January 18, 2005

Ruby Tuesday (NYSE: RI) is not the only eatery offering cautious projections for 2005. Applebee's (Nasdaq: APPB) was far from bullish with its latest guidance. For 2005, the company expects its comparable sales to increase by 3%. Compare that to the unimpressive 4.8% comparable sales in 2004, and you can see why investors aren't rushing to buy its stock. In contrast, Buffalo Wild Wings (Nasdaq: BWLD) and even the giant of eateries, McDonald's (NYSE: MCD), are achieving superior comparable sales. So what's causing Applebee's, Ruby Tuesday, and O'Charley's (Nasdaq: CHUX) to have a slowdown in growth while other restaurants are offering up record numbers? Perhaps it comes down to a lack of differentiation at this level of dining. Surely there is some benefit in offering a clearly distinguishable dining experience like Buffalo Wild Wings or Sonic (Nasdaq: SONC). But if differentiation was the only answer, what explains the recent success of McDonald's as opposed to the lackluster results being served up by Wendy's (NYSE: WEN)? Applebee's ability to differentiate itself from the likes of Ruby Tuesday and O'Charley's, among a list of others, is part of the answer. But just about every business can learn from McDonald's and its ability to reinvent itself while at the same time maintaining exemplary operating performance. Applebee's ability to do so will mean the difference between a stellar stock and an average one going forward. Is it all doom and gloom for Applebee's? Far from it. There is plenty to like about this company, starting with its knockout net profit margins of 10.2%. O'Charley's, with its 2.5% net profit margins, can only dream of this level of profitability. Applebee's outstanding margins have allowed the company to turn out ample amounts of structural free cash flow that is being used for a variety of purposes. A part of its cash generation continues to go toward the expansion of its units. With 1,637 restaurants already in operation, the company is expecting to open at least 125 more restaurants in 2005 -- making it the 13th consecutive year of at least 100 new openings. The other part of its stash of cash is going into the repurchasing of its shares. In 2004, it bought back 3,993,670 shares at an average cost of $24.97 -- that should offer some confidence for investors considering opening a position here at around $25. It is not stopping there; Applebee's board recently approved another buyback program where up to $150 million will be used to purchase its stock beginning this year. The share-repurchase program is part of the reason why the company is projecting 15% earnings per share growth. For 2005, it expects to earn $1.48 to $1.51 per share, which would give its stock a forward price-to-earnings of 16.5. Given its slowing growth, this is hardly a bargain, but it's also not outrageously expensive when you consider the company's margins and cash flow. With a tough 2005 on tap for Applebee's, a patient investor will likely be able to find a better deal in the coming months.