Applebee's Looks Appetizing

Way, way down the list of woes left by Hurricane Katrina was the temporary closure of 15 Applebee's (APPB ) restaurants. Just the same, the distraction hardly could have come at a worse moment for this casual-dining chain, which only days before warned investors of slowing profit growth.

The economic uncertainty brought by Katrina helped push shares of Applebee's International below 22, down from over 29 in March and to a level not seen in almost two years. This is only the latest trouble for the Overland Park (Kan.) chain of Applebee's Neighborhood Grill & Bars, which long had delighted growth-stock investors with regular advances in same-store sales. Then, early this year, Applebee's first noticed a faint sputtering. For example, fewer customers were ordering dessert. More were choosing to drink plain water instead of soda. Sales in some regions, first the Midwest and then New England, were softening, too. By August, Applebee's saw customer traffic decline by 4% at company owned stores. Its main clients -- those in households with annual incomes of $50,000 to $70,000 -- were cutting back on dining out, the company figured, as gasoline prices dug deeper into budgets. With that, and a belief that higher gas prices will be with us for a while, Applebee's warned that earnings per share this year would grow only by 5% or so -- if at all.

YET AFTER LOOKING at the company's financial position, patient investors may find that the stock near 22 offers a reasonable opportunity. For starters, the company's balance sheet is strong. Total debt comes to $87 million, or less than 15% of total capital. The median debt-to-capital ratio for comparable companies is 31%, according to Capital IQ, a unit of Standard & Poor's (MHP ). The company's strategy of partnering with franchisees for nearly three-quarters of its 1,745 units means it enjoys sharply wider margins than many rival restaurateurs. Applebee's gets 4% off the top of sales at franchised locations, so any uptick in sales makes its way swiftly to the bottom line. Steven Lumpkin, the company's chief financial officer, told me that these royalties translate into cash flow of some $130 million this year.

That liquidity has helped to keep Applebee's balance sheet lean while fueling growth. In 2003 the company opened 100 restaurants, last year it brought on 109 more, and this year it's set to open at least 135 new units. Lumpkin said that next year's number of openings should be higher still, with an ultimate goal of at least 3,000 U.S. locations and another 1,000 abroad, where 63 Applebee's are now found in 12 countries.

In the meantime, there's the problem of driving traffic back into the restaurants. Lumpkin told me that Applebee's is preparing to roll out a marketing campaign stressing a "value message." He was vague about specific details, but that could translate into reminding consumers of Applebee's relatively low prices -- the average check runs about $10.50 -- or of inviting them back with specials at slower times of the week, such as during lunchtimes on Mondays and Tuesdays.

Rival restaurant chains are responding to the slowdown in middle-class consumer spending similarly, so fresh marketing won't yield magic results. What will help investors is the simple passage of time. Applebee's year-over-year sales comparisons this summer were made difficult by a surge last year when it introduced a menu designed in partnership with Weight Watchers International. Same-store sales might start improving by yearend, Lumpkin told me, with clearly better comparisons a fair bet by next spring. Applebee's trades at 15 times the next 12 months' earnings, in line with the broad market and its rivals. Priced, in other words, to rise on any pickup in demand.

By Robert Barker

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