Popeyes' Lucrative Franchise Model

By Ryan C. Fuhrmann | May 30, 2011 AAA

AFC Enterprises Inc. (Nasdaq:AFCE) operates the Popeyes restaurant concept and bills itself as the "second-largest quick-service chicken concept based on number of units." A focus on franchising the majority of its stores means high margins for the parent company, and management has ambitions to ramp up new store growth going forward. At the current share price, this growth will be needed to justify the current earnings multiple.

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First Quarter Recap
Company sales advanced 6.8% to $46.8 million on a 6.4% increase in comparable store sales at the company-owned locations. Franchised locations reported less robust same store sales growth of 3.8%. During the quarter, no company-owned stores were opened, but 32 franchised locations were opened both domestically and internationally. As of quarter-end, there were nearly 2,000 global locations and only 38 were owned by the parent company. As a result, most of the top line is from franchise fees and they accounted for nearly 60% of the first quarter sales.

Total expenses rose faster than sales, rising 8.5% to $34.3 million. As a result, operating income increased only 2.5%, but net income jumped 24.2% to $7.2 million on lower interest expense. A slightly higher share count resulted in earnings growth of 21.7% to 28 cents per diluted share. Free cash flow came in at $6.9 million, or very close to reported net income.

Outlook
Analysts currently project full year sales growth of 5% and total sales of nearly $154 million. The company expects to report earnings between 87-91 cents per diluted share, which is up slightly from previous guidance.

The Bottom Line
Given the lucrative franchise model AFC operates, first-quarter net margins were impressive at 15.4%. The wild card is how fast the company can grow franchise revenues and the total top line. For the year, it expects to open between 120 and 140 stores, but close 60 to 80 locations for net new openings between 40 and 80, or only a couple of percent.

AFC has a goal to further ramp new unit growth, including international locations. Rival Yum! Brands (NYSE:YUM) is seeing success opening its competing KFC locations in China and across the world, so it is reasonable to expect AFC to also utilize this strategy. Domestically, competition remains intense, with KFC and other fast food brands including Wendy's/Arby's (NYSE:WEN), Jack in the Box (Nasdaq:JACK) and McDonald's (NYSE:MCD). At a forward P/E of 17, AFC will need to grow in the double digits to justify its lofty earnings valuation. (For related reading, also take a look at Food Price Inflation Still a Big Deal.)

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