Despite having a well-known name, Denny's (DENN) has had a lot of trouble gaining
    recognition on Wall Street. The company was founded in 1980 and quickly grew to be among
    the larger restaurant franchises in the United States. Things changed in 1997 when its
    parent company filed for bankruptcy and buried Denny's under a ton of debt. Towards the end
    of 2003, the company that wants to be known as “America's Diner” saw its share price
    bottom out at $0.40.

Since then, management decided to start selling company-owned units to franchisees, a
move that would eat at the company's revenue, but reduce its debt and increase its margins.
The idea worked, at least for a little while, and the company has managed to turn a profit now
for the last five years. The stock climbed from $0.40 to $6.00 by late 2005 as earnings were
once again a reality. This run looks even better if we consider that the number of shares
outstanding more than doubled to 90 million between the end of 2003 and the end of 2004.

The stock trickled back down and found another low point just above $1.00 in February of
2009. A major problem at that time was managements inability to capitalize on some
expensive Super Bowl commercials. The ad campaign involved a free breakfast during a
certain time at all Denny's locations. The problem is that they did not invest in upgrades to its
electronic presence. People were aware of the promotion, but had trouble finding the closest
restaurant online or with their favorite device. The company also failed to take advantage of
the potential social buzz that could have been generated from all the searching.

That was Denny's first Super Bowl effort, and in 2010, a second attempt was made with
slightly better results, including some long lines reported across the country. Some investors
have started getting in line as well, and the stock has clawed its way back to $4.00. Some
shareholders have even seen enough potential to wage a proxy battle, forming a group
called “The Committee to Enhance Denny's”. The activist investors eventually lost their battle
to gain three seats on the company's board, but their actions may have caused some
significant changes at Denny's. One was the departure of a CEO perhaps in the twilight of
his career and the arrival of a new, up and comer (30 years experience as opposed to 40),
John C. Miller, who was formerly the CEO at Taco Bueno Restaurants Inc. The company has
also appointed a new chief marketing officer, and decided against running any Super Bowl
advertisements this year.

Despite seeing a run up of around 230% since February of 2009, valuations for this stock
continue to look low or in-line with the industry. The average P/E for restaurant stocks is 21.
Shares of Denny's have ratios of 17, 10 and 8 for the price to 2010, 2011 and 2012 earnings
respectively. The earnings and cash flow growth are what has some starting to take notice.
For the past five years, the company has seen 40% annual earnings growth. The stock's P/E
to growth (PEG) ratio is surprisingly low at 0.5. Ironically, this ratio is commonly used to
make high-growth stocks with high P/E's look cheaper. By this measure, Denny's is trading
at half of fair value.

This growth could be even more than what is currently expected. The company has been
improving net margins over the last five years, and a lot of this has to do with the debt
reduction. Since 2005, the company has reduced their long-term debt from $547 million to
$253 million, while only adding about 10 million to the share count, which now stands at
around 100 million. The company even bought a million shares back last year. The balance
sheet, which has been getting leaner but more balanced, is not where the value in this stock
is, but further improvements will help raise net margins back in line with the industry.
Denny's has been working on refinancing almost all its debt. Details recently disclosed
indicate that management was able to slash interest rates by a percentage point and
potentially more depending on what the LIBOR rate does. The company says that the move
will save $2.5 million a year that is not yet included in any estimates. All this means that the
company will continue to see earnings growth without revenue growth.

Denny's earned 22 cents a share for all of 2010, just over half of what they earned in 2009,
but there was about 8 cents a share that was from the sale of company-owned restaurants
to franchisees in 2009 that was not there in 2010. There was also 4-5 cents from the $4.5
million they spent on the refinancing, a couple of cents from expenses related to the proxy
battle, and another $4.5 million in workers compensation claims included in 2010. Ignoring
these items bring 2009 and 2010 more in line, and analysts see 39 cents for 2011 with even
fewer restaurant sales. The company has said that they are winding down the program and
sold 57 fewer restaurants to franchisees in 2010 as compared to 2009.

Meanwhile, Denny's opened 58 brand new restaurants in the fourth quarter of 2010 alone,
and overall, they had the most domestic openings in 2010 than in any other year of the
company's history. Denny's ended the year with a total of 1,658 units, 232 of which are
company-owned. For the fourth quarter of 2010, company-owned restaurant revenues were
$103 million while franchise revenues were $32 million. After the cost of revenue, restaurant
sales brought in just $13 million, while franchise gross profits were $21 million. Those 232
company-owned units, however, will begin to improve the earnings more significantly if
same-store sales finally begin to pick up. Holding on to as many company units as they can
may make sense for the long haul, as the increased earnings from the increase in
franchised units will not last.

If earnings have continued to grow while overall revenues have declined, what will happen if
revenues bottom out and begin to climb slowly back up? This may already be happening.
Sales in 2007 were close to $1 billion, in 2008 they were around $760 million, $608 in 2009,
and finally, $548 million in 2010. 2011 revenues are expected to be in line with 2010, and
2012 is seen with a slight decrease to $536 million.

As to whether or not management will, in fact, stop selling restaurants to franchisees, and at
what pace they will continue to slow the program down, remains to be seen. If they continue
to see cash flow growth, their ability to pay down the remainder of the debt without the need
to sell restaurants may not be in question. The revenue projections for 2011 and 2012 could
even prove to be conservative if the company were able to stop the bleeding from the
company-owned revenue stream and continue to add brand new restaurants at a historic
pace. Management mentioned that head counts were up in the second half of 2010, and
might have been even higher had the weather been better.

Denny's has been getting creative with these new restaurants. Out of the 70-75 new units
they plan to open in 2011, 10 are university sites. In March of 2010, Denny's was selected by
the privately held company Pilot Travel Centers LLC to convert restaurants in 140 of its
recently acquired Flying J Travel Centers (now called Pilot Flying J) to the Denny's brand. At
that time, Denny's had planned to convert 80 in 2010, but they actually converted 100. They
wish to convert an additional 25 in 2011, 5-10 of which will be company-owned. Also this
year, the company plans to open two company-operated fast-casual Denny's Cafe test sites.
All these new types of restaurants will generate less revenue per unit, but will also
experience better margins, and are a lot cheaper to start-up.

Denny's always has and always will face a lot of competition, from the local dinner to the new
Bob Evans (BOBE) down the street, and the economy may be the determining factor in how
fast they can begin growing revenues again. Denny's, Bob Evans, Cracker Barrel (CBRL) and
other breakfast oriented restaurants have been affected by the recent spike in food costs,
particularly sow prices. Denny's image of possibly being the cheapest and fastest of this
group may help them, especially as they are all forced to raise their prices. There is some
indication that a slow economic recovery could be advantageous for this business model, as
well. Denny's has come a long way over the past decade, and now it appears that most
people will not have to go a long way to eat at one.
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    Will Shares of Denny's soon Begin Selling like Hotcakes?
    March 16, 2011  PSW Staff
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