Denny’s Corporation (NASDAQ: DENN) is an American diner-style restaurant chain with a rich history of 70 years. The company broadly operates via two brands, Denny’s and Keke’s, and offers more affordable menu pricing than its industry peers. As of June, the company operated or franchised a total of 1,603 restaurants, with Denny’s brand representing 1,541 global restaurants and the remaining 62 by the Keke’s brand. Here, we summarized an April bullish thesis published by agape1095 on Value Investors Club.
A close-up of a table of people enjoying their meal and conversing in a Denny’s restaurant.
DENN is a good investment opportunity despite declining revenue and EBITDA trends in the first normalized post-COVID year of 2023 relative to 2019 financials and higher revenues of other restaurant chain operators. The small market cap and low daily-traded volumes cause investors overlook the stock as an investment idea. However, deeper analysis reveals that DENN operates a lucrative franchise business model with recurring revenue, solid free cash flow-generating potential, and a history of returning capital to shareholders via strong buyback programs. The company’s outstanding shares have dropped to 56 million from 101 million in 2011, when it began repurchasing shares. There remains a possibility that DENN could return all FCF and repurchases to drive EPS growth and hedge downside investor risks.
Franchising restaurants to operators facilitate priority claims to cash flow, enhanced revenue transparency, higher margins, and lower operating risks. DENN reduced company-owned restaurants from 561 in 2004 to 75 in 2024, with franchisees managing over 95% of the restaurants. The thesis argues that the stock continues to trade at a discounted value since the company is often considered a value trap with uncertain earnings consistency. Several factors contribute to this perception. For instance, the company’s key metrics like EBITDA and revenue have dropped in FY23 compared to pre-COVID years till FY18. Meanwhile, DENN’s transition to an almost wholly franchise model in FY19, when it franchised 105 company-owned restaurants, was masked by the timing of the pandemic. The lack of clarity around the economics of the franchise segment has also portrayed DENN’s revenue growth as much worse than it is since DENN started shifting to a franchise business model. The thesis highlighted that operating revenue is the sum of franchise and company-owned restaurant revenue, which could take a hit when portfolios shift towards franchise models.
However, the underlying trends point to the dramatic change in DENN’s franchise earnings since FY18. Earnings have grown each year since 2020 and represent the majority of company earnings. Leadership anticipates same-store sales growth of up to 3% and adjusted EBITDA between $85 million and $89 million in the current financial year. While the thesis forecasts FCF close to $50 million, management-defined FCF was $44.7 million. DENN bought back shares worth $52.1 million in FY23 and has returned capital to shareholders yearly since 2011, excluding 2020. The company’s commitment to share buybacks could also drive EPS growth between 5% and 6%. The thesis priced the stock at 16X FCF or $14.7 per share, citing its capital-light business, recurring income streams, and projected organic growth of up to 2%.
DENN is not on our list of the 31 Most Popular Stocks Among Hedge Funds. As per our database, 16 hedge fund portfolios held DENN at the end of the second quarter compared to 15 in the previous quarter. While we acknowledge the potential of DENN as an investment, our conviction lies in the belief that AI stocks hold greater promise for delivering higher returns and doing so within a shorter timeframe. If you are looking for an AI stock that is as promising as DENN but that trades at less than 5 times its earnings, check out our report about the cheapest AI stock.
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