less competitive pressures.
Rivalry Among Existing Firms
Rivalry among existing firms is not only one of the most powerful
determinants of the dynamics in an industry but also the level of profitability of
the industry. An industry with high levels of rivalry will have firms that
aggressively seek market share, resulting in heightened pressures to lower price,
and therefore result in thin profit margins. Factors in the fast food industry that
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will determine the level of rivalry within the industry are industry growth,
concentration, differentiation and switching costs, scale/learning economies, and
exit barriers.
Industry Growth
One measure for industry growth is growth in sales by firms. Industries
that are having stagnant growth will have heightened competitive pressures
because the only means to increase revenues is to take it away from
competitors. The table below shows that sales growth for the fast food
hamburger restaurant industry has been moderate with an annualized growth
rate of 7.13%. However, if you adjust for inflation of 2.62% over the same
period of time, sales for the FFHR industry only grew 4.51% per year
(inflationdata.com). Additionally, it appears that the sales growth over the past
two years lags behind the growth that was experienced in 2003 and 2004. This
lack of rapid growth should lead to higher competitive pressures since firms must
try to steal market share from competitors to increase sales.
US Estimated Sales
2002
2003
2004
2005
2006
2,252,318
2,337,127
2,618,206
2,732,089
2,961,278
McDonald's
21,396,726
24,046,581
26,089,341
26,825,582
28,870,409
Burger King
6,218,702
6,986,668
7,625,868
8,440,419
8,843,699
Wendy's
7,555,840
7,929,632
8,334,761
8,223,970
8,250,596
Sonic
2,368,355
2,513,874
2,835,955
3,157,521
3,481,296
39,791,941
43,813,882
10.11%
47,504,131
8.42%
49,379,582
3.95%
52,407,278
6.13%
Jack in the Box
Industry
Growth Rate
Annualized Growth Rate
7.13%
Information was attained from each firm’s 10-k report.
*Sales for Burger King in 2003 and 2002 are estimates
**Sales are in Thousands (000)
Concentration
Concentration of an industry measures the relative size of firms within the
industry. A high concentration of firms occurs when there are few firms who
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dominate market share within an industry such as an oligopoly or monopoly.
Alternatively, an industry with low concentration of firms has many firms with
low relative market share. In the case for an industry with low concentration,
competitive pressure is heightened and pressure to compete on price is elevated.
Currently, the fast food industry has over 200,000 restaurants with hamburger
restaurants accounting for 50 percent of the market share. Hoovers describes
the fast food industry as “highly fragmented [low concentration]: the top 50
companies hold about 25 percent of industry sales” (Hoovers).
The overall fast food industry may be highly fragmented; however, the
fast food hamburger industry appears to be dominated by McDonald’s which has
over 50% of the market share compared to competitors. The rest of the
competitors in the fast food hamburger restaurant industry may have to fight
over the remaining market share since it appears that McDonald’s has been able
to maintain its dominance. This could lead to higher competitive pressures for all
firms except for McDonald’s.
Jack in the
Box
McDonald's
Burger King
Wendy's
Sonic
2002
5.7%
53.8%
15.6%
19.0%
6.0%
Market Share
2003
2004
5.3%
5.5%
54.9%
15.9%
18.1%
5.7%
54.9%
16.1%
17.5%
6.0%
2005
5.5%
2006
5.7%
54.3%
17.1%
16.7%
6.4%
55.1%
16.9%
15.7%
6.6%
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*Market share is based on estimated U.S. sales. Information was attained from each
firm’s 10-k report.
Differentiation and Switching Costs
Product differentiation is the extent to which products are dissimilar from
competitor to competitor. The more differentiated product offerings there are
the less price pressure a firm faces. However, the more that the industry’s
products are similar, the more that firms must compete primarily on price.
Products and service in the fast food hamburger industry are relatively similar in
price and quality. Firms within this industry typically offer the same core items
(hamburgers, fries, sodas, and etc.) and the same restaurant design of kitchen,
dining area, parking lot, and drive through (Hoovers).
Also, as products within an industry become more similar, customers face
lower switching costs. Switching costs are the monetary and opportunity costs
that customers face when/if they choose to use another product. When
switching costs are low, customers are more able to switch from one
competitor’s product to another competitor at little to no cost. Therefore, low
(high) switching costs results in a greater (lesser) pressure on firms to compete
on price. Firms within the FFHR industry are aggressively using advertising to
develop a brand image and to inform customers about products and promotions
in order to steal customers from competitors.
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Scale/Learning Economies
In order to become a profitable national fast food chain in the United
States, economies of scale become increasingly important. Economies of scale is
the notion that as a firm increases its size, it is able reduce its average cost per
unit. Since the fast food industry competes primarily on similar products and its
customers face low switching costs, economies of scale can be very important to
the profitability of a firm. As seen in the table of total assets, the asset size
range the main competitors focusing on hamburgers within the fast food industry
is $638 million to $29 billion. McDonalds’s is almost 12 times the size of Burger
King and 20 times the size of Jack in the Box.
Total Asset Size
2003
Burger King Holdings Inc**
Jack in the Box, Inc.
McDonald's Corp
Sonic Corp.
Wendy's International, Inc.
Average
$1,176
$25,525
$486
$3,164
$7,587
2004
$2,665
$1,285
$27,838
$519
$3,198
$7,101
2005
$2,723
$1,338
$29,989
$563
$3,440
$7,610
2006
$2,552
$1,520
$29,024
$638
$2,060
$7,158
* in millions
**Information for Burger King was not available for 2003
Information was attained from each firms 10-k
Another component of economies of scale is that of learning economies.
Learning economies of scale occur when steep learning curves exist. Low
learning economies of scale increase competitive pressures since the learning
curve for employees is relatively flat. The fast food industry is a very labor
intensive, low knowledge-based industry in regards to employees. Learning how
to run a cash register, manage a grill, or make french fries requires very little
technical expertise and thus, less of a learning curve. Therefore, firms must
compete for lower wage workers, typically ages 18 to 24, and deal with high
turnover rates.
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Exit Barriers
Exit barriers are the cost to a firm to exit its current industry. With higher
exit barriers, competitive pressures are increased since a firm cannot freely exit
the industry. Unlike some industries, the fast food industry does not face very
many exit barriers.
Conclusion
The rivalry among existing firms is very high for the fast food hamburger
restaurant industry. Factors that aid to an increase in rivalry are that the
industry are highly fragmented, products are undifferentiated, learning
economies do not exist, and customers have low switching costs. These factors
lead to high levels of competition and an increased pressure to compete on
price.
Five Forces Conclusion
Based on the Five Forces analysis, the fast food hamburger restaurant
industry is mixed in regard to competitive pressure. Although the industry is a
mixed industry with aspects of both high and low competitive pressures, the
industry as a whole is very competitive. Factors such as rivalry among existing
firms, threat of substitute products, and power of buyers contributes to this
industry being highly competitive. The following chart sums up our findings.
Five Forces Summary
Threat of New
Entrants
Threat of
Substitute
Products
Bargaining
Power of Buyers
Bargaining
Power of
Suppliers
Rivalry Among
Existing Firms
Rating
7
9
9
3
10
Level of
Competition
Moderate
High
High
Low
High
We have rated the industry on each of the five forces based on a 1-10
scale with 10 illustrating that the factor contributes to high competitive
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pressures. Overall, we rate the industry as 7.6, which we conclude illustrates
high competitive pressures. We expect this high amount of competitive pressures
to lead to more price pressures amongst competitors in the FFHR industry. This
could ultimately lead to smaller profit margins. The successful firms in the FFHR
industry will be those that are able to control their costs.
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Key Success Factors Overview: FFHR Industry
Key success factors are those attributes in which firms must possess in
order to be successful in their respective industry. Based on the high
competitive pressures in the FFHR industry, firms should be following many
strategies for creating a competitive advantage for cost leadership as outline by
Porter. Based on Porters suggested strategies and analyses of the industry, the
following key success factors have been identified: cost control, convenience,
brand image, and a diversified product portfolio.
Cost Control
An industry with high competitive pressures must compete on price in
order to be successful. Therefore, to be profitable a firm must be able to
minimize its costs in order to increase its profit margins and have the flexibility to
lower its prices. There are two main factors in the FFHR industry that firms can
utilize to low costs: economies of scale/scope and a tight cost control system.
Firms who are able to leverage these to factors will be able to lower their
average cost per unit and thus increase their margins. However, firms who are
inefficient and cannot control costs will have a difficult time surviving in this
industry.
Convenience
As seen in the five forces analysis, buyers have the power over firms in
the FFHR industry. Therefore, firms that do not meet the demands and needs of
the buyers/customers, will fail in the industry. Customers of the FFHR industry
demand convenience in the form of locations, speed, hours, and value
(Hoovers). Firms will have a competitive advantage if they are able to have the
best locations, be able to prepare the food quickly, have a wide range of hours,
and at the lowest price.
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Brand Image
Brand image becomes more and more important since products in the
FFHR industry are undifferentiated. To differentiate their offerings, successful
firms are creating distinct brand images. Firms that are successful to leverage
their brand are able to differentiate their firm in an industry that sell the same
product and therefore create loyal customers.
Diversify Product Portfolio
A diversified product portfolio is when a firm owns a collection of
subsidiaries that are in other markets or using franchises to reduce business risk
of the firm. Since the FFHR industry is highly competitive, it is necessary for
firms to finds ways to reduce their exposure to pressures of this industry. Also,
as previously explained, the FFHR industry has experienced stagnant growth
which forces firms to steal market share from other competitors. In order to
increase margins and reduce dependence on the FFHR industry, firms can move
into growing market segments such as Mexican or sandwich shops. Additionally,
firms can franchise new stores to reduce risk since franchises bring in a steady
stream of fee and royalty revenue. Both of these approaches allow firms to
leverage their other competitive advantages while reducing their dependence on
the highly competitive FFHR market.
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Firm Competitive Advantage Analysis
The competitive advantage analysis is a tool to analyze how well the firm
is implementing key success factors of the industry. Jack in the Box is striving to
become a leader in the industry; however, the company needs to be compared
against the industry’s key success factors to determine its position within the
industry. These key success factors are cost control, convenience, brand image,
and diversification.
Cost Control
Jack in the Box is trying to achieve cost control through the use of
economies of scale, lower input costs, and a tight cost control system.
Economies of scale are important to the industry in order to reduce cost
through size. Jack in the Box is campaigning to open 120-135 new restaurants in
2007. Of these, 40-45 would be new Jack in the Box stores and 80-90 would be
Qdoba restaurants. This growth strategy “includes expansion into new
contiguous markets” (JBX 10-K 2006). As Jack in the Box’s growth increases,
they hope to be able to lower costs through economies of scale. However Jack
in Box admits that, “Some of our competitors have substantially greater financial,
marketing, operating and other resources than we have, which may give them a
competitive advantage” (JBX 10-K 2006).
Lower input costs are achieved through the reduction of cost of supplies
and reducing non-value added activities. Tight cost control is necessary to turn a
profit in the highly competitive fast food hamburger restaurant industry.
Operating margin is one measure of management’s ability to lower input costs
and have tight cost control. A firm that has a higher operating margin than the
industry average tends to have lower average costs and a better gross margin.
The chart below shows operating margin for Jack in the Box, its major
competitors, and the industry average. As seen, Jack in the Box is well below
industry average, showing that it probably needs to improve in is cost control.
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As seen in the net profit margin graph, the two firms that had the highest
operating profit margin, MCD and SONC, had the highest net profit margin. As
the graph above illustrates, JBX’s net profit margin was less that 4%. This is not
a surprise since JBX’s operating margin was only 7%. This indicates that JBX is
fairly inefficient in their cost controls. We feel that this inefficiency may by one
of the driving reasons that JBX is moving to more franchised restaurants that
company operating stores. Since cost control is a major competitive advantage
in the industry, we feel that JBX is going to have to play catch up with the
industry leaders for at least the next 3 to 5 years.
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Convenience
Another industry key success factor is the convenience associated with
fast food hamburger restaurants. Location, speed, hours, and value all create
the convenience consumers expect when visiting a fast food hamburger
restaurant.
Location is a very important aspect of a new restaurant to JBX. Selection
of a new location is based off of several factors, including “population density,
traffic, competition, restaurant visibility and access, available parking,
surrounding businesses and opportunities for market penetration” (JBX 10-K
2006). All of these are determining factors in the future success of a restaurant.
Speed of service, hours, and value are other factors that create
convenience for the customer. In order to implement speed of service, JBX
utilizes order confirmation screens in the drive-thru windows. This allows the
customer to verify their order and proceed without having to sort through their
items and make sure everything is correct. JBX also operates their stores 18-24
hours a day to meet the demand of customers. Value for the customer is the
right amount of food at the right price. Jack in the Box has a value menu, which
allows customers to buy an item at a very low price. JBX also has value meals,
which are full meals at one price.
Convenience is an important key success factor to the industry. Jack in
the Box appears to meet, but does not exceed, the industry in location, speed of
service, hours, or value. We consider Jack in the Box to be placed firmly in the
middle with respect to this industry key success factor.
Brand Image
Jack in the Box believes that its brand offers a superior dining experience
compared to its competitors. Jack in the Box is in the process of reinventing their
brand through menu innovation, improved service, and re-imaging their
restaurants.
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Jack in the Box’s menu innovation is a “focus on higher quality products”
in order to “attract a broader consumer audience” (JBX 10-K 2006). Jack in the
Box has added to their line of burgers, enhanced their dessert line, and
partnered with brand name vendors. Jack in the Box is also continuously testing
and developing new products to add to menu and differentiate themselves from
their competition.
During 2006, Jack in the Box team members attended a three day
conference to “engage them in a service vision and provide tools for improving
guest service” (JBX 10-K 2006). This conference was to support the company’s
goal of brand reinvention. The company feels that improving service gives the
customer a good feeling about the restaurant and leave them wanting to return.
To measure progress, JBX has implemented a Voice of the Customer program,
which is a program that measures performance through online or telephone
surveys.
Finally, Jack in the Box is upgrading their facilities. 150 restaurants were
redesigned in 2006, and JBX’s goal is to update all facilities in four or five years.
The redesigning process includes “ceramic tiled floors, a mix of seating styles
from booths to high-top round tables, decorative pendant lighting, and graphics
and wall collages” (JBX 10-K 2006). JBX wants to create a “destination dining
experience” that will meet and exceed customer expectations (JBX 10-K 2006).
Jack in the Box’s strategic goal of brand reinvention is directly in line with
the industry’s key success factor of brand image. However, JBX’s focus on
improved quality, product innovation, and improved service may not be
consistent with successful strategies for a industry focused on cost leadership.
Diversify Product Portfolio
A final industry key success factor is diversification of the business
through franchising and multiple operations.
Franchising is an industry standard that JBX is working on increasing.
Currently, Jack in the Box is only 29% franchised. However, Jack in the Box has
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a goal of being 35% franchised by 2008 and a long term goal of increasing
franchise ownership by 5% per year after that. Increasing franchising allows JBX
to “penetrate new markets with local operators while also mitigating increases in
operating costs and investment risks” (JBX 10-K 2006).
Restaurant Breakdown
Franchised
Company Owned
Total
2002
355
1507
1862
2003
394
1553
1947
2004
448
1558
2006
2005
515
1534
2049
2006
604
1475
2079
This chart shows how Jack in the Box has been continually increasing the
number of its franchised restaurants while reducing the number of company
owned restaurants for the past five years.
Jack in the Box expanded into the fast-casual restaurant segment when it
acquired Qdoba Mexican Grill in January of 2003. JBX also owns and operates 55
Quick Stuff convenience stores and fuel stations. Both of these are examples of
how JBX is an industry leader of expansion into multiple operations. These stores
diversify JBX and reduce some of the risk associated with running a fast food
hamburger restaurant.
Jack in the Box has made diversifying its holdings and building up
franchises a strategic goal of the company. Therefore, we feel that JBX is in line
to achieving this success factor of diversification.
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Accounting Analysis
When analyzing the financial condition of a firm, it is important to conduct
an accounting analysis to uncover potential distortions in the financial
statements. The reason for distortions is the flexibility offered to managers by
Generally Accepted Accounting Principles (GAAP). Firms have been given a level
of flexibility so that they can better reflect the nature of their business.
However, since managers face pressure to meet financial expectations,
managers may utilize accounting flexibility to withhold or manipulate information
that is necessary to determine a firm’s financial position.
It is a financial analyst’s job to assess the quality of the firm’s financial
statements by using this six step process to filter out what numbers and
information the firm may be distorting. The first step in this process is to identify
the firm’s key accounting policies which relate to the firm’s key success factors.
Since these factors could materially affect the firm’s financial position, accounting
policies need to be reviewed and analyzed.
The next step is assessing the amount of flexibility a firm has in
accounting for these important items. Even though GAAP does allow for some
accounting flexibility, there are some portions of accounting that are unyielding.
For example, research and development is an important factor to some firms,
but have no discretion when it comes to accounting (Palepu and Healy, 3-8).
The third step is evaluating a firm’s actual accounting strategy. This will
allow an analyst to understand if a firm’s accounting strategy is aggressive or
conservative. An aggressive accounting strategy will overstate net income
whereas a conservative strategy will tend to understate net income.
The fourth step of accounting analysis is to evaluate the actual quality of
the firm’s disclosure. This step is broken down in to two categories: qualitative
and quantitative. Qualitative analysis deal with how much extended disclosure is
in the footnotes, segment disclosure, and how the company addresses bad news.
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(Palepu and Healy 3-10). Quantitative analysis uses ratios to show potential
manipulations in sales and expenses.
These ratios lead the analysis to the fifth step of identifying the potential
“red flags” of a firm. Ratios that show abnormal changes in numbers are
deemed as “red flags” and could point to mistakes or intentional
misrepresentation of numbers.
The final step in this procedure is to undo any distortions made by the
firm. Undoing these distortions shall lead to more accurate information in the
financial statements and thus a better understanding of the value of a firm.
By conducting this six-step accounting analysis, an analyst should have a
better understanding of the true financial position of the firm. This will allow the
analyst to conduct a financial and prospective analysis with figures that better
reflect the financial reality of the firm.
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Key Accounting Policies
Key accounting policies are accounting items that are related to key
success factors that create value for the firm. Key accounting policies can also
be material asset or liability items that affect the user’s view of the firm. Firms
who use aggressive or conservative accounting techniques could alter the
accounting perspective of the firm and thus make it more difficult to assess the
true financial standing of a firm. For the fast food hamburger restaurant
industry, key accounting policies include lease accounting, franchise accounting,
and segment disclosure.
Lease Accounting
A lease is a contract between two parties concerning the use of an asset.
The owner of the asset (the lessor) accepts monthly payments from the user of
the asset (the lessee). In exchange, the lessee gains full use of the asset for the
term of the lease contract. The Federal Accounting Standards Board (FASB) FASB
divides the accounting treatment of leases into two categories: leases where the
lessee is effectively purchasing the asset (capital), and leases where payments
are simply rentals (operating).
Capital leases are used when the lessee is effectively financing the
purchase of an asset. A capital lease records an asset and a liability at the
present value of future minimum lease payments. Payments are structured like a
loan with payment of interest and a reduction of principal. As the lessee makes
payments, the liability is reduced by the amount of payment less interest. The
asset is depreciated over the life of the lease, increasing the firm’s depreciation
expense. Capital leases are generally viewed as unfavorable by firms because
they increase liabilities on the balance sheet, and initially increase expenses and
lower net income during the first few years of inception.
Operating leases treat lease payments as rent, and should only be used
when the lease is short compared to the life of the asset. Operating leases do
not show up on the balance sheet as rent; rather, they are expensed at a fixed
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amount every year. Since the consequences of utilizing operating leases are
considered more favorable compared to capital leases (due to GAAP weakness),
many companies legally manipulate lease contracts to allow them to classify their
lease as operating.
The use of an operating lease when a capital lease is appropriate
materially affects the firm’s balance sheet and income statement. Financial
statements that have been manipulated can potentially mislead investors. For
example, an investor that is uninformed may only look at the numbers that have
been stated for assets and liabilities. The investor, therefore, will be mislead
because the assets and liabilities are understated on the balance sheet. As
shown in the graph below, the fast food hamburger restaurant industry uses a
small percentage of capital leases compared to total lease obligations.
* Information drawn from companies’ respective 10-K’s. Total minimum
payments under capital lease obligations are used for this calculation.
Jack in the Box
McDonald's
Burger King
Wendy's
Sonic
Capital Leases
$32,102
134,000
31,776
54,437
Operating Leases
$1,664,976
11,119,800
1,391,000
965,239
168,707
Total
$1,697,078
11,119,800
1,525,000
997,015
223,144
*Values in thousands
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We feel that the fast food hamburger restaurant industry should be using
capital leases because most restaurant locations intend to use the building for
the majority of the asset’s life. If the company does end a lease, the building
cannot be used for another purpose without costly renovations. Therefore, the
firm is essentially financing the purchase of the building where it operates its
business. As the previous table illustrated, these firms possibly have understated
their assets and liabilities ranging from $224 million for Sonic to $11.1 billion for
McDonald’s. These amounts are definitely material and would change the
balance sheet of the firm. If firms within the industry capitalized these leases,
we could get a better understanding of their true financial position.
Franchise Accounting
Franchising is the “right or license granted by a company to an individual
or group to market its products or services in a specific territory”
(www.dictionary.com). The parent company (franchisor) allows the individual
(franchisee) to operate a store in return for an initial franchise fee, rents, and
royalties based on sales. The FASB regulates how franchisors recognize revenue
from franchising activities. The FASB states that revenue from a franchise be
recognized when “all material services or conditions relating to the sale have
been substantially performed or satisfied by the franchisor” (www.fasb.org). The
FASB also has regulations concerning the definition of substantial performance.
Franchise accounting is important to the fast food hamburger restaurant
industry because a significant part of their business comes from franchised
locations. For example, Jack in the Box is currently 29% franchised, with goals
of increasing franchises by 5% a year (JBX 10-K 2006, 11). Franchising gives
firms in the FFHR industry an opportunity to enter new markets while decreasing
investment risks and operating costs (JBX 10-K 2006, 11).
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Segment Disclosure
Segment disclosure can be defined as how much information managers
release in regards to various parts of operation. In the fast food hamburger
restaurant industry, a key success factor is diversification of segments and
business holdings. If a firm has diversified holdings but does not disclose
information about the various segments, users of financial statements will not be
able to get a fair and clear picture of the firm. Segment disclosure aids users in
gauging the full performance of every aspect of the firm. In the FFHR industry, a
few disclosure items that are useful to the user include number of franchised
versus company owned stores, sales of subsidiaries, and a detailed breakdown of
revenues.
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Potential Accounting Flexibility
There are many ways a firm is legally able to disclose information to the
public, specifically to its investors. One of the main tools for facilitating
information is by providing financial statements. These financial statements
purpose is to credibly portray the financial status of the firm. However, because
GAAP allows for flexibility in the reporting of particular items within these
statements, a firm may appear to be more or less attractive than in reality
Therefore, it is necessary to analyze the financial statements to detect these
intentional or unintentional distortions in order to make educated investment
decisions. Two of the main line items that firms in the FFHR industry have
flexibility in reporting are leases and intangible assets.
Operating versus Capital Leases
One way a firm may mislead investors is through the reporting of leases.
A firm can record them as operating leases or capital leases. In an operating
lease, the owner transfers the right to use property to the lease holder. When
the lease or contract becomes expired, the holder returns the property to the
owner. Through this process, the lease holder assumes no risk because he/she
does not own the property. Therefore, the lease expense is treated as an
operating expense and is only recorded on the income statement. In capital
leases, however, the lease holder assumes some or all of the risks of ownership.
Capital leases are recorded on the balance sheet as liabilities and assets. In
conclusion, the expenses recorded from capital leases are recognized before
operating leases. This makes the company seem less profitable and appealing to
investors; therefore, most companies, including Jack in the Box, record the
majority of their leases as operating leases.
Intangible Assets
Another way a company may mislead investors is through the reporting of
intangible assets. Intangible assets are assets that are not physically in the
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firm’s possession. Examples of intangible assets include goodwill, patents,
copyrights, and brand recognition. The FASB requires that certain intangible
assets are amortized, while others can be amortized at the firm’s discretion.
Jack in the Box records both amortized and unamortized assets. Lease
acquisition costs and acquired franchise contracts are the amortized intangible
assets, whereas, goodwill and trademarks are the unamortized intangible assets.
Jack in the Box “evaluates goodwill and intangible assets not subject to
amortization annually or more frequently if indicators of impairment are present.
If the determined fair values of these assets are less than the related carrying
amounts, an impairment loss is recognized” (JBX 2006 10-K). As shown in Jack
in the Box’s annual reports, JBX has recorded $93 million in goodwill since 2003.
This goodwill is attributable to the purchase of Qdoba. Jack in the Box utilizes
future cash flow assumptions in order to estimate the fair value of intangible
assets. These assumptions may differ from the actual cash flows, due to
numerous conditions. For example if too high a discount rate is used, the fair
value will be understated. In conclusion, because fair value is just an estimate,
the numbers that are recorded on financial statements may not correctly reflect
the true market value.
Conclusion
The purpose of flexibility is to allow managers, including those at Jack in
the Box, to accurately report the financial condition of their firm. However, this
flexibility potentially allows managers to distort economic reality for their own
gain or to achieve certain objectives. As stated above, Jack in the Box chooses
to record the majority of their leases as operating leases. Also, Jack in the Box
records certain intangibles assets as amortized or unamortized. Along with JBX,
the fast food hamburger restaurant industry has flexibility in how it reports
operating leases and intangible assets.
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Actual Accounting Strategy
As alluded to previously, the accounting strategy of a firm has the
potential to distort the true financial position of the firm. It is important to
analyze a firm’s actual accounting strategy in order to undo any potential
distortions. Assessing the accounting strategy of a firm is broken into two parts:
the overall disclosure of the firm and the degree of the use conservative or
aggressive accounting policies
Disclosure
The majority of disclosure, as outlined by GAAP, is voluntary and not
required by the reporting firm. However, the more information that is disclosed,
the easier it is for an investor to assess the financial performance of a firm.
Jack in the Box’s overall disclosure is fair. Jack in the Box does give
adequate disclosure in regards to breakdown of franchises versus company
owned stores, company strategy, and leasing strategy. However, this disclosure
seems to be an industry norm. Overall, JBX does not provide much information
that other members of the industry do not provide. Also, better disclosure in
regards to sales and expense by franchise versus company owned stores would
give a better understanding of restaurant performance. Another important
disclosure would have been a breakdown of expenses. JBX does not give much
additional information on expenses other than the main categories of cost of
sales, operating costs, costs of distribution, and franchised restaurant costs.
More disclosure on the expense structure would allow for a better understanding
of JBX’s efficiency.
Accounting Policy Strategy
As with disclosure, firms are able to choose accounting policies that fit
within the guidelines of GAAP but may distort the usefulness of the financial
statements. As mentioned, the two main accounting aspects that JBX has
flexibility in accounting are the recognition of leases and intangible assets.
39 | P a g e
Intangible assets such as goodwill only account for only $133 million or 7.4% of
JBX’s total assets. It is important to note that this percentage is even less when
the financial statements are restated to capitalize leases. This percentage has
been steady over the past 5 years. Since these assets have not been written
down, JBX might be aggressive accounting since writing these assets would
increase expenses. Despite this, a write-off in these assets would not have much
material change in the view of the firm.
Alternatively, JBX’s accounting strategy for its $1.05 billion in operating
leases could have a material affect on the view of JBX’s financials. In regards to
lease accounting, JBX is very aggressive. Only 1.89% of JBX’s leases are
reported as capital leases. Despite this, it is in our view that the majority of the
operating leases should be considered a liability of the firm; thus, the operating
leases should be capitalized. By reporting the leases as operating leases, JBX is
able to reduce its assets and liabilities on the balance sheet and reduce expenses
in the short term.
Conclusion
JBX is utilizing a fairly aggressive accounting policy. This primarily comes
from how JBX accounts for leases. By reporting lease obligations as operating
leases, JBX is able to reduce the size of its balance sheet and reduce expenses in
the early years of the lease agreement. Both of these aspects reduce the
credibility of the financial statements of JBX.
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Qualitative Analysis of Disclosure
Footnotes and other discussions in a firm’s 10-K report help supplement
financial statements that may not be clear when users view the financial
statements. Through footnotes a firm can explain a dramatic decrease in sales or
a sharp rise in property assets. The quality of these disclosures is dependent on
their transparency, or how much information the firm reveals about certain
economic transactions. The level of transparency can usually be directly
correlated to financial performance. Jack in the Box generally does a adequate
job of using footnotes to tell more about their financial position. Most of the
significant sections of the financial statements are detailed and show what those
sections encompass. An example would be the section titled “Other Assets” in
the balance sheet which “primarily include[s] lease acquisition costs, acquired
franchise contract costs, deferred finance costs and COLI policies” (JBX 2006
10K). Explanations are given about the type of accounting policies used for
sections such as inventory, impairment of long-lived assets, and revenue
recognition. Jack in the Box also discloses variations in numbers. For example,
they explain that the $26 million increase in restaurant cost of sales from 2004 to
2005 was due to beef cost increase of 11% when the U.S. border closed to
Canadian meat (JBX 2006 10-K). One problem with Jack in the Box’s
transparency was the fact that there is no separation of franchises sales from
company operated sales. This could be helpful in revealing the percentage
impact franchises have on Jack in the Box’s revenues. Overall the company gives
a fair look into the activities of their financial statements. This gives the
shareholders confidence, because they see the firm is not holding back
information that could hurt the firm’s reputation.
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Quantitative Analysis of Disclosure
As explained previously, managers have some flexibility in the accounting
of various aspects within their financial statements. This flexibility is given to
managers since they have a better understanding of the dynamics of their firm
and industry. However, flexibility in accounting may allow managers to manage
their earnings by manipulating aspects such as expenses and/or revenues.
These manipulations could distort the true financial reality of the firm. A
quantitative analysis of disclosure through the use of accounting diagnostic ratios
should uncover any attempts of manipulation by management.
Accounting Diagnostic Ratios
The purpose of accounting diagnostic is to uncover any potential
manipulations in accounting policies. If there are any deviations in the ratio from
the norm, there may be an accounting problem that should be addressed. As
the summary on the next page displays, it is important to compare Jack in the
Box’s ratios to that of the industry in order to indentify and understand any
differences in accounting policies.
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Summary of Accounting Diagnostic Ratios
Jack in the Box
2002
2003
2004
2005
2006
1.002
75.009
66.402
1.003
65.173
64.932
0.994
126.732
68.163
1.001
117.942
62.578
1.004
89.579
67.124
1.849
1.056
0.179
1.265
1.802
1.099
0.176
1.899
1.805
1.195
0.198
0.816
1.871
1.041
0.180
1.155
1.819
1.133
0.225
0.917
1.004
29.092
175.973
1.007
26.288
164.630
1.002
29.659
151.069
1.001
33.140
165.709
1.004
32.592
165.062
0.987
1.014
0.273
0.489
0.919
1.008
0.261
0.637
1.034
1.037
0.274
0.264
1.106
1.087
0.302
0.304
1.087
0.968
0.267
0.483
0.998
18.012
137.920
0.993
23.336
132.461
1.001
24.942
126.061
1.002
24.981
137.439
1.005
23.873
144.875
0.643
1.368
0.156
1.818
0.663
1.154
0.164
0.178
0.668
1.103
0.189
0.941
0.661
1.086
0.222
1.063
0.744
0.977
0.208
0.943
1.001
31.594
57.560
N/A
N/A
N/A
19.678
44.673
0.974
39.483
82.402
1.009
28.751
80.632
1.024
1.165
0.240
0.652
N/A
1.028
N/A
N/A
0.783
2.328
0.214
-0.465
0.714
2.714
0.354
-4.024
1.184
6.732
0.221
-11.339
Net Sales/Cash from sales
Net Sales/Net Accounts Receivable
Net Sales/Inventory
N/A
N/A
N/A
N/A
N/A
N/A
N/A
N/A
N/A
N/A
17.636
N/A
1.000
18.789
N/A
Asset Turnover (sales/assets)
CFFO/OI
CFFO/NOA
Total Accruals/Change in Sales
N/A
N/A
N/A
N/A
N/A
N/A
N/A
N/A
N/A
2.726
N/A
N/A
0.712
1.444
0.242
1.651
0.803
0.435
0.084
3.583
Net Sales/Cash from sales
Net Sales/Net Accounts Receivable
Net Sales/Inventory
Asset Turnover (sales/assets)
CFFO/OI
CFFO/NOA
Total Accruals/Change in Sales
Sonic
Net Sales/Cash from sales
Net Sales/Net Accounts Receivable
Net Sales/Inventory
Asset Turnover (sales/assets)
CFFO/OI
CFFO/NOA
Total Accruals/Change in Sales
McDonalds
Net Sales/Cash from sales
Net Sales/Net Accounts Receivable
Net Sales/Inventory
Asset Turnover (sales/assets)
CFFO/OI
CFFO/NOA
Total Accruals/Change in Sales
Wendy's*
Net Sales/Cash from sales
Net Sales/Net Accounts Receivable
Net Sales/Inventory
Asset Turnover (sales/assets)
CFFO/OI
CFFO/NOA
Total Accruals/Change in Sales
Burger King**
*Wendy’s did not have a balance sheet for 2003.
**Burger King went public in 2004; therefore, financial statements for previous years are not
available.
***Information attained from each firm’s 10-k
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Revenue Diagnostic Ratios
Looking at the revenue diagnostic ratios allows analysts to examine trends
that exist in JBX’s reported revenue figures in order to identify any potential
discrepancies. We are then able to compare the firm’s reported figures to their
closest competitors. This allows us to be able to determine if the firm’s revenue
numbers are following industry trends or if the discrepancies are firm specific.
The following section contains the revenue diagnostic ratios that will help show
where Jack in the Box’s revenues are coming from and help explain the overall
FFHR industry trends in revenue.
Net Sales/Cash from Sales
Net sales/cash from sales is a diagnostic tool that indicates whether or not
a firm’s cash flows are able to support the reported revenues. The ratio should
be close to 1.0 since firms should be receiving the same amount of cash as they
report as sales. However, because of timing issues with accounts receivable, the
cash may be received in a different period. Also, a consistent ratio of less than
1.0 could indicate that the firm has more account receivables that went into
default.
The fast food hamburger restaurant industry should not have much
deviation from a 1:1 ratio since most sales in this industry are in the form of cash
and not accounts receivable. Therefore, once a firm makes a sale they receive
cash, check, or credit. All of these forms of payment are basically considered
cash; therefore, very little, if any, accounts receivable.
As seen in the table below, Jack in the Box, Sonic, and McDonalds have a
net sales/cash from sales ratio of 1.0 as expected. However, since Wendy’s and
Burger King have lack of data, their results are not meaningful. Therefore, we
conclude that revenues of the FFHR industry are supported by cash flow.
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Net Sales/Net Accounts Receivable
As mentioned, account receivables for the FFHR industry are relatively
low; therefore, the net sales/net accounts receivable ratio may not be that
meaningful for this industry. However, in general, a higher net sales/net
accounts receivable is desired since there is less time between the date of the
sale and receiving payment for the sale.
As seen in the graph below, the industry appears to have a net sales/net
accounts receivable around 20 to 40. However, Jack in the Box ratio varies from
65 to 126. Although this appears to be significant, the problem with this ratio is
that Jack in the Box has a small amount of accounts receivable. Therefore, any
small change in accounts receivable will result in large deviations in this ratio.
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Net Sales/Inventory
Net sales/inventory is an indication of how well a firm turns inventory into
revenues. However, for accounting diagnostics, the sales/inventory ratio
indicates if the firm’s sales are supported by inventroy. Large deviations in net
sales/inventory may indicate that their may be manipulations in sales since it
would be expected that as a firm increases sales, their inventory would probably
increase proportionately.
As seen in the graph below, all firms in the industry appear to have a
constant net sales/inventory ratio. Sonic had a slight decrease from 2002 to
2004. However, overall, it appears that firms in the FFHR industry are consistent
in their reporting of net sales and inventory. This indicates that sales for each
firm in the industry are supported by their inventory. Therefore, it does not
appear that firms are manipulating their sales.
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Revenue Diagnostic Conclusion
The Net Sales/Cash from Sales ratio seems to be following the industry
wide average of 1.00 which is to be expected. The Net Sales/Net Accounts
Receivable ratio for Jack in the Box tends to be higher than the industry average
because JBX has smaller amounts of accounts receivable than comparison firms.
The Net Sales/Inventory has been very steady for Jack in the Box for the past
several years, but remains lower than the industry average. This can be
explained by the fact that Jack in the Box is a smaller firm when compared to its
competitors. Overall, it appears that revenue is supported by sales for Jack in
the Box, and there are no real “red flags” presented in this information.
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Expense Diagnostic Ratios
Examining expense diagnostic ratios for a firm allows us to determine if
the JBX is trying to hide additional expenses for the purpose of increasing profit
margins. We are able to compare the firm’s expense numbers against previous
years as well as competitors. The following section contains the expense
diagnostic ratios for JBX as well as competitors in the FFHR industry.
Asset Turnover
Asset turnover is a firm’s net sales/total assets. This ratio should be fairly
constant over time since as sales increase (decrease), total assets should
increase (decrease). Major deviations in this ratio could indicate a manipulation
in assets such as under/over stating assets or possibly a large writeoff in assets.
Also, a declining asset turnover could be an indication of either a lack of
efficiency or a possibility that the firm has been forced write down assets on
their balance sheet.
As the following graph indicates, the asset turnover for firms in the FFHR
industry are relatively stable and slightly upward sloping. This indicates that
firms in this industry are probably not manipulating their expenses by delaying
writing off their assets. Also, this stable trend should be expected since firms
should not be able to change their asset efficiency in a short period of time. Jack
in the Box has the highest turnover at slightly over 1.8 for the past 5 years. This
illistrates that JBX has the highest asset utilization efficiency in the industry.
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CFFO/OI
CFFO/OI is a firm’s cash flows from operating activities divided by its
operating income. This ratio shows how much operating income is supported by
cash operations. Since the FFHR industry is mainly a cash business, this number
should be fairly close to one. However, this number is not always close to one
when depreciation and working capital changes are calculated in the equation. A
decrease in this ratio indicates that the firm is gaining income through increases
in accounts receivable. The probability of increases in accounts receivable in the
FFHR industry is extremely small, since it is primarily a cash business.
As shown in the graph below, Jack in the Box, Sonic, and McDonald’s all
have ratios very close to one. It is difficult to determine the reason for the large
deviation in Wendy’s and Burger King’s ratios.
49 | P a g e
Expense Diagnostic Ratios Conclusion
The asset turnover ratio for Jack in the Box has remained steady for the
past several years with an average around 2. Compared to the industry, Jack in
the Box’s asset turnover ratio is higher than its competitors. This can be
explained by that Jack in the Box uses it assets more efficiently and effectively
than its competitors in the FFHR industry. The CFFO/OI ratio for Jack in the Box
is consistent with the industry average of 1. This can be explained by that the
FFHR industry is primarily a cash business. Overall, we feel that there are no
potential “red flags” presented when analyzing the expense diagnostic ratios.
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Identify Potential Red Flags
In the analysis of Jack in the Box, no ratios present a red flag. The only
item that presents a “red flag” is the extensive use of operating leases instead of
capital leases. As discussed in the key accounting policies section, the use of
operating leases when a capital lease is appropriate affects assets, liabilities, and
expenses. For Jack in the Box, a capital lease would be more appropriate than an
operating lease because the firm does not expect to leave the location once the
lease term is up. According to JBX, the firm generally is able to “renew our
restaurant leases as they expire at then-current market rates” (JBX 2006 10-K,
15). This statement can be viewed as an intention of the firm to continue leasing
at that location for extended periods of time, where significant portions of the
leased asset would be consumed by Jack in the Box. Therefore, using capital
leases would be more appropriate for Jack in the Box.
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Undo Accounting Distortions
The purpose of financial statements is to accurately portray the economic
consequences of business activities. As explained in the red flag section, Jack in
the Box expenses their operating leases rather than capitalizing the leases. This
accounting practice changes the structure of the firm’s balance sheet and
expenses. Because of this, a restated financial statement showing operating
leases as capital leases for Jack in the Box is needed in order to give users a true
and fair picture of their firm.
The full analysis and restated balance sheets for fiscal years 2002-2006
for Jack in the Box can be found in the Restatements Appendix. In order to
undo this distortion, some assumptions were made. According to Jack in the
Box, the average lease term is 5-20 years (JBX 10-K 2002-2006). It is assumed
that the lease term is 12 years, which is the average of 5-20 years. For fiscal
years 2004-2006, JBX disclosed the average interest rate for their capital leases.
Minor adjustments were necessary to make the calculated present value match
the present value stated in the 10-K. For fiscal years 2002 and 2003, the
interest rate is assumed to be the rate which makes the calculated present value
match the present value stated in the 10-K.
Restating Financials
Restating JBX’s financial statements to reflect operating leases as capital
leases has major effects on the balance sheet as seen in the following table and
graphs. For example, fiscal year 2006 assets and liabilities should be increased
by about $1.05 billion from $1.5 billion to $2.5 billion or an increase of 69.11% in
assets and liabilities. Also, the restated assets will reduce the asset turnover
from about 1.8 to 1. However, the asset ratio is consistent over the past five
years. This restatement makes Jack in the Box less attractive to potential
investors due to a significant increase in liabilities.
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Restated Financials
Total Assets
Before
After
Asset Turnover
Before
After
2003
2004
2005
2006
2007
1,063,483
1,877,621
76.55%
1,142,481
2,063,943
80.65%
1,285,342
2,339,408
82.01%
1,337,986
2,407,971
79.97%
1,520,461
2,571,319
69.11%
1.848981
1.047261
1.801597
0.997261
1.805329
0.991903
1.871132
1.039692
1.818954
1.075576
Conclusion
This restatement of capitalizing leases as assets and liabilities of Jack in
the Box clearly changes our financial perspective of the firm. From this
restatement, Jack in the Box has understated its leasing obligations and its
assets. More detail of the affects of capital leasing will be seen in the financial
analysis. Now that this accounting distortion has been corrected, the analysis of
JBX can give a truer and fairer picture of the firm and its activities.
53 | P a g e
Financial Analysis
Financial analysis is a method of determining the financial health of a firm.
The main objective of financial analysis is to “evaluate the current and past
performance of a firm and to assess its sustainability” (Palepu & Healy, 1-9).
The most common way of performing financial analysis is through the use of
ratios. There are dozens of ratios, but the most commonly used can be broken
into three categories: liquidity, profitability, and capital structure ratios. The
ratios of one firm can be compared to the ratios of competitive firms and the
industry to determine how well the firm is performing. Additionally, it is
important to monitor changes in a firm’s financial ratios in order to identify any
changes or trends in the structure of the firm. In this section, Jack in the Box
will be compared to its competitors through the use of ratio analysis.
Furthermore, some of the ratio analysis includes “Jack in the Box - RS”. This
represents the restated financials of Jack in the Box after capitalizing their
operating leases. Note, this measure was only included in those ratios where the
original and restated financials differed.
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Liquidity Ratios
Liquidity can be defined as the “ability to convert an asset to cash quickly”
(www.investopedia.com). A firm often has the need to acquire cash quickly in
order to pay off short term debt. Liquidity ratios are primarily used to determine
a firm’s ability to pay off any short term liability obligations. The larger a liquidity
ratio is, the better the firm’s ability to meet any of these obligations. Liquidity
ratios that are used to analyze Jack in the Box include current ratio, quick asset
ratio, inventory turnover, receivables turnover, and working capital turnover.
Current Ratio
The current ratio is current assets divided by current liabilities. This ratio
says that for every dollar in current liabilities, there is x amount in current assets
to cover the debt. A larger ratio means that the firm has a lower likelihood of
defaulting on any debt.
From 2001 to 2003 Jack in the Box had a low current ratio with an
average of about $.5 of current assets covering every dollar of current liabilities.
Jack in the Box does seem to be improving, averaging about a 1:1 current asset
ratio from 2004 to the present. The industry on average has always had a ratio
slightly above Jack in the Box in most years. The reason for this is that Jack in
the Box doest not carry as much cash or have the amount of receivables the
other companies do on average.
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Jack in the Box
McDonalds
Burger King
Sonic
Wendy's
2001
2002
2003
2004
2005
2006
0.55
0.81
0.34
0.71
0.63
0.69
0.87
0.70
0.82
0.90
0.70
0.92
0.93
0.88
0.70
0.67
1.03
1.51
1.61
0.54
1.30
1.19
1.21
0.92
0.54
1.66
There appears to be some volatility in the FFHR industry in regards to the
current ratio. Most firms have a ratio of greater than 1; however, Sonic has
been consistently below this value. Jack in the Box has been increasing its
current ratio, primarily through cash and cash equivalents. As of 2005, JBX has
enough in current assets to cover its current liabilities. Overall, there appears to
be a trend in the industry to improve the current ratio to a range from 1 to 1.5.
Quick Asset Ratio
The quick asset ratio is an even more stringent test of a firm’s ability to
pay short term debt. It is cash or cash-like assets divided by current liabilities.
Cash or cash-like assets are assets that could be converted to cash within 24-36
hours. Accounts receivable and marketable securities can be included, whereas
items such as inventory or prepaid expenses cannot. A ratio greater than or
equal to one is desirable. A ratio of less than one means that the firm must sell
more illiquid assets in order to pay short term obligations.
Where Jack in the Box’s current assets were below similar companies in
their industry, their quick asset ratios are about average with other competitors
in the industry. Since 2001, where the quick asset ratio reached dangerously low
levels, there has been an upward trend in the ratio for Jack in the Box and has
almost reached a 1:1 ratio.
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Jack in the Box
McDonalds
Burger King
Sonic
Wendy's
2001
2002
2003
2004
2005
2006
0.12
0.58
0.10
0.49
0.23
0.45
0.54
0.60
0.67
0.43
0.53
0.52
0.75
0.37
0.53
0.30
0.45
1.23
1.38
0.39
0.44
0.78
1.01
0.75
0.40
1.23
Similar to the results of the current ratio, it appears that there is a trend
in the FFHR industry to improve liquidity through the quick asset ratio. In each
of the past 4 years, Jack in the Box has improved this ratio closer to the desired
1:1 ratio.
Inventory Turnover
Inventory turnover is a unit-less measure of how many times a year a firm
must ‘restock the shelves’ with inventory. Inventory turnover is cost of goods
sold divided by inventory. A very large ratio can indicate poor inventory
management or obsolescence, while a very small ratio may indicate high sales or
a just in time strategy. Industry averages are a good indicator of how a firm is
performing relative to the industry.
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*Burger King did not report inventory in their financial statements. Thus, Burger
King was excluded.
Jack in the Box holds a steady trend in inventory turnover at an average
of about 65 times a year. Aside from Wendy’s, the firms have remained at a
fairly constant level. Although Jack in the Box has remained at this level, it is
lagging behind the industry leaders.
Days’ Supply of Inventory
Days’ supply of inventory is how many days of inventory is held by the
firm. It is found by dividing the number of days in a year by inventory turnover.
This number is the first half of the cash-to-cash cycle, which is how long it takes
for a firm to convert an investment in inventory into cash.
Again, in a similar fashion to inventory turnover, most companies in this
industry tend to have a very steady day’s supply of inventory. Jack in the Box’s
average is a little under six days of being able to turn inventory into cash. The
reason the firms in this industry have such a low number of day’s supply of
inventory is because of the amount of food that makes up their inventory and
also because of food spoilage. Jack in the Box is lagging behind the industry
58 | P a g e
leaders with Sonic and McDonalds having half the number of days of inventory
that Jack in the Box holds.
*Burger King did not report inventory in their financial statements. Thus, Burger
King was excluded.
Receivables Turnover
Receivables turnover is a unit-less measure of how many times a year a
firm collects its receivables. Receivables turnover is determined by sales to
accounts receivable. The smaller this ratio is, the less efficiently a firm is
collecting its receivables. Whereas, a higher ratio indicates strong cash sales
(www.investopedia.com).
Jack in the Box has only recently closed the gap with the leader Sonic in
part because of a $13 million dollar reduction in accounts receivable in 2004.
Although, since 2004, Jack in the Box’s receivables turnover has been on the
decline again. In comparison with their main competitors, Jack in the Box finds
its self as one of the leaders in the test of liquidity due to the high amount of
receivables owned by other companies in the industry.
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It is important to note that A/R turnover may not be a meaningful
measure in this industry, specifically for JBX. The FFHR industry is primarily a
cash industry with little use or need of accounts receivable. Also, accounts
receivable is very small for JBX; therefore, any changes in accounts receivable
will have large changes in this ratio. This may not be a great measure of
liquidity for forms in this industry.
Days’ Sales Outstanding
Days’ sales outstanding is how many days it takes for a firm to collect
receivables. This number is the second half of the cash-to-cash cycle. A
significant change is days’ sales outstanding can be explained by changes in
credit policies, which is not normally disclosed on the 10-K.
The industry number of accounts receivable days has remained relatively
constant for most companies. Despite being in the top two in the least number of
days, Jack in the Box has seen an increasing trend due to the increasing amount
of receivables being taken on. This being said, Jack in the Box’s average of five
days is very impressive.
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Working Capital Turnover
Working capital turnover is the ratio of sales to working capital. This ratio
means that for every dollar of net investment in the business, there is x amount
of sales. A larger ratio is preferred because the “company is generating a lot of
sales compared to the money it uses to fund the sales” (www.investopedia.com).
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Jack in the Box
McDonalds
Burger King
Sonic
Wendy's
2001
2002
2003
2004
2005
2006
-17.94
-34.66
-8.90
-21.79
-23.10
-19.86
-65.33
-28.06
-66.05
-78.83
-30.92
-93.32
-155.35
-48.44
-36.90
-10.90
288.43
9.39
8.08
-20.70
14.18
43.07
34.97
-52.51
-19.48
9.31
Jack in the Box and most of its main competitors have a negative working
capital because their current liabilities are more than their current assets. The
reason for the large jump in 2005 in working capital turnover is because Jack in
the Box added almost $44 million dollars in current assets while everything else
stayed constant. Aside from the large jump, Jack in the Box sits mostly in the
middle of its competitors in this liquidity ratio.
Cash-to-Cash Cycle
By combining the inventory days and the accounts receivable days, the
analyst is able to calculate the amount of time from the initial sale to the day the
cash is received. This measure may not be as applicable for the FFHR industry as
it would be for other industries since the FFHR industry is primarily a cash
industry that does not depend primarily on accounts receivable. Despite this, the
industry appears to have a cash to cash cycle of about twenty days with JBX
leading the group with a cycle of about ten days.
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Conclusion
Overall, it appears that McDonalds leads the industry in regards to
liquidity. Jack in the Box has improved their liquidity in recent years by
accumulating cash and cash equivalents. Much of this accumulation was
required by covenants of their long-term debt. This may be an indication that
lenders previously saw Jack in the Box’s liquidity as an issue of concern. As of
2005, Jack in the Box appears to have strong liquidity based on all of the
measures discussed above.
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Profitability Ratios
Profitability ratios can be defined as “a class of financial metrics that are
used to assess a business's ability to generate earnings as compared to its
expenses and other relevant costs incurred during a specific period of time”
(www.investopedia.com). Having a high profitability ratio is favorable for both
stakeholders and shareholders. Comparing ratios from the firm’s previous years
or even the firm’s competitors is a good way to assess how well the firm is
doing. Some of the ratios that may help with this comparison includes: return on
equity, return on assets, and gross profit margin.
Gross Profit Margin
Gross profit margin is another measurement that is used to assess a firm’s
financial well-being. This ratio “reveals the proportion of money left over from
revenues after accounting for the cost of goods sold” (www.investopedia.com).
Gross profit margin is computed by dividing the firm’s gross profit (Sales –
COGS) by sales.
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Jack in the Box
McDonalds
Burger King
Sonic
Wendy's
2001
2002
2003
2004
2005
2006
19.44%
31.04%
19.19%
30.24%
40.04%
35.76%
49.32%
17.62%
30.32%
38.32%
34.68%
48.62%
17.55%
31.75%
38.03%
33.10%
45.27%
16.99%
31.45%
38.40%
32.29%
44.51%
17.45%
32.36%
36.72%
32.40%
44.56%
40.92%
48.59%
It appears that the industry's gross profit margin has been decreasing
slightly over the past few years. This could indicate that firm’s COGS is
increasing or that firms are having to lower their prices. The above graph and
shows that Jack in the Box’s gross profit margin is almost at a constant rate of
about twenty percent; however, there are slight variations within the years. It is
clear there was a slight decrease from 2002 to 2003. Then, from 2003 to 2006,
the ratio remained at a constant rate. It appears that the trend in the industry's
gross profit margin is relatively flat. However, we estimate that this margin will
increase slightly as firms continue to move to franchising locations.
Operating Expense Ratio
Operating expense ratio is a profitability ratio that measures the firm’s
selling, general, and administration costs in proportion to sales. Therefore, this
equation is computed by taking the operating expenses and dividing it by the
firm’s sales. The lower the ratio, the more efficient the firm is.
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As the graph indicates, the majority of the FFHR industry has an operating
expense ratio between 7 and 15 percent. All firms seem to have a very
consistent expense ratio. Jack in the Box appears to have a high expense ratio
compared to most of the industry, excluding Burger King. This will affect Jack in
the Box’s profitability since a larger proportion of its sales are tied up in SG&A
expense. However, as mentioned previously, we expect JBX’s expenses to
decrease as they move to franchising more locations. Therefore, we expect this
expense ratio to continue its slight decline.
Net Profit Margin
Net profit margin is one of the most important measures of profitability of
a firm. Net profit margin is computed as net income over total sales. This ratio
illustrates the amount from each sale that will be recorded as profit for the firm.
Therefore, the higher the percentage, the more the firm is able to retain from
each sale as profit.
The following graph and table illustrates that JBX is performing poorly in
regards to net profit margin. JBX’s net profit margin is only 4% compared to
over 10% for McDonald’s and Sonic. JBX’s low net profit margin indicates that
JBX is fairly inefficient compared to the industry leaders. Also, to increase net
income at the same pace as competitors, JBX would have to significantly
increase their sales since they are only able to retain 4% of sales as net income.
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Jack in the Box
McDonalds
Burger King
Sonic
Wendy's
2001
2002
2003
2004
2005
2006
4.48%
11.01%
4.08%
5.80%
NM
11.92%
8.01%
3.40%
8.58%
NM
11.70%
7.49%
3.22%
12.25%
0.29%
10.82%
2.08%
3.66%
13.12%
2.42%
11.31%
9.13%
3.91%
16.42%
1.32%
11.35%
3.87%
11.78%
8.10%
NM – Not meaningful
Asset Turnover
Asset turnover is a profitability measure that quantifies a firm’s utilization
of their assets. The ratio is computed by dividing the current period’s total sales
by last period’s total assets. A higher ratio indicates that a firm is more efficient
by producing more sales from their assets.
From looking at the following graph and table, JBX is the most efficient in
generating sales from their asset base with an asset turnover of about 2:1.
However, when we restated JBX’s financial statements, JBX fell to the lower half
of the industry with an asset turnover of 1.15. By accounting for JBX’s capital
lease obligations, an analyst may have a very different outlook on JBX’s asset
turnover and efficiency.
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Jack in the Box
McDonalds
Burger King
Sonic
Wendy's
Jack in the Box RS
2002
2003
2004
2005
2006
1.91
0.68
1.94
0.72
2.03
0.72
1.12
1.31
1.10
1.51
1.10
1.10
0.80
1.12
1.95
0.71
0.71
1.20
0.78
1.07
2.07
0.72
0.80
1.23
0.71
1.15
Return on Assets
Return on assets (ROA) measures how well a firm is able to generate
profits through the use of its assets. This equation is a product of net income
over sales multiplied by sales over assets. This equation can be broken down
into net income divided by assets. In this calculation, one must utilize the
previous year’s assets for the denominator.
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Jack in the Box
McDonalds
Burger King
Sonic
Wendy's
Jack in the Box RS
2002
2003
2004
7.79%
3.97%
6.59%
6.14%
6.54%
8.82%
10.88%
10.5%
11.77%
8.8%
3.73%
10.75%
1.7%
3.62%
2005
2006
7.12%
9.35%
1.73%
11.19%
7.0%
3.91%
8.07%
11.82%
1.06%
12.51%
2.7%
4.49%
Shown from the graph above, Jack in the Box has had a stable ROA over
the past five years. Despite this, Jack in the Box is well below competitors
McDonalds and Sonic. Interestingly, taking into account the restated financial
statements, JBX has an ROA of only 4.49%, well below the industry average.
We feel that ROA would also be significantly lower for all firms if leases were
capitalized.
Return on Equity
Return on equity (ROE) measures a firm’s performance through its
capability to generate returns by using the funds that have been invested by its
shareholders from the previous year. This ratio is found by multiplying net
income over assets to the assets over shareholder’s equity. Broken down, this
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equation is read as net income divided by shareholder’s equity. Below is a graph
of Jack in the Box and its competitors’ ROE.
Jack in the Box
McDonalds
Burger King
Sonic
Wendy's
2002
2003
2004
2005
2006
19.40%
9.42%
15.10%
14.31%
16.58%
19.02%
23.76%
21.25%
22.66%
16.29%
21.87%
2.96%
16.54%
18.32%
9.85%
21.04%
13.06%
19.11%
23.40%
4.76%
20.29%
4.58%
The above graph indicates that Jack in the Box has a relatively strong ROE
ranging from 15 to 19 percent. Jack in the Box’s ROE has been stable during this
period unlike Wendy’s and McDonalds. This ROE is comparable to the rest of the
industry. Overall, it appears that JBX and the industry appear to have a strong
ROE around 20%.
Conclusion
Overall, it appears that Jack in the Box is performing below average in
regards to profitability compared to the FFHR industry. JBX appears to be
inefficient in regards to controlling expenses as shown with operating expense
margin and net profit margin. Alternatively, JBX is performing fairly well in terms
of asset efficiency even when capitalizing their leases. Also, JBX is performing
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fair in regards to ROA and ROE; however, JBX is lagging behind MCD and SNC in
both measures. Therefore, in regards to profitability, MCD and SNC appear to be
leading the industry with JBX coming in third.
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Capital Structure Ratios
Capital structure ratios answer the question of how a firm finances new
and existing assets. After examining the different rations, the analyst will be able
to see if the firm financed it assets through debt or equity. Capital structure is
what makes up a firms liability and owner’s equity. A firm’s overall valuation can
be greatly affected by how the firm is financed. Most often these ratios are used
to determine the credit worthiness of the firm, financial leverage, ability to cover
interest charges, ability to pay off liabilities and likelihood of bankruptcy. There
are two primary reasons for analyzing capital structure ratios. First, look at the
amount of debt in relation to owner’s equity. Secondly, examine a firm’s ability to
pay the principal and interest requirements due on its debt. One must compare
a firm’s capital structure ratios against the industry in which it operates. The
three ratios that will be examined for Jack in the Box include the debt to equity
ratio, times interest earned, and the debt service margin.
Debt to Equity Ratio
The debt to equity ratio is calculated by taking the total liabilities and
dividing them into total owner’s equity. This ratio measures the financial leverage
of the firm and it is often used to measure the credit risk. The lower the ratio,
the more the capital structure is financed with equity. Alternatively, a large debt
to equity ratio indicates that the firm is leveraged through debt financing.
Jack in the Box, with an average debt to equity ratio of 1.29 over the last
six years, indicates that Jack in the Box has $1.29 of liabilities for every dollar of
owner’s equity. This debt to equity ratio is well above industry average. More
importantly, looking at JBX’s restated debt to equity ratio, which takes into
account the capitalization of operating leases, illustrates that the firm is very
highly leveraged. By capitalizing the operating leases, JBX has a debt to equity
ratio around 3:1.
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Jack in the Box
McDonalds
Burger King
Sonic
Wendy's
Jack in the Box - RS
2001
2002
2003
2004
2005
2006
1.45
0.90
NA
0.78
0.44
1.24
0.94
NA
0.76
0.47
2.99
1.49
0.78
NA
0.83
0.39
3.53
1.25
0.59
NA
0.55
0.35
3.15
1.26
0.59
4.71
0.45
0.26
3.15
1.04
0.54
3.50
0.63
0.55
2.52
As the debt/equity graph illustrates, JBX has a slightly higher proportion of
debt in their capital structure than their competitors. Additionally, capitalizing
JBX’s operating leases truly affects the financial position of the firm as JBX’s
restated debt/equity ratio is three times the industry average. In terms of the
overall fast food industry, most competitors have maintained steady debt to
equity ratios.
Times Interest Earned
The times interest earned ratio is determined by taking operating income
and dividing them into interest expense. This ratio determines how many times a
firm can cover its interest charges on short term debt and other obligations on a
before tax basis. A higher value for this ratio is a good indicator that the firm has
sufficient income from operations to cover their interest on debt.
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Jack in the Box’s times interest earned ratio average of 8.33 over the last
six years indicates that Jack in the Box is able to cover one dollar of interest
charges 8.33 times over. Interestingly, by capitalizing JBX’s leases, JBX has a
times interest earned coverage of 1.59 to 2.04 times. This is significantly less
than their originally stated financial statements. Also, we expect all times
interest earned ratios for the industry to be significantly less if the firms
operating leases were restated as capital leases. Overall, there does not appear
to be a clear trend in the times interest earned ratio within the FFHR industry.
Jack in the Box
McDonalds
Burger King
Sonic
Wendy's
Jack in the Box - RS
2001
2002
2003
2004
2005
2006
6.33
5.96
NA
10.20
10.87
6.28
5.96
1.16
11.12
9.20
1.6
5.41
5.65
(9.94)
11.99
(9.14)
1.59
5.62
5.65
1.14
12.96
(5.14)
1.69
11.31
7.30
2.07
18.30
(4.08)
1.66
15.05
7.30
2.36
14.87
(1.13)
2.04
Debt Service Margin
The debt service margin ratio is determined by taking cash flow from
operations and dividing them into installments due on long term debt
(CFFO1/ILTDo). This ratio determines how many times a firm can cover its
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current debt obligations on a before tax basis. A number less than one would
also indicate that the firm is currently unable to cover its annual debt payments
with is operating income. Jack in the Box’s average debt service margin of 25.67
over the last six years indicates that $25.57 of cash provided by operations was
generated to service each dollar of long term debt. With Jack in the Box having a
large debt service margin, the firm does not have to worry about servicing its
long term debt with operating cash flows.
2002
Jack in the Box
McDonalds
Burger King
Sonic
Wendy's
67.41
15.63
NA
77.08
105.52
2003
1.39
NA
NA
84.15
90.13
2004
13.85
NA
NA
65.60
NA
2005
19.25
NA
54.50
21.26
3.67
2006
26.43
7.98
14.80
19.53
108.68
Jack in the Box seems to have refinanced their debt after their fiscal year
of 2003. It is after 2003 that Jack in the Box has seen steady increases in their
debt service margin. With Jack in the Box having an increasing debt service
margin, the firm is better able to service its debt obligations and interest
charges. In terms of the overall fast food industry, they seem to not follow any
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trends. This can be attributed to the fact that these companies have structured
their debt in different ways and have each taken on different debt obligations.
Conclusion
In conclusion, capital structure ratios measure the debt and equity
financing of a firm. The only ratio that shows a trend for the FFHR industry is
the debt to equity ratio. Analyzing the capital structure of a firm allows the
analyst to determine trends and evaluate the firm’s performance. Overall, firms
in the FFHR industry appear to be very different in the way they structure debt
and equity.
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IGR/SGR Analysis
Internal growth rate (IGR) and sustainable growth rate (SGR) analysis
provides a limit to the amount a firm can grow. Therefore, this measure serves
as a limit to our forecasts of Jack in the Box. This analysis shows how much a
firm can grow through internal financing only and the maximum sustainable
growth that a firm can experience.
Internal growth rate
A firm’s internal growth rate (IGR) is equal to the return on assets
multiplied by one minus the dividend payout ratio. IGR measures how much the
firm can grow without increasing its debt. The formula shows that internal
growth can only be equal to the rate of return on assets less any income paid
out as dividends. A low IGR results in a firm not having much room for growth
without being obligated to acquire additional debt in the future. If a firm is
forced to take on more debt, it in turn creates a less profitable firm. The
opposite happens when a firm has a high IGR. Less debt that has to be paid
means the more money a firm can retain. Jack in the Box has been in line with
the industry with its internal growth rate. Since JBX and SONC do not pay
dividends, they tend to have a higher IGR than the rest of the industry. The
graph below shows the IGR for JBX and industry average IGR.
*BKC was not included in industry average
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Sustainable growth rate
Sustainable growth rate (SGR) is calculated by taking IGR and multiplying
by one plus the debt to equity ratio. Where IGR measures how much a firm can
grow without more debt, SGR measures how much a firm can grow by matching
the amount of internal growth with outside financing. By growing at a rate equal
to SGR, the firm does not allow the capital structure of the firm to change. The
sustainable growth rate of the firm can be grown by increasing return on assets,
reducing dividends, or changing the capital structure of the firm. In the fast food
hamburger restaurant industry, Jack in the Box and Sonic have the highest SGR.
This could again be explained by the fact that these firms do not pay dividends.
As shown in the graph below, JBX has historically been well above the industry
average for SGR.
*BKC is not included in the industry average
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Forecasting
Forecasting the financial statements is the fourth step in the valuation
process. To value a firm, one must discount all future cash flows. Since future
cash flows of a firm are uncertain, it is the job of the analyst to make reasonable
assumptions and forecast the firm’s future cash flows based on those
assumptions. Forecasting assumptions are made by looking at common sized
financial statements and industry trends, which provide an estimate of the firm’s
future activity. The following section breaks down all assumptions that were
made to forecast Jack in the Box’s financials for ten years. First, quarterly
statements were used to forecast the income statement for 2007. Next, the
income statement was forecasted for the following nine years. Finally, the
balance sheet, restated balance sheet, and statement of cash flows were
forecasted for ten years. These financial statements can be found at the end of
this section and in the appendix.
Year 1 Income Statement Forecast
Jack in the Box’s fiscal year ends on October 1 of every year. The most
recent 10-K filing is October 1, 2006; therefore, there currently are three
quarters of reported financial data. To forecast 2007 for JBX, it was only
necessary to forecast one quarter of data, since the other three quarters are
already provided. Only the 2007 income statement was forecasted in this
manner because quarterly balance sheet and cash flow data was not accurate
and might create a forecast error. It is important to have accurate first year
forecasts because errors in year one have a greater effect on valuation than
errors in later years.
Income statement forecasts for the first year were found based on the
following process. First, historical 40 week totals were found for major income
statement items and subtracted from 10-K reported annual totals. Next, the
geometric growth rate for the difference was found. Finally, this growth rate
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was applied to the 2007 third quarter data to discover the fourth quarter and
annual totals. The geometric growth rates for major line items are as follows:
Net revenue – 9.7%, Cost of Goods Sold – 9.5%, and SG&A expenses – 2.75%.
Net income for 2007 was not computed in this manner because quarterly
information for net income was very erratic and did not provide a logical growth
rate. Net income for 2007 was computed using the method described in the
income statement section.
Also, it was found during the investigation of quarterly data that Jack in
the Box does experience some seasonality. Historically, JBX has seen higher first
and fourth quarter numbers, which suggests that the firm brings more business
during the late summer and early fall.
Income Statement
The first step in forecasting is the income statement. To forecast the
income statement for Jack in the Box, common sized statements and growth
rates were obtained for both the firm and the industry. Based on this
information, logical growth rates were determined for major line items. Net
revenue was forecasted at 8.6% growth rate, which is the firm’s five year growth
rate. This growth rate is deemed to sustainable due to the analysis of SGR and
IGR for Jack in the Box. Forecasted cost of goods sold was computed as 82% of
net revenue, which is the five year historical average and in line with the industry
average. Selling, general, and administrative expense was forecasted using a
rate of 10.5%. The historical average is 11.23%; however, the percent of SG&A
expenses to sales has been steadily declining. It appears that the percent of
SG&A expense to sales will decline to a steady rate of 10.5%, which is indicative
of Jack in the Box’s attempt to attain cost control in its business. Forecasted net
income was computed using the historical average net profit margin percentage
of 3.77%. There is no real industry or firm trend, but the historical rate of
3.77% is comparable to net income as a percentage of operating income. The
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forecasted income statement shows major line items doubling over the next ten
years, with smooth, even growth.
Balance sheet
Forecasting the balance sheet is the second step of forecasting financial
statements. The balance sheet is more difficult to forecast, but the use of
financial ratios creates links between the income statement and the balance
sheet. Asset turnover is one of the ratios that create a link between these two
statements. For Jack in the Box, the historical asset turnover ratio has been
hovering around two. Since asset turnover is sales divided by assets in the
previous period, forecasted assets can be determined by taking sales and
dividing by asset turnover. Therefore, Jack in the Box’s forecasted total assets
are forecasted sales divided by two. The next item that was forecasted was the
current and long term portions of assets. The percentage of current assets to
total assets has been growing steadily over the past six years. In 2006, current
assets were 26% of total assets. It appears that this percent will grow to 28% in
2007 and level at 30% for 2008 and beyond. The long term portion of assets
was computed as forecasted total assets less forecasted current assets.
The next step of forecasting the balance sheet deals with is forecasting
liabilities and owner’s equity. Since Jack in the Box does not pay dividends,
owner’s equity was forecasted as the previous year’s equity plus net income.
This method of forecasting equity puts limitations on the usefulness of forecasted
liabilities. A more useful tool for forecasting liabilities would be the debt to
equity ratio. However, the goal is to obtain an equity valuation of the firm which
means that it is important to gain the most accurate forecast of owner’s equity.
The accuracy of owner’s equity creates inaccuracies for liabilities.
Restated Balance Sheet
Capitalizing Jack in the Box’s operating leases affects the forecasted
balance sheet because it increases long term assets and long term liabilities.
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The process for forecasting the restated balance sheet is the same as the
reported balance sheet. Total assets are forecasted using the restated asset
turnover ratio. This ratio has historically been about 1.1, which is much lower
than the reported ratio of 2. This lower ratio means higher forecasted assets,
due to the capitalized leases. Current assets as a percentage of total assets has
been growing over the past few years, but capital leases as a percentage of total
assets has been stable at about 45%. It is expected that the restated balance
sheet will have growth in current assets from 16% to 20% over the next two
years. This is due to Jack in the Box increasing the amount of current assets,
not decreasing the amount of capital leases. It is expected that the percent of
capital leases to total assets will remain the same over the forecast period.
Since capitalizing leases does not affect owner’s equity, this forecast
remains the same for both balance sheets. Liabilities will be higher in the
restated balance sheet due the capital leases. As with the reported balance
sheet, forecasted liabilities have inherent errors.
Statement of Cash Flows
Forecasting the statement of cash flows is the final step in the forecasting
process. The statement of cash flows is the most difficult to forecast because
cash flows can be very erratic for a firm. Since forecasting the statement of cash
flows is so difficult, the only two line items that are forecasted include cash flows
from operating and investing activities. These line items are needed in order to
determine free cash flows to the firm for valuation purposes.
When forecasting the cash flows from operating activities, the analyst
utilizes three of the expense diagnostic ratios and determines which ratio has the
best explanatory power for cash flows. Those three ratios are CFFO/OI,
CFFO/Net Sales, and CFFO/NI. For Jack in the Box, all three of these ratios show
variability, and it was necessary to evaluate the usefulness of each ratio. After
this evaluation, it was determined that CFFO/OI had the most explanatory power
for forecasting cash flows from operating activities. The average ratio was 1.11
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and the standard deviation was .06. CFFO/OI was clearly the best choice for
forecasting cash flows from operating activities.
Forecasting the cash flows from investing activities is done by using the
growth rate in non-current assets. Jack in the Box has a negative growth rate in
non-current assets because it is selling many of its firm owned restaurants to
franchisees. This trend supports the firm’s long term goal of increasing
franchised ownership. It is expected that the decline in long term assets will
average 5% per year. For the forecasts, the initial 5% decline was taken from
the historical average cash flow from investing activities.
Conclusion
Forecasting the financial statements is a best guess estimate of the future
of the firm. To forecast the financial statements of Jack in the Box, some
reasonable assumptions based on historical individual and industry averages
were made. Those forecasts show smooth, even growth over the next ten years,
with net income and assets doubling over this time period. The forecasts for
Jack in the Box will be utilized when valuing the firm. No one knows what is
truly in the future for Jack in the Box, but, by making forecasts, the current
valuation of the firm can be obtained.
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Common Size Balance Sheet
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Cost of Financing (KE, KD & WACC)
Cost of Equity (KE)
The cost of equity or KE is the minimum or required rate of return
demanded by shareholders given the risk of the firm. The model used to
approximate JBX’s KE is the CAPM, Capital Asset Pricing Model. CAPM estimates
KE by adding the risk-free rate to beta times the market risk premium. Beta is
the measure of systematic risk of a firm and the market risk premium is added
compensation above the risk-free rate that is required by investors (market risk
premium = market return – risk-free rate).
Estimating Beta
It is important to calculate an estimate beta for JBX rather than relying on
Yahoo! Finance or other firm since these firms do not disclose their methodology
for their beta estimates. By computing JBX’s beta manually, we are able to
understand and control the assumptions of beta and the model.
We calculated the estimate for the beta of JBX by regressing JBX’s
monthly return (y-variable) to the market-risk premium (x-variable). In our
analysis, we ran 30 regressions using the 3-month, 1-year, 2-year, 5-year, 7year, and 10-year Treasury rates1 as proxies for the risk-free rate over periods of
the most recent 72, 60, 48, 36, and 24 months. The reason for the multiple riskfree proxies and time periods is to determine the most appropriate measure for
beta which is determined by which regression had the highest adjusted R2. As
seen in the beta results, beta for JBX is not stable when changing the number of
periods. Therefore, it is important to use model that provides the highest
explanatory power. The CAPM states that KE = RFR + β (Market Risk Premium).
However, CAPM does indicate what the appropriate RFR or MRP. By running
these 30 iterations, we were able to select the most appropriate beta coefficient
for JBX.
1
Treasury rates were attained from the St. Louis Federal Reserve website.
92 | P a g e
Beta Results
The following table illustrates the results of the 30 regressions. The
model with the most explanatory is that using the 10-year note as the risk free
rate and using the 36 months of returns. This indicates that investors in JBX
have a 3 year (36 month) investment horizon. Also, as seen below, the
regression models for the 36 and 24 months provide the best explanatory power.
This illustrates that investors have a short-term time horizon for JBX.
This model yielded a beta for JBX of 1.789 which is only slightly different
from Yahoo! Finance’s beta for JBX of 1.78. Interestingly, this model’s adjusted
R2 was only .001 to .003 higher than using the other risk free proxies. Despite
this, we will use the current 10-year rate, 4.52%, as the appropriate risk free
rate, a beta of 1.789, and a market risk premium of 6.8%2. Imputing these
figures into the CAPM yields a KE of 16.90%
3-Month
# of Months
Beta
72
0.922
60
1.112
48
1.352
36
24
Adj. R
2
1-Year
KE
Beta
0.136
10.26%
0.919
0.106
11.88%
1.109
0.114
14.15%
1.350
1.782
0.200
16.86%
1.780
0.181
16.98%
# of Months
Beta
Adj. R
72
0.917
60
1.114
48
1.333
36
1.785
24
1.771
0.180
2
2-Year
Adj. R2
KE
Beta
0.135
10.39%
0.917
0.135
10.24%
0.106
12.01%
1.110
0.106
11.86%
0.114
14.14%
1.345
0.114
13.97%
1.781
0.201
17.07%
1.782
0.201
17.09%
1.775
0.180
16.98%
1.768
0.180
16.79%
5-Year
Adj. R
2
7-Year
2
KE
10-Year
KE
Beta
Adj. R2
KE
0.136
10.99%
0.919
0.136
11.01%
0.107
12.13%
1.117
0.107
12.16%
KE
Beta
Adj. R
0.135
10.99%
0.918
0.106
12.10%
1.116
0.111
13.65%
1.329
0.110
13.62%
1.326
0.110
13.61%
0.202
16.83%
1.787
0.202
16.84%
1.789
0.203
16.90%
16.71%
1.772
0.180
16.73%
1.773
0.181
16.78%
Other Interesting Findings from the Regression Analysis
The regression analysis yielded some other findings that should be noted.
As seen in the graphs on the next page, the estimated beta for each time period
is relatively constant across all points on the yield curve. However, the actual
2 We assumed a market risk premium of 6.8%. This is the average market risk premium from
1926 to 2005(Palepu & Healy, 8-2 to 8-4).
93 | P a g e
estimate for beta ranges greatly from .922 to 1.789. This illustrates the
limitations of CAPM since beta is not constant for a firm. Using different betas
from .922 to 1.789 would yield significantly different KE for JBX. As seen in the
table above, using the .922 as the beta, JBX would have a KE of 10.26%. This KE
is 664 basis points less than that for a beta of 1.789.
The variability of beta for JBX and thus the estimate of KE is shown in the
second graph below. Depending on how many data points used in the
regression analysis yields significantly different estimates of the cost of equity for
beta. This illustrates that investors have a different required rate of return based
on their investment horizon. It appears that the shorter the investment horizon,
the higher the required rate of return for equity.
# of Data
Points
# of Data
Points
94 | P a g e
Cost of Debt (KD)
The cost of debt is the interest rate that the firm must pay on the funds
that they borrow. The interest rate used for accounts payable and accrued
liabilities is the current interest rate for commercial paper for nonfinancial firms.
The other interest rates in the following tables were disclosed by JBX in their 10k report. In the 10-k, JBX disclosed the appropriate interest rates for their
liabilities are LIBOR+1.5% for long-term liabilities and 8.9% for lease obligations.
Using these rates and the weight of each particular component of JBX’s
liabilities, we were able to calculate JBX’s appropriate cost of debt. Notice in the
tables below, that JBX has two costs of debt: KD based on JBX’s original financial
statements and KD after we restated their financials to account for JBX’s lease
obligations. JBX’s original pretax cost of debt is 5.81% and 7.62% when
capitalizing leases. It is important to note that JBX’s cost of debt is higher when
capitalizing its operating lease since these leases are a high proportion of their
debt and carry a higher interest rate. The after-tax cost of debt for the original
and restated using a 35.7% tax rate are 3.74% and 4.9% respectively.
Cost of Debt (KD) – Original Financials
Amount
Current maturities of long-term debt
37,539
Weight
5.08%
Rate
6.41%
Value
Weighted
Rate
0.33%
Accounts payable
61,059
8.27%
4.94%
0.41%
Accrued liabilities
240,320
32.53%
4.94%
1.61%
338,918
45.88%
Long-term debt, net of current
maturities
254,231
34.41%
6.41%
2.21%
Other long-term liabilities
145,587
19.71%
6.41%
1.26%
0
0.00%
8.90%
0.00%
738,736
100.00%
Before Tax
KD = 5.81%
After Tax*
KD = 3.74%
Total current
liabilities
Capital Lease Obligations
Total Liabilities
*Tax rate: 35.7%
95 | P a g e
Cost of Debt (Kd) – Restated Financials
Amount
Weight
Rate
Value
Weighted
Rate
Current maturities of long-term debt
37,539
2.10%
6.41%
0.13%
Accounts payable
61,059
3.41%
4.94%
0.17%
Accrued liabilities
240,320
13.43%
4.94%
0.66%
Total current liabilities
338,918
18.94%
Long-term debt, net of current
maturities
254,231
14.21%
6.4100%
0.91%
Other long-term liabilities
Capital Lease Obligations
Total Liabilities
145,587
8.14%
6.4100%
0.52%
1,050,858
58.72%
8.90%
5.23%
1,789,594
100.00%
Before Tax
KD = 7.62%
After Tax
KD = 4.90%
*Tax rate: 35.7%
96 | P a g e
Weighted Cost of Capital – WACC
The weighted cost of capital, WACC, is the overall cost of capital when
taking both the cost of debt and cost of equity into consideration.
WACC = KE (L/ (E +L)) + KE (E / (E+L)). The following table shows the results
of the WACC calculations.
Original Financial
Statements
KDBT
KDAT
KE
L/(E+L)
E/(E+L)
WACCBT
WACCAT
Restated Financial
Statements
5.81%
3.74%
16.90%
0.51
0.49
11.25%
10.19%
KDBT
KDAT
KE
L/(E+L)
E/(E+L)
WACCBT
WACCAT
7.62%
4.90%
16.90%
0.72
0.28
12.17%
10.78%
*Tax rate: 35.7%
It is important to notice the difference in both the WACCBT and WACCAT
between the original and restated financial statements. As seen in the restated
figures, JBX has a larger portion of the financing consisting of debt from 51% to
72%. The reason for the increase in this proportion is because of the
capitalization of operating leases, which hold an interest rate of 8.9%. This
increased the cost of debt which then slightly increased the WACCBT and
WACCAT.
For the purpose of valuing JBX, the appropriate WACCBT and WACCAT will
be 12.17% and 10.78% respectively. These WACC values are based on the
restated financial statements which capitalize JBX’s operating leases. We feel
that these leases are financial obligations of JBX. As seen in the table above,
restating JBX’s financial statements results in an increase of 92 and 59 basis
points in JBX’s WACCBT and WACCAT. This increase in the cost of capital will
decrease the valuation of JBX in some of the valuation models. This decrease in
the current valuation of JBX will be explained in the following section.
97 | P a g e
Valuation Analysis
The purpose of this entire report is to construct a value for Jack in the Box
as of November 1, 2007 so that we can develop an investment recommendation.
Utilizing the analysis and data that were gathered in the previous sections, we
will present our valuation analysis. In this section, we will use two main
approaches to value JBX. The first approach will utilize comparable industry
ratios to compute JBX’s value. The method of comparables, P/E, PEG, P/B, and
etc, is widely used for its ease of use. However, as we will explain, we feel that
the method of comparables is not that great at determining a value for the firm.
The second approach will use more financial data of JBX to uncover an intrinsic
value for the firm. We feel that this intrinsic approach, which uses more theory,
provides a more reliable valuation than the method of comparables. The intrinsic
valuation approach dissects the financials of JBX in order to assign a value to
JBX.
98 | P a g e
Valuation: Method of Comparables
In the method of comparables approach, the averages from various
industry ratios are used to estimate the share price for a specific firm. This can
be done by computing and averaging several different industry ratios individually
and then working backwards to find the target firm’s price per share. For
example, we assume that P/EJBX = P/EFFHR Industry. We have estimated JBX’s
earnings in the previous sections and we have computed the average P/E for the
FFHR industry. With these values, we can solve for the unknown price.
The firms used for the industry average are the same ones that have been
used throughout this valuation report: Burger King, McDonalds, Wendy’s, and
Sonic. JBX’s numbers are from their 10-K report, while the other companies’
numbers are from finance.yahoo.com.
Summary of Comparables
P/E
P/E
Forward
P/B
McDonalds
30.57
18.12
Burger King
22.89
D/P
PEG
P/EBITDA
P/FCF
EV/EBITDA
4.66
3.119
9.01
22.68
11.04
16.79
4.69
1.477
62.74
106.94
10.00
Jack in the Box
Sonic
25.88
18.12
-13.48
1.442
108.03
55.05
10.09
Wendy’s
41.05
21.01
3.64
2.084
100.45
24.21
9.40
Industry Average
30.10
18.51
4.33
2.03
70.06
52.22
10.13
JBX Value
90.60
57.17
85.67
52.56
54.03
205.46
203.47
JBX Value Adjusted*
45.30
28.59
42.84
26.28
27.01
102.73
101.74
JBX Observed Price
29.83
F-O
F-O
U
U
Under/Fairly /Over
U
F
Valued
F – Fairly Valued, O – Overvalued, U - Undervalued
*adjustment for a 2-1 stock split on Oct. 16th 2007
U
N/A
99 | P a g e
Trailing Price to Earnings ratio
The trailing price to earnings ratio is computed by taking the current share
price and dividing it by last year’s earnings per share. After getting this ratio for
each comparable firm, the average came out to be $30.10. In order to come up
with a value per share for Jack in the Box, the industry average is multiplied by
Jack in the Box’s last earnings per share. After the adjustment for the October
16th 2-1 stock split, Jack in the Box’s estimated price per share came out to be
$45.30. This makes the company undervalued compared to the per share price
of $29.83 as of November 1st.
Trailing P/E
McDonalds
Burger King
Sonic
Wendy’s
30.57
22.89
25.88
41.05
Industry Average
30.10
Jack in the Box (EPS)
Jack in the Box Value
Jack in the Box Adj Value*
Jack in the Box Observed
Price
Conclusion
3.01
90.60
45.30
29.83
Undervalued
th
*adjustment for a 2-1 stock split on Oct. 16 2007
Forward Price to Earnings Ratio
When using the forward price to earnings ratio as a comparable, the same
method as the trailing price to earnings ratios is used except that instead of the
earnings per share from last year, forecasted earnings per share is used in its
place. This results in the industry averages to fall to $18.51 and turns Jack in the
Box’s estimated share price to $28.59. This shows that the firms current share
price is fairly valued being that it is only a little more than a dollar over of the
estimated value.
100 | P a g e
Forward P/E
McDonalds
Burger King
Sonic
Wendy’s
18.12
16.79
18.12
21.01
Industry
18.51
Jack in the Box (EPS)
Jack in the Box Value
Jack in the Box Adj Value*
Jack in the Box Observed
Price
Conclusion
3.09
57.17
28.59
29.83
Fairly Valued
*adjustment for a 2-1 stock split on Oct. 16th 2007
Price to Book Value Ratio
The P/B ratio is calculated by dividing the current price per share by the
book value of equity per share. The industry average, which was calculated
without Sonic because of their negative book value per share, came out to be
4.33. This resulted in an estimated share price of $42.84 for Jack in the Box.
When compared to Jack in the Box’s current share price, this comparable shows
JBX as an undervalued firm.
Price/Book Ratio
McDonalds
Burger King
Sonic
Wendy’s
Industry Average
Jack in the Box (BVS)
Jack in the Box Value
Jack in the Box Adj Value
Jack in the Box Observed
Price
4.66
4.69
-13.48
3.64
4.33
19.79
85.67
42.84
29.83
101 | P a g e
Conclusion
Undervalued
*adjustment for a 2-1 stock split on Oct. 16th 2007
Dividend Yield
Another commonly used comparable is the dividend yield. Since Jack in
the Box does not issue dividends this was not applicable.
PEG Ratio
The PEG. ratio is a firm’s P/E ratio divided by their estimated growth rate.
The industry average PEG. ratio was 2.03. Multiplying that average by Jack in
the Box’s 8.6% growth rate then by their earnings per share results in a per
share price of $26.28. This shows that JBX is a fairly valued firm to slightly
overvalued.
PEG Ratio
McDonalds
Burger King
Sonic
Wendy’s
3.12
1.48
1.44
2.08
Industry Average
2.03
Jack in the Box Value
Jack in the Box Adj Value
Jack in the Box Observed
Price
Conclusion
52.56
26.28
29.83
Fairly Overvalued
*adjustment for a 2-1 stock split on Oct. 16th 2007
Price to EBITDA Ratio
The price to earnings before interest, taxes, depreciation, and
amortization (EBITDA) ratio is computed by dividing the per share price of a firm
by their EBITDA, which is in billions. The calculated industry average came out
to be 70.06. Multiplying this by Jack in the Box’s EBITDA of 0.771, gives the
102 | P a g e
estimated value of $27.01 per share. Again this is shows the firm is fairly value
to slightly overvalued compared with the November 1st price.
P/EBITDA
McDonalds
Burger King
Sonic
Wendy’s
9.01
62.74
108.03
100.45
Industry Average
70.06
Jack in the Box Value
Jack in the Box Adj Value
Jack in the Box Observed
Price
Conclusion
54.03
27.01
29.83
Fairly Overvalued
*adjustment for a 2-1 stock split on Oct. 16th 2007
Price to Free Cash Flows Ratio
The price to free cash flows ratio is similar to the previous ratio, except
free cash flows is used in the place of EBITDA. Free cash flows is calculated by
adding up a firm's cash flows from operations and cash flows from investing.
The industry average comes out to be 52.22. When multiplied by Jack in the
Box’s free cash flows, the estimated price of $102.73 makes the firm extremely
undervalued.
P/FCF
McDonalds
Burger King
Sonic
Wendy’s
Industry
22.68
106.94
55.05
24.21
52.22
Jack in the Box Value
205.46
103 | P a g e
Jack in the Box Adj Value
Jack in the Box Observed
Price
Conclusion
102.73
29.83
Undervalued
*adjustment for a 2-1 stock split on Oct. 16th 2007
Enterprise Value to EBITDA ratio
The final ratio is the enterprise value to EBITDA ratio and is calculated by
taking a firm’s enterprise value, which is the market value of equity plus the
book value of liabilities subtracted by short term investments, and dividing it by
their EBITDA. As with EBITDA, the enterprise value is calculated in billions for
conformity. The ratio average for the industry was 10.13. Since there the price
per share is part of the enterprise value, different calculations had to be made in
order to find the estimated price per share. The industry average is first
multiplied by Jack in the Box’s EBITDA, then JBX’s short term investments is
added in, after this the book value of liabilities is subtracted, and ultimately
everything is divided by the number of shares outstanding. According to this
comparable JBX’s estimated price per share is $101.74, again making the firm
extremely undervalued.
EV/EBITDA
McDonalds
Burger King
Sonic
Wendy’s
11.04
10.00
10.09
9.40
Industry Average
10.13
Jack in the Box Value
Jack in the Box Adj Value
Jack in the Box Observed
Price
Conclusion
203.47
101.74
29.83
Undervalued
*adjustment for a 2-1 stock split on Oct. 16th 2007
104 | P a g e
Conclusion
For the most part, Jack in the Box is fairly valued to undervalued using the
method of comparables. Of the seven applicable comparables, four
comparables resulted in showing that Jack in the Box is significantly undervalued
with intrinsic values ranging from $42.84 to $102.73 compared to JBX’s observed
price of 29.83. The other three comparables show that the firm is fairly valued
to slightly overvalued. Lack of consistency is one of the main problems with
comparables. Another problem is the differences in firms used for comparison.
McDonalds creates problem because of the size of their operations. It is unfair to
create any sort of average within in an industry with a firm that dwarfs the
others as McDonald does. Finally, these estimated prices do not show us
anything because there is no theory backing them up. These ratios are merely
numbers, some which are more applicable for some firms than others. Despite
these drawbacks, we conclude through the use of comparables that JBX is
undervalued.
Summary of Comparables
P/E
P/E
Forward
P/B
D/P
PEG
P/EBITDA
P/FCF
EV/EBITDA
Jack in the Box
McDonalds
30.57
18.12
4.66
3.119
9.01
22.68
11.04
Burger King
22.89
16.79
4.69
1.477
62.74
106.94
10.00
Sonic
25.88
18.12
-13.48
1.442
108.03
55.05
10.09
Wendy’s
41.05
21.01
3.64
2.084
100.45
24.21
9.40
Industry Average
30.10
18.51
4.33
2.03
70.06
52.22
10.13
JBX Value
90.60
57.17
85.67
52.56
54.03
205.46
203.47
JBX Value Adjusted*
45.30
28.59
42.84
26.28
27.01
102.73
101.74
JBX Observed Price
29.83
F-O
F-O
U
U
Under/Fairly /Over
U
F
Valued
F – Fairly Valued, O – Overvalued, U - Undervalued
*adjustment for a 2-1 stock split on Oct. 16th 2007
U
N/A
105 | P a g e
106 | P a g e
Valuation: Intrinsic Valuation Models
As mentioned, we feel that the intrinsic valuation approach should provide
a more reliable and realistic value for JBX. The primary reason for this belief is
that the intrinsic valuation models look at and dissect the financials of the firm in
order to determine a value for its equity. Alternatively, the comparables method
merely assumes that the firm being valued should resemble the industry or
group of competitors that it is being compared to. The methods that we utilized
for the intrinsic valuation of JBX are the dividend discount model, free cash flow
model, residual income model, the long run ROE residual income model, and the
abnormal growth earnings (AEG) model.
Intrinsic Valuation Summary
Dividend Discount (DDM)
Free Cash Flow (FCF)
Residual Income
Long Run ROE Residual Income
Abnormal Earnings Growth (AEG)
Conclusion
N/A
Slightly
undervalued
Overvalued
Overvalued
Overvalued
Dividend Discount Model
The dividend discount model is a valuation that discounts future
dividends. In theory, the summation of the present value of dividends should be
the value of a the firm. However, the dividend discount model is not applicable
for Jack in the Box since JBX does not pay dividends and there is no indication
that they will being to pay dividend in the near future.
107 | P a g e
Free Cash Flow Model
Similar to the dividend discount model, the free cash flow model discounts
future cash flows to the present in order to create an intrinsic value for JBX.
However, the cash flow that is discounted in the FCF method is the free cash
flows to the firm (cash flow from operations minus cash flows from investments).
FCFs are cash flows available to both debt and equity parties and is already
computed on an after-tax basis; therefore, the proper discount factor will be
JBX’s WACCBT. Since FCFs are cash flows available to equity and debt parties,
JBX’s value of debt must be subtracted from the value calculated in order to
attain an intrinsic value of JBX’s equity.
Free Cash Flow Methodology
As mentioned above, the major inputs in the free cash flow model are the
cash flows from operations, the cash flows from investing activities, WACCBT,
book value of debt, and a growth rate for the FCF perpetuity.
As seen in the model below, the first step is to compute the free cash
flows for JBX. Then, these FCFs are discounted using JBX’s WACCBT to time 0
(October 1st, 2006). The present value of these FCFs are now summed together
to compute the total present value of annual FCFs of $1.48 billion. The next step
involves estimating the value of the perpetuity of FCFs from 2017 to infinity. We
assumed a low growth rate in this perpetuity since our forecasts of FCFs indicate
a 15% growth over the next 10 years. We feel that this growth cannot continue
at this pace; therefore, a growth rate of 0 to 5% will probably more appropriate.
Once the perpetuity value is computed, we discounted it back to October 1st,
2006 and attained a value of $1.39 billion. By adding the present value of the
annual FCFs with the present value of the perpetuity, we are able to come up
with an intrinsic value of the entire firm of $2.87 billion. Lastly we must
subtract the book value of liabilities ($.73 billion) from this value to come up with
JBX’s value of equity of $2.135 billion or $29.73 per share on October 1, 2006.
108 | P a g e
The estimated price per share as of November 1, 2007 is $33.37 per share. This
is 12% above the observed price of $29.83; therefore, based on these inputs to
the model, JBX appears to be slightly undervalued. Alternatively, once we used
the WACCBT of 12.17% from the restated financials, JBX is properly valued with
an intrinsic value of $29.34.
Despite appearing slightly undervalued based on the assumptions of a
growth rate of 0% and a WACCBT of 11.25%, a better picture of JBX can be
attained by conducting a sensitivity analysis. In this sensitivity analysis, we are
able to see the effect on the value of JBX by adjusting the WACCBT and the
growth rate of the perpetuity. Below is the sensitivity analysis for the FCF
model.
WACC(BT)
8.25%
9.25%
10.25%
11.25%
12.25%
13.25%
14.25%
Growth Rate in
Perpetuity
1.00%
0%
52.99
58.21
45.00
48.76
38.60
41.39
33.38
35.49
29.02
30.66
25.34
26.63
22.20
23.22
Overvalued if less than
Fairly Valued
Undervalued if more than
2.00%
65.10
53.57
44.87
38.09
32.61
28.14
24.41
3.00%
74.61
59.92
49.30
41.27
35.00
29.95
25.81
4.00%
88.60
68.68
55.15
45.39
37.96
32.15
25.36
25.36
within 15%
34.30
In the table above, we have color coded the intrinsic values that are +/15% from JBX’s observed price. We feel that JBX is undervalued (overvalued) if
the intrinsic value is 15% more (less) than the observed price.
From the sensitivity analysis, it appears that JBX is undervalued as long as
their WACCBT is below 12.25%. However, as mentioned before, we computed a
restated WACCBT of 12.17%. This places the intrinsic value of JBX right on the
109 | P a g e
5.00%
111.20
81.57
63.23
50.76
41.73
34.89
29.52
cusp of being undervalued. Therefore, based on the sensitivity analysis of the
FCF model, JBX appears to be slightly undervalued. However, the
perpetuity portion of the model accounts for 48% of the value of the firm. Since
the perpetuity is based on numerous assumptions and is forecasting FCFs from
year 11 to infinity, this value will contain a large forecasting error. Therefore, we
feel that this intrinsic value for JBX may not be reliable. Thus, although the
model indicates that JBX is slightly undervalued, we feel that less weight should
be put on this conclusion since the perpetuity accounts for a large proportion of
the intrinsic value.
*Cash flows are in $thousands (000)
**JBX had a 2:1 stock split Oct. 16th 2007; thus, we had to adjust the intrinsic value to reflect
this split.
110 | P a g e
Residual Income Model
The residual income model also discounts cash flows to compute an
intrinsic value. The cash flow for this model is residual income. Residual income
is the amount of actual or forecasted earnings that JBX earns minus the “normal”
benchmark earnings that it should earn given its Ke3. As with the FCF model, the
present value of these residual earnings should provide an intrinsic value of JBX.
The residual income model is said to be the most accurate of the intrinsic
valuation models by providing the largest adjusted R2 (explain variability)
compared to the other models.
Residual Income Methodology
The major inputs into the residual income model are the book value of
equity, Ke, forecasted earnings, forecasted dividends, and a perpetuity growth
rate. The forecasted earnings for the residual income model are those earnings
that we forecasted for JBX’s financial statements. We previously computed a Ke
of 16.9% and JBX does not pay dividends.
To compute the residual income for each period, we would subtract the
benchmark forecasted earnings from the actual forecasted earnings. The
benchmark earnings are the earnings (net income) that JBX should have earned
on their previous year’s equity4 for that time period given their KE. Therefore, for
2007, JBX should have earned benchmark earnings of $120 million on their 2006
equity of $710 million ($710 million X 16.9% = $120 million). As seen in the
model, JBX’s benchmark earnings for 2007 are $9.2 million more than forecasted
earnings. This illustrates that JBX is destroying value based on our forecasts of
earnings and Ke. Actually, using our estimated Ke of 16.9%, JBX appears to have
negative residual income for the 10 years that we have forecasted. This
3
Ke is used instead of WACC since the residual income model looks at whether or not the firm is able to
earn more than the shareholder’s required rate of return.
4
Book value of equity for period 1 = BVE0 + (Earnings1 – Dividends1)
111 | P a g e
illustrates our belief that JBX will continue to earn less than their benchmark
earnings. After computing the residual income for each period, we discounted
each residual income by the Ke of 16.9%. Summing up each of these residual
incomes, the present value of the annual residual income was -$214 million.
This illustrates that we expect JBX to destroy $214 million in value in the next 10
years based on residual income. The next step involved is estimating the value
of the perpetuity of residual income from 2017 to infinity. For the perpetuity, we
used a baseline growth of 0% and a Ke of 16.9%. Once the perpetuity value is
computed, we discounted it back to October 1st, 2006 and attained a present
value of -$157 million. The last step in the residual income model is to add the
present value of annual residual income plus the present value of the perpetuity
plus the initial book value of equity. By adding these three values, we computed
a total value of JBX’s equity of $338 million or $4.84 per share as of October 1st,
2006. The estimated price per share as of November 1st, 2007 is $5.73. This
intrinsic value of $5.73 is significantly less than the observed price of $29.83
signifying that JBX is significantly overvalued.
This is an interesting find since this value is significantly less than the
observed price. We thought that our net income or revenue forecasts may be
off or overly conservative. However, net income would have to improve from
3.7% of revenue to 20% for JBX to be fairly valued. Or, revenue would have to
grow at an annual rate of over 30% compared to our forecast of 8.6%. Both of
these scenarios are highly unlikely; therefore, JBX is overvalued.
Again, we conducted a sensitivity analysis of the residual income model to
see how manipulating the various variables of the model would affect the
intrinsic value of JBX. Growth rates for the residual income model are negative
due to the long term economic goal of reaching equilibrium. In the long run, the
firm will eventually earn its benchmark earnings, and residual income will equal
zero.
112 | P a g e
Growth Rate
Ke
6.00%
8.00%
10.00%
12.00%
14.00%
16.90%
18.00%
-30.00%
22.61
18.22
14.77
12.04
9.86
7.44
6.71
-20.00%
23.57
18.65
14.87
11.95
9.66
7.18
6.44
-10.00%
25.72
19.54
15.08
11.78
9.31
6.53
5.98
0.00%
5%
35.05 109.70
22.67 32.07
15.69 16.91
11.33 10.63
8.45
7.29
5.73
4.61
5.00
3.95
10.00%
N/A
N/A
N/A
6.42
3.26
1.86
1.58
Overvalued if less than 25.36
Fairly Valued within 15%
Undervalued if more than 34.30
As shown in the sensitivity analysis, it appears that JBX is overvalued with
almost all values for KE and the growth rate of the perpetuity. It seems that only
with a KE less than 8%, which is highly unlikely, that JBX would be properly or
undervalued. Therefore, we conclude that, based on the residual income model,
JBX is significantly overvalued.
*Cash flows are in $thousands (000)
**JBX had a 2:1 stock split Oct. 16th 2007; thus, we had to adjust the intrinsic value to reflect
this split.
113 | P a g e
Long Run Residual Income Perpetuity Model
The long run residual income perpetuity model is based on the same
assumptions of the residual income model. It assumes that the market value of
equity should be a function of a firm’s ability to earn a return on equity greater
than the required rate of return that is demanded by investors. The long run
residual income perpetuity model creates a theoretically justified price to book
ratio. The market value of equity for the long run residual income perpetuity
model is derived from the following equation.
Long Run Residual Income Perpetuity Methodology
The major inputs into the long run residual income perpetuity model are
the book value of equity, KE, long run return of equity (ROE), and the long run
growth in equity. The book value of equity in 2006 was $710 million. We
previously computed a KE of 16.9%. The long run return on equity (ROE) was
computed by taking the 10 year average of forecasted ROE (forecasted NIt
divided by our forecasted BVEt-1). The long run return on equity for Jack in the
Box was computed at 12.78%. The growth rate in the forecasted ROE was 3.9%.
Book Value of Equity
$
710,885
Long Run Return on Equity
Long Run Growth Rate in Equity
Cost of Equity
Shares Outstanding
12.78%
-3.90%
16.90%
34,944
Estimated Price per Share (Oct
2006)
Estimated Price per Share (Nov
2007)
Adjusted Price
Observed Share Price
16.31
19.32
9.66
29.83
114 | P a g e
As the chart above shows, the time and split adjusted share price for November
1, 2007 is $9.66. This is significantly less than the observed share price of
$29.83.
The following tables are the results from the sensitivity analysis of the
long run residual income perpetuity model.
ROE
12.78%
Long Run Growth Rate in Equity
Ke
6.00%
8.00%
10.00%
12.00%
14.00%
16.90%
-3.90%
18.25
15.50
13.53
12.06
10.92
9.66
0.00%
23.08
17.66
14.41
12.25
10.70
9.11
Long Run Growth Rate in Equity
ROE
Ke
Ke
6.00%
8.00%
10.00%
12.00%
14.00%
16.90%
12.78% 14.00%
18.25
19.59
15.50
16.63
13.53
14.52
12.06
12.95
10.92
11.72
9.66
10.37
1.50%
27.16
19.19
14.97
12.35
10.58
8.82
3.00%
35.52
21.63
15.76
12.50
10.42
8.48
4.50% 6.00%
59.81 N/A
26.16
37.48
16.98
19.12
12.70
13.00
10.22
9.94
8.04
7.49
-3.90%
16.00% 18.00% 20.00% 22.00%
21.87
23.97
26.16
28.34
18.49
20.35
22.21
24.06
16.15
17.77
19.39
21.01
14.39
15.84
17.29
18.73
13.03
14.34
15.65
16.96
11.53
12.68
13.84
15.00
16.9%
Long Run Growth Rate in Equity
ROE
12.78%
14.00%
16.00%
18.00%
20.00%
22.00%
-3.90%
9.66
10.37
11.53
12.68
13.84
15.00
0.00%
9.11
9.98
11.41
12.83
14.26
15.68
1.50%
8.82
9.78
11.34
12.91
14.47
16.04
3.00%
8.48
9.53
11.27
13.00
14.73
16.47
4.50%
8.04
9.23
11.17
13.12
15.06
17.00
6.00%
7.49
8.84
11.05
13.26
15.47
17.68
Overvalued if less than 25.36
Fairly Valued within 15%
115 | P a g e
Undervalued if more than 34.30
Since the long run residual income perpetuity model utilizes three input
variables, it is necessary to perform three separate sensitivity analyses. As
shown above, the only situation where JBX would be fairly or undervalued is with
a KE of less than 8%5, which is unreasonable, and a growth in equity of more
than 3%. This is consistent with the findings of the residual income model and
shows that JBX is significantly overvalued.
5
We computed JBX’s KE as 7.22% based on the backdoor approach by inputting JBX’s observed price,
forecasted earnings, ROE, and forecasted growth in ROE. This figure is in line with this model and the
residual income model showing that JBX would need a significantly lower KE in order to be adding value.
116 | P a g e
Abnormal Earnings Growth (AEG) Model
Where the residual income models in theory created the P/B, the
abnormal earnings growth model produces a theoretical forward P/E ratio. The
AEG model produces an intrinsic price by adding earnings per share and
discounted abnormal earnings and dividing by the cost of equity. Abnormal
earnings, similar to residual income, are the future forecasted earnings and
dividend reinvestment income (DRIP) minus normal benchmark earnings. This
process is very similar to that of the residual income model except that 1)
dividends are assumed to be reinvested at the rate of KE (DRIP) and 2) the
annual AEG and perpetuity are discounted back to time 1 rather than time 0.
Abnormal Growth Earnings Model Methodology
The major inputs into the AEG model are forecasted earnings, dividends,
the growth in the AEG perpetuity and KE. As in previous models, the forecasted
earnings are those earnings that we forecasted for JBX’s financial statements.
We previously computed a Ke of 16.9% and JBX does not pay dividends. We
used a growth rate of 0% as the baseline for the model.
The first step in the AEG model is to calculate the DRIP earnings.
However, JBX does not pay dividends; therefore, they will not have any dividend
reinvestment income. Therefore, the result from this model should be somewhat
similar to that of the residual income model. Next, we computed the normal
benchmark earnings (previous periods NI X KE) that JBX should be earning on
their equity. By subtracting the normal benchmark earnings from the forecasted
earnings plus DRIP, we computed the abnormal earnings. These abnormal
earnings are discounted back to 2007 or t=1. The sum of the PV of AEG was
-$53 million for JBX. Next, similar to the other intrinsic models, we estimated a
value for the perpetuity for AEG from 2017 to infinity. The present value of this
perpetuity assuming a KE of 16.9% and a growth in AEG of 0% is -$27 million.
The total PV of the AEG flows in 2007 are -$81.6 million. This, combined with
117 | P a g e
the core forecasted earnings of $110.9 million, results in total earnings of $29.4
million in 2007. By dividing those earnings by the shares outstanding of 34,944,
we are left with the forecasted earnings per share for 2007 of $.699. By dividing
this amount by the KE of 16.9%, we are able to come up with an intrinsic value
of $2.48 as of October 1, 2006 and thus, an intrinsic value of $2.94 on
November 1st, 2007. This value is about 90% less than the observed price of
$29.83 illustrating that JBX is overvalued.
The following tables are the results from the sensitivity analysis of the
AEG model.
Growth Rate
KE
-30.00%
-20.00%
-10.00%
0.00%
2.50%
5.00%
6.00%
37.57
38.54
40.72
50.17
60.96
125.72
8.00%
23.03
23.16
23.43
24.37
29.83
27.20
10.00%
15.14
14.96
14.60
13.51
12.78
11.33
12.00%
10.42
10.14
9.60
8.15
7.31
5.87
14.00%
7.42
7.11
6.56
5.21
4.51
3.41
16.90%
4.73
4.45
3.98
2.94
2.45
1.76
Overvalued if less than 25.36
Fairly Valued within 15%
Undervalued if more than 34.30
As with the other models, JBX has to have a KE less than 8 percent in
order to be considered fairly to undervalued. We feel that this is highly unlikely
to occur; therefore, based on the findings of the AEG model, JBX is
significantly overvalued.
Residual Income and AEG Check Figure
There is a link between the residual income model and the AEG model
that provides a check measure to ensure that the inputs are correct. For this
118 | P a g e
check measure, the AEG value year-to-year should equal the change in residual
income. The following table illustrates this check figure assuming a 0% growth
in the perpetuity and a KE of 16.9%. As the table illustrates the two figures are
equal.
Residual & AEG Check (0% growth, 16.9 KE)
2008
2009
2010
2011
2012
2013
2014
2015
2016
AEG
(9,205)
(9,996)
(10,856)
(11,790)
(12,805)
(13,906)
(15,102)
(16,402)
(17,813)
∆ RI
(9,205)
(9,996)
(10,856)
(11,790)
(12,805)
(13,906)
(15,102)
(16,402)
(17,813)
119 | P a g e
Intrinsic Valuation Conclusion
The valuation models discussed above did not lead to a consensus
conclusion. The free cash flow model was the only model that had JBX priced
under- or even close to properly valued. In our opinion, this model should be
underweighted in our analysis since the free cash flows of JBX appear to be
difficult to forecast and the other models typically provide a more reliable
valuation. Therefore, we feel that more weight should be put on the residual
income, long run ROE residual income perpetuity, and the abnormal earnings
growth. All three of these models showed that JBX is consistently earning a ROE
significantly less than their KE, and thus JBX is forecasted to destroy value yearafter-year. This deterioration of value leads the intrinsic value of JBX to be
significantly less than the observed price on November 1st, 2007 of $29.83.
Therefore, since these intrinsic valuations are less than the observed price, we
conclude that based on intrinsic valuations that Jack in the Box is overvalued as
of November 1st, 2007 and set our recommendation to sell.
Intrinsic Valuation Summary
Dividend Discount (DDM)
Free Cash Flow (FCF)
Residual Income
Long Run ROE Residual Income
Abnormal Earnings Growth (AEG)
Conclusion
N/A
Slightly
undervalued
Overvalued
Overvalued
Overvalued
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Credit Analysis
Credit analysis is a method of determining the financial health of a firm. A
firm that faces financial distress may not be able to repay its loans and fall into
bankruptcy. Jack in the Box’s credit was analyzed utilizing the Altman Z-score,
which “weights five variables to compute a bankruptcy score” (Palepu & Healy,
10-15). The higher the Z-score, the risk for bankruptcy lowers. Scores above 3
are considered low risk, scores between 1.81 and 3 are considered borderline,
and scores below 1.81 are considered high risk. The Altman Z-Score is
computed as follows:
⎡ MarketValueEquity ⎤ ⎡ Sales ⎤
⎡ Re tainedEarnings ⎤
⎡WorkingCapital ⎤
⎡ EBIT ⎤
+ 3.3⎢
+ 0.6 ⎢
+ 1 .4 ⎢
Z = 1 .2 ⎢
⎥+⎢
⎥
⎥
⎥
⎥
⎣ TotalAsset s ⎦
⎦
⎣ BookValueLiabilities ⎦ ⎣ TotalAssets ⎦
⎣ TotalAssets
⎣ TotalAsset s ⎦
These ratios, respectively, are measures of liquidity, cumulative profitability,
return on assets, market leverage, and sales generating potential of assets. The
model puts a greater emphasis on return on assets, and the least emphasis on
market leverage. The Z-Score results for Jack in the Box are below.
2001
2002
2003
2004
2005
2006
3.458
3.289
2.962
3.512
3.577
4.313
(0.099)
(0.208)
(0.078)
(0.028)
0.006
0.042
RE/TA
0.301
0.301
0.246
0.277
0.334
0.365
EBIT/TA
0.127
0.114
0.096
0.091
0.103
0.112
MV of Equity/BV of L
1.596
1.487
0.989
1.752
1.482
2.607
Sales/TA
1.780
1.849
1.802
1.805
1.871
1.819
Altman's Z-Score
WC/TA
As shown above, Jack in the Box has been above the safe level of 3 every
year except 2003. However, the 2003 score is close enough to still be
considered in the ‘safe zone.’ In the past couple years, JBX has seen significant
improvement, moving from 3.58 to 4.31 from 2005 to 2006. Therefore, it has
been determined that Jack in the Box is not a bankruptcy risk at this time.
121 | P a g e
Analyst Recommendation
After accounting for all of the data and analysis from industry analysis,
firm competitive advantage analysis, accounting analysis, financial statement
analysis, forecasted financial statements, cost of capital, equity valuation and
credit analysis, we conclude that JBX is overvalued and we set our
recommendation to sell the security.
To determine our recommendation, we utilized past financial data for Jack
in the Box, as well as financial data for competitors McDonald’s, Wendy’s, Sonic,
and Burger King. The fast food hamburger restaurant industry is a cost
leadership industry with key success factors of cost control, convenience, brand
image, and a diversified product portfolio.
While performing the accounting analysis, we determined that the
revenue/expense diagnostic ratios presented no real “red flags” for Jack in the
Box. However, JBX’s extensive use of operating leases where capital leases are
more appropriate creates a distortion in the financial statements. By capitalizing
these operating leases, we were able to get a more true and fair picture of JBX’s
financial activities.
Using the financial ratios and average growth rates, we were able to
forecast Jack in the Box’s financial statements for the next ten years. These
forecasts show smooth, even growth over the next ten years, with net income
and assets doubling over this time period.
We conducted a valuation of Jack in the Box through two methods:
comparables and intrinsic. We determined that JBX is undervalued by the
method of comparables and overvalued through the intrinsic valuations. As
previously discussed, the method of comparables should not hold as much
weight since there is no theory behind this method. Therefore, our
recommendation is primarily based on the results of the intrinsic valuations.
In conclusion, we feel that Jack in the Box is overvalued on November 1,
2007 and place a sell rating on this security.
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Common Size Balance Sheet
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Liquidity Ratios
Current Ratio
Inventory
Turnover
2001
2002
2003
2004
2005
2006
Jack in the Box
0.55
0.34
0.63
0.87
1.03
1.19
McDonalds
0.81
0.71
0.69
0.70
1.51
1.21
McDonalds
1.61
0.92
Burger King
Burger King
Jack in the Box
2001
2002
2003
2004
2005
2006
63.24
66.40
64.93
68.16
62.58
67.12
140.95
137.92
132.46
126.06
137.44
144.88
Sonic
0.82
0.70
0.93
0.70
0.54
0.54
Sonic
96.23
113.04
107.54
101.06
112.21
111.58
Wendy's
0.90
0.92
0.88
0.67
1.30
1.66
Wendy's
27.12
29.17
49.03
24.45
45.73
44.70
Jack in the Box
RS
0.55
0.34
0.63
0.87
1.03
1.19
Jack in the Box
RS
63.24
66.40
64.93
68.16
62.58
67.12
2001
2002
2003
2004
2005
2006
Jack in the Box
5.77
5.50
5.62
5.35
5.83
5.44
2.59
2.65
2.76
2.90
2.66
2.52
3.79
3.23
3.39
3.61
3.25
3.27
13.46
12.51
7.44
14.93
7.98
8.17
5.77
5.50
5.62
5.35
5.83
5.44
2001
2002
2003
2004
2005
2006
43.07
Quick Asset
Ratio
Inventory Days
2001
2002
2003
2004
2005
2006
Jack in the Box
0.12
0.10
0.23
0.54
0.45
0.78
McDonalds
0.58
0.49
0.45
0.60
1.23
1.01
McDonalds
1.38
0.75
Burger King
Burger King
Sonic
0.67
0.53
0.75
0.53
0.39
0.40
Sonic
Wendy's
0.43
0.52
0.37
0.30
0.44
1.23
Wendy's
Jack in the Box
RS
0.12
0.10
0.23
0.54
0.45
0.78
Jack in the Box
RS
A/R Turnover
WC Turnover
2001
2002
2003
2004
2005
2006
Jack in the Box
67.71
60.62
53.69
104.49
97.90
73.95
Jack in the Box
-17.94
-8.90
-23.10
-65.33
288.43
McDonalds
16.86
18.01
23.34
24.94
24.98
23.87
McDonalds
-34.66
-21.79
-19.86
-28.06
9.39
34.97
17.64
18.79
Burger King
8.08
-52.51
Burger King
Sonic
27.23
29.09
26.29
29.66
33.14
32.59
Sonic
-66.05
-30.92
-155.35
-36.90
-20.70
-19.48
Wendy's
28.60
31.59
25.39
19.68
39.48
28.75
Wendy's
-78.83
-93.32
-48.44
-10.90
14.18
9.31
Jack in the Box
RS
67.71
60.62
53.69
104.49
97.90
73.95
Jack in the Box
RS
-17.94
-8.90
-23.10
-65.33
288.43
43.07
2001
2002
2003
2004
2005
2006
Jack in the Box
11.16
11.52
12.42
8.85
9.56
10.37
24.24
22.91
18.40
17.53
17.27
17.81
A/R Days
Cash-to-Cash
Cycle
2001
2002
2003
2004
2005
2006
5.39
6.02
6.80
3.49
3.73
4.94
21.65
20.26
15.64
14.63
14.61
15.29
McDonalds
20.70
19.43
Burger King
20.70
19.43
Sonic
13.40
12.55
13.88
12.31
11.01
11.20
Sonic
17.20
15.78
17.28
15.92
14.27
14.47
Wendy's
12.76
11.55
14.37
18.55
9.24
12.70
Wendy's
26.22
24.07
21.82
33.48
17.23
20.86
5.39
6.02
6.80
3.49
3.73
4.94
Jack in the Box
McDonalds
Burger King
Jack in the Box
RS
131 | P a g e
Profitability Ratios
Gross Profit Margin
Asset Turnover
2001
2002
2003
2004
2005
2006
Jack in the Box
19.44%
19.19%
17.62%
17.55%
16.99%
17.45%
Jack in the Box
1.91
1.94
2.03
1.95
2.07
McDonalds
31.04%
30.24%
30.32%
31.75%
31.45%
32.36%
McDonalds
0.68
0.72
0.72
0.71
0.72
40.04%
38.32%
38.03%
38.40%
36.72%
Burger King
0.71
0.80
Burger King
2002
2003
2004
2005
2006
Sonic
40.92%
35.76%
34.68%
33.10%
32.29%
32.40%
Sonic
1.12
1.10
1.10
1.20
Wendy's
48.59%
49.32%
48.62%
45.27%
44.51%
44.56%
Wendy's
1.31
1.51
0.80
0.78
0.71
Jack in the Box - RS
19.44%
19.19%
17.62%
17.55%
16.99%
17.45%
Jack in the Box - RS
1.91
1.10
1.12
1.07
1.15
Operating Expense Ratio
Return on Assets
2001
2002
2003
2004
2005
2006
Jack in the Box
13.65%
14.68%
13.45%
13.81%
13.18%
13.18%
McDonalds
11.17%
11.12%
10.69%
10.43%
10.93%
25.64%
28.49%
27.02%
Burger King
2002
2003
2004
2005
2006
Jack in the Box
7.79%
6.59%
6.54%
7.12%
8.07%
10.83%
McDonalds
3.97%
6.14%
8.82%
9.35%
11.82%
25.10%
23.83%
Burger King
1.73%
1.06%
Sonic
9.26%
8.36%
7.93%
8.34%
7.62%
7.51%
Sonic
Wendy's
9.04%
8.84%
8.29%
8.40%
9.00%
9.74%
10.99%
11.87%
11.08%
11.39%
10.94%
10.88%
Jack in the Box - RS
Net Profit Margin
Jack in the Box
McDonalds
10.88%
11.77%
10.75%
11.19%
12.51%
Wendy's
10.5%
8.8%
1.7%
7.0%
2.7%
Jack in the Box - RS
7.79%
3.73%
3.62%
3.91%
4.49%
2002
2003
2004
2005
2006
19.40%
15.10%
16.58%
16.54%
19.11%
9.42%
14.31%
19.02%
18.32%
23.40%
9.85%
4.76%
Return on Equity
2001
2002
2003
2004
2005
2006
4.48%
4.08%
3.40%
3.22%
3.66%
3.91%
11.01%
5.80%
8.58%
12.25%
13.12%
16.42%
McDonalds
0.29%
2.42%
1.32%
Burger King
Burger King
Sonic
1.23
11.78%
11.92%
11.70%
10.82%
11.31%
11.35%
Wendy's
8.10%
8.01%
7.49%
2.08%
9.13%
Jack in the Box - RS
4.48%
4.08%
3.40%
3.22%
3.66%
Jack in the Box
Sonic
23.76%
22.66%
21.87%
21.04%
20.29%
3.87%
Wendy's
21.25%
16.29%
2.96%
13.06%
4.58%
3.91%
Jack in the Box - RS
19.40%
15.10%
16.58%
16.54%
19.11%
132 | P a g e
Capital Structure Ratios
Debt to equity ratio
Debt service margin
2001
2002
2003
2004
2005
2006
Jack in the Box
1.45
1.24
1.49
1.25
1.26
1.04
McDonalds
0.90
0.94
0.78
0.59
0.59
0.54
4.71
3.50
Burger King
Sonic
0.78
0.76
0.83
0.55
0.45
0.63
Sonic
Wendy's
0.44
0.47
0.39
0.35
0.26
0.55
Wendy's
Jack in the Box - RS
1.45
2.99
3.53
3.15
3.15
2.52
Jack in the Box - RS
2001
2002
2003
2004
2005
2006
Jack in the Box
6.33
6.28
5.41
5.62
11.31
15.05
McDonalds
5.96
5.96
5.65
5.65
7.30
7.30
1.16
-9.94
1.14
2.07
2.36
Burger King
2002
2003
2004
2005
2006
Jack in the Box
67.41
1.39
13.85
19.25
26.43
McDonalds
15.63
7.98
NA
NA
NA
54.50
14.80
77.08
84.15
65.60
21.26
19.53
105.52
90.13
3.67
108.68
67.41
1.39
19.25
26.43
13.85
Times interest earned
Burger King
NA
Sonic
10.20
11.12
11.99
12.96
18.30
14.87
Wendy's
10.87
9.20
-9.14
-5.14
-4.08
-1.13
133 | P a g e
Valuation Models
*Cash flows are in $thousands (000)
**JBX had a 2:1 stock split Oct. 16th 2007; thus, we had to adjust the intrinsic value to reflect
this split.
134 | P a g e
135 | P a g e
Beta Analysis
3-Month
# of Months
Beta
Adj. R
72
0.922
60
48
2
1-Year
Beta
Adj. R2
KE
0.135
10.39%
0.917
0.135
10.24%
1.109
0.106
12.01%
1.110
0.106
11.86%
1.350
0.114
14.14%
1.345
0.114
13.97%
16.86%
1.781
0.201
17.07%
1.782
0.201
17.09%
16.98%
1.775
0.180
16.98%
1.768
0.180
16.79%
Beta
Adj. R
0.136
10.26%
0.919
1.112
0.106
11.88%
1.352
0.114
14.15%
36
1.782
0.200
24
1.780
0.181
5-Year
# of Months
Beta
Adj. R
72
0.917
60
48
36
24
2
2-Year
KE
KE
2
7-Year
10-Year
KE
Beta
Adj. R2
KE
0.136
10.99%
0.919
0.136
11.01%
1.116
0.107
12.13%
1.117
0.107
12.16%
1.329
0.110
13.62%
1.326
0.110
13.61%
1.787
0.202
16.84%
1.789
0.203
16.90%
1.772
0.180
16.73%
1.773
0.181
16.78%
KE
Beta
Adj. R
0.135
10.99%
0.918
1.114
0.106
12.10%
1.333
0.111
13.65%
1.785
0.202
16.83%
1.771
0.180
16.71%
2
# of Data
Points
# of Data
Points
136 | P a g e
Cost of Debt (KD) – Original Financials
Amount
Weight
Rate
Value
Weighted
Rate
Current maturities of long-term debt
37,539
5.08%
6.41%
0.33%
Accounts payable
61,059
8.27%
4.94%
0.41%
Accrued liabilities
240,320
32.53%
4.94%
1.61%
338,918
45.88%
Long-term debt, net of current
maturities
254,231
34.41%
6.41%
2.21%
Other long-term liabilities
145,587
19.71%
6.41%
1.26%
0
0.00%
8.90%
0.00%
738,736
100.00%
Before Tax
KD = 5.81%
After Tax*
KD = 3.74%
Total current
liabilities
Capital Lease Obligations
Total Liabilities
*Tax rate: 35.7%
Cost of Debt (Kd) – Restated Financials
Amount
Weight
Rate
Value
Weighted
Rate
Current maturities of long-term debt
37,539
2.10%
6.41%
0.13%
Accounts payable
61,059
3.41%
4.94%
0.17%
Accrued liabilities
240,320
13.43%
4.94%
0.66%
Total current liabilities
338,918
18.94%
Long-term debt, net of current
maturities
254,231
14.21%
6.4100%
0.91%
Other long-term liabilities
Capital Lease Obligations
Total Liabilities
145,587
8.14%
6.4100%
0.52%
1,050,858
58.72%
8.90%
5.23%
1,789,594
100.00%
Before Tax
KD = 7.62%
After Tax
KD = 4.90%
*Tax rate: 35.7%
137 | P a g e
Lease Adjustments
138 | P a g e
139 | P a g e
140 | P a g e
141 | P a g e
142 | P a g e
References
Burger King 10-k, 2001-2006
Google Finance
Hoover’s – hoovers.com
Investopedia.com
Jack in the Box Information – jackinthebox.com
Jack in the Box 10-k, 2001-2006
McDonalds 10-k, 2001-2006
Mergent Online
Palepu and Healy, Business Analysis and Valuation (Ohio: ThomsonSouthwestern, 4th Edition, 2008).
Sonic 10-k, 2001-2006
St. Louis Federal Reserve website
Wendy’s 10-k, 2001-2006
Yahoo! Finance
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