What a brutal six months it’s been for Denny's. The stock has dropped 36.9% and now trades at $4.23, rattling many shareholders. This was partly due to its softer quarterly results and might have investors contemplating their next move.
Is now the time to buy Denny's, or should you be careful about including it in your portfolio? Check out our in-depth research report to see what our analysts have to say, it’s free.
Why Do We Think Denny's Will Underperform?
Even though the stock has become cheaper, we're cautious about Denny's. Here are three reasons why DENN doesn't excite us and a stock we'd rather own.
1. Flat Same-Store Sales Indicate Weak Demand
Same-store sales show the change in sales at restaurants open for at least a year. This is a key performance indicator because it measures organic growth.
Denny’s demand within its existing dining locations has barely increased over the last two years as its same-store sales were flat.
2. Free Cash Flow Margin Dropping
If you’ve followed StockStory for a while, you know we emphasize free cash flow. Why, you ask? We believe that in the end, cash is king, and you can’t use accounting profits to pay the bills.
As you can see below, Denny’s margin dropped by 9 percentage points over the last year. If its declines continue, it could signal increasing investment needs and capital intensity. Denny’s free cash flow margin for the trailing 12 months was breakeven.
3. High Debt Levels Increase Risk
Debt is a tool that can boost company returns but presents risks if used irresponsibly. As long-term investors, we aim to avoid companies taking excessive advantage of this instrument because it could lead to insolvency.
Denny’s $414.2 million of debt exceeds the $2.17 million of cash on its balance sheet. Furthermore, its 5× net-debt-to-EBITDA ratio (based on its EBITDA of $79.27 million over the last 12 months) shows the company is overleveraged.
At this level of debt, incremental borrowing becomes increasingly expensive and credit agencies could downgrade the company’s rating if profitability falls. Denny's could also be backed into a corner if the market turns unexpectedly – a situation we seek to avoid as investors in high-quality companies.
We hope Denny's can improve its balance sheet and remain cautious until it increases its profitability or pays down its debt.
Final Judgment
We see the value of companies helping consumers, but in the case of Denny's, we’re out. Following the recent decline, the stock trades at 8.1× forward P/E (or $4.23 per share). While this valuation is optically cheap, the potential downside is huge given its shaky fundamentals. There are better investments elsewhere. We’d recommend looking at the Amazon and PayPal of Latin America.
Stocks We Like More Than Denny's
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