Is Denny’s a Contrarian Restaurant Play?

Many people are wondering why stock prices at Denny’s (NASDAQ: DENN) the iconic diner chain have suddenly shot up? Possibly because of a new share buyback scheme or maybe because some investors think Denny’s is a contrarian play in the restaurant business.

Denny’s shares have gone up by around $2 in the last two months. Back on October 3, Denny’s was trading at $10.66 a share but by December 15, the price had risen to $12.81 a share. Naturally this attracts the attention of contrarian investors and those looking for something to short.

Denny’s is an interesting company because a lot of people dismiss it because of its old fashioned food and working-class clientele. Like Darden Restaurants (NYSE: DRI), Denny’s is vulnerable to rising income inequality, particularly working and middle class families with less disposable income.

Denny’s is Big Business

Yet it’s also in a position to profit from income inequality because families with less money still want to eat out. That makes Denny’s value menu quite attractive. Denny’s has some other attributes including its 24 hour a day, seven day a week business model and the disappearance of traditional diners in some parts of the country.

Denny’s is also a surprisingly big business operating over 1,700 locations in all 50 US states and a number of foreign countries. Proving that there is demand for its Grand Slams and pies.

Does Denny’s Make Money?

Despite all that Denny’s does not make that much money. It reported revenues of $501.37 million and a net income of just $16.89 million on September 30, 2016, despite a profit margin of 7.58%.

The company also reported just $66.84 million in cash from operations and $1.526 million in cash and short-term investments at the end of third quarter 2016. There was also just $13.66 million in free cash flow and assets of $297.73 million giving the company very little float.

This occurs because most of Denny’s restaurants are franchised which limits the profits the company itself can make. Most of Denny’s profit comes from the $40,000 franchise fee, 5.25% in royalty fees and 4% advertising fees it collects from franchisees.

That adds up but not to the kind of profits seen at giant chains like Starbucks (NASDAQ: SBUX) and McDonalds (NYSE: MCD). The limited resources at Denny’s should give pause to persons interested in new restaurant brands such as Shake Shack (NYSE: SHAK).

Denny’s has been in business for 63 years and it operates 1,700 locations yet it only has revenues of $501.37 million. It also has a very strong brand that is known to most Americans. That does not bode well for a new brand like Shake Shack.

Shake Shack did report a net income of $9.772 million on September 30, 2016, and revenues of $246.26 million on the same day. That means the gourmet burger brand is doing pretty well, although it was very lousy investment at $38.08 a share on December 9, 2016.

Is Denny’s a Better Stock than Shake Shack?

The $12.8 share price makes Denny’s a better deal than Shake Shack; which was trading at $38.01 a share on December 15, 2016, but it’s still a pretty lousy investment. Ycharts data indicates that there’s no dividend at Denny’s and a return on equity of -36.4%.

The moral of the story is a simple one, Denny’s is a pretty good place to eat breakfast but a lousy investment. Stay away from Denny’s and the rest of the lower end restaurant stocks. There’s simply no money to be made in this corner of the restaurant business at least in stocks.

Even successful brands are not generating that much cash so stay away unless of course you plan to franchise. Then you’ll need $5 to $10 million in liquid capital to meet Denny’s minimum financial requirements.

The only people who should buy Denny’s stock are those looking for something to short. Everybody else should stay far away from this diner brand’s shares.