SumZero Pair Trade: Fast Food Restaurants

Jack in the Box (Nasdaq: JACK)--Long
Red Robin Gourmet Burgers (Nasdaq: RRGB)--Short

Jack in the Box (Nasdaq: JACK)--Long
Current Price: $23.86
Target Price: $46.32
Source: Hedge Fund. New York, NY.

Quick Pitch: With the sale of 332 company-owned stores in FY2011, JACK has successfully re-franchised approximately 70% of its 2,236 system-wide units. An additional 150-200 company-owned stores are scheduled to be re-franchised over the next ~9-18months. Going forward, JACK’s re-franchising strategy will result in significantly higher EBIT margins and reduced CAPEX requirements. At the same time, JACK is aggressively expanding its Qdoba brand, a strategy which parallels that of McDonald’s (NYSE: MCD) in the years leading up to MCD’s 2006 IPO spin-off of Chipotle (NYSE: CMG). My analysis suggests that Qdoba alone could be valued at close to $20.00 per JACK share in the event of a spin-off. My analysis suggests fair value for JACK in the mid-$50 range, implying significant upside from current levels.

Red Robin Gourmet Burgers (Nasdaq: RRGB)--Short
Current Price: $37.23
Target Price: $28.31
Source: Hedge Fund. New York, NY.

Quick Pitch: The market appears to overlook critical fundamental issues, which threaten the sustainability of Red Robin’s improved performance and call into question its recently improved valuation. The most concerning issues include (1) Declining traffic trends masked by recent price increases, (2) Margin pressure from persistent commodity price inflation, and (3) Growing competition from two segments: the rapidly-growing fast casual “better burger” industry and the increasingly promotional casual dining segment. These issues combine to create an environment where management is tasked with maintaining comp performance in 2012 with little room to take pricing without sacrificing traffic to its casual dining and fast casual competitors. I believe the resultant hit to margins will disappoint investors and cause the company’s stock to fall short of optimistic 2012 street estimates, prompting a re-rating of its multiple to pre-2011 levels. I recommend initiating a short position with a target price of $28.31, representing ~23.5% downside from current levels.

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