Denny's has had an impressive run over the past six months as its shares have beaten the S&P 500 by 17%. The stock now trades at $5.16, marking a 35.8% gain. This performance may have investors wondering how to approach the situation.
Is there a buying opportunity in Denny's, or does it present a risk to your portfolio? Dive into our full research report to see our analyst team’s opinion, it’s free.
Why Do We Think Denny's Will Underperform?
We’re happy investors have made money, but we're swiping left on Denny's for now. Here are three reasons there are better opportunities than DENN and a stock we'd rather own.
1. Flat Same-Store Sales Indicate Weak Demand
Same-store sales is a key performance indicator used to measure organic growth at restaurants open for at least a year.
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
Free cash flow isn't a prominently featured metric in company financials and earnings releases, but we think it's telling because it accounts for all operating and capital expenses, making it tough to manipulate. Cash is king.
As you can see below, Denny’s margin dropped by 8.7 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 negative 1.2%.
3. Short Cash Runway Exposes Shareholders to Potential Dilution
As long-term investors, the risk we care about most is the permanent loss of capital, which can happen when a company goes bankrupt or raises money from a disadvantaged position. This is separate from short-term stock price volatility, something we are much less bothered by.
Denny's burned through $5.55 million of cash over the last year, and its $416.1 million of debt exceeds the $1.17 million of cash on its balance sheet. This is a deal breaker for us because indebted loss-making companies spell trouble.
Unless the Denny’s fundamentals change quickly, it might find itself in a position where it must raise capital from investors to continue operating. Whether that would be favorable is unclear because dilution is a headwind for shareholder returns.
We remain cautious of Denny's until it generates consistent free cash flow or any of its announced financing plans materialize on its balance sheet.
Final Judgment
Denny's doesn’t pass our quality test. With its shares topping the market in recent months, the stock trades at 10.4× forward P/E (or $5.16 per share). While this valuation is fair, the upside isn’t great compared to the potential downside. There are superior stocks to buy right now. We’d suggest looking at the Amazon and PayPal of Latin America.
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