We have seen some impressive turnarounds in 2014.

 

#-ad_banner-#Target Corp. (NYSE: TGT) experienced an embarrassing and costly data security breach in late 2013, but its misfortune has reversed, shares are up 18% year-to-date and are now at all-time highs.

 

After a long stretch of underperformance that culminated in its ejection from the Dow Jones Industrial Average in 2013, the former ‘king of aluminum,’ Alcoa, Inc. (NYSE: AA), is finally looking a lot better, too. Its stock has soared 46% this year.

 

Meanwhile, shares of the nation’s third-largest pharmacy chain, Rite Aid Corp. (NYSE: RAD), have gained 34% on the company’s makeover efforts.

 

These are just a few examples of this year’s many comeback stories. The question for investors: Which comeback stocks are most likely to continue delivering solid gains?

 

Investors should consider the rejuvenated diner chain Denny’s Corp. (Nasdaq: DENN). The firm is in making a major transformation, and the payoff to shareholders has already been enormous.

 

 

A half-decade ago, Denny’s was struggling and not just because of the recession. At the time, it was losing market share to other better-managed rivals, particularly DineEquity, Inc. (NYSE: DIN), which owns the venerable IHOP chain.

 

Simply put, Denny’s was shooting itself in the foot by raising prices, even as it allowed the quality of its food and service to drop off. This contributed to sharp declines in same-store sales. The company was also saddled with heavy debt and couldn’t seem to keep a lid on various operating expenses.

 

The stock price reflected these woes, having dropped nearly 60% during the prior five years.

 

Times are much better now, though. And I expect they’ll get better still, now that the recession is in the rearview mirror and Denny’s is creating its own growth catalysts.

 

A key one is the company’s accelerated shift away from costlier company-owned restaurants to a less capital-intensive franchise model. Although the bulk of this initiative occurred by 2012, some conversions have taken place during the past two years, as well. Of Denny’s 1,689 locations, 91% are franchises, compared with just 66% in 2006.

 

The shift is clearly generating savings. For instance, depreciation and amortization costs are down to $21 million, from $30 million in 2010. At $8 million, annual interest expense is a third of 2010 levels.

 

Denny’s is paying so much less interest now partly because it used refranchising proceeds to pay off long-term debt, which now stands at $148.8 million. That is down 36% since 2010. Periodic debt refinancings have helped, too.

 

To help rejuvenate its brand and boost same-store sales, Denny’s has been stepping up its pace of remodeling restaurant. It completed renovations of 174 stores last year and 129 in the first three quarters of this year. The firm plans to have 70% of its locations refurbished within four years.

 

Remodels will mainly incorporate what management refers to as the new Heritage design, which combines a more contemporary look with the familiar Denny’s brand. However, the firm is also starting to target millennials (the 18-to-33 age group) with simpler menus and locations designed specifically to their tastes. For example, a youth-oriented concept restaurant called the Den recently opened at the University of Alabama.

 

At Denny’s regular locations, the menu has also evolved to include healthier options, higher-quality side dishes and limited-time specials. Behind the scenes, kitchen operations have been streamlined to help maximize margins.

 

With all the effort to jumpstart growth, investors may be surprised that total revenues have actually fallen almost 4% a year since 2010. However, this is due mainly to lost sales while stores were being remodeled. So the issue is likely temporary and, at this point, more a sign of Denny’s willingness to trade near-term results for healthy long-term performance.

 

Sales are now growing at a modest 1% clip, the first top-line gains  since 2006. Also consider that third-quarter same-store sales were up 2.4% overall, 4.1% at company-owned restaurants and 2.1% at franchises — the best such results in eight years.

 

A leaner cost structure has helped to lift operating margins and net profits. Per share profits have been rising roughly  16% annually since 2012. Analysts expect the earnings growth rate to remain robust in coming years.

 

Thanks to a leaner cost structure, margins generally look much better now than they did before 2009 and earnings per share are expanding rapidly, soaring about 16% annually since 2012. Analysts see that rate accelerating a bit to 16.5% through 2019, a reasonable estimate especially now that sales growth is turning positive. At the projected earnings multiple of 27, this suggests a potential gain of about 74% for Denny’s stock during the next five years.

	2004	2005	2006	2007	2008	2009	2010	2011	2012	2013	Current
EPS	-$0.58	-$0.08	$0.31	$0.35	$0.15	$0.42	$0.22	$1.13	$0.23	$0.26	$0.31
Gross Margin (%)	61.3	17.4	18.5	17.6	20.4	24.3	24.7	25.3	28.6	28.7	28.9
Operating Margin (%)	5.6	5.0	11.1	8.9	8.0	11.9	10.1	9.5	11.5	10.3	10.7
Net Margin (%)	-3.9	-0.8	3.1	3.7	1.9	6.8	4.1	20.9	4.6	5.3	6.0

 

 

Risks To Consider: Although Denny’s has been slashing debt, the company is still highly leveraged relative to peers. A slowing economy, higher commodity prices or an increase in other expenses could lead to fresh concerns about debt service.   

 

Action To Take –> Don’t stress about Denny’s debt. The firm has no major principal payments for well over three years and liquidity is sufficient to meet current obligations. Thanks to the impressive turnaround, Denny’s should be ready to handle larger obligations as they come due, while still generating the bottom-line growth necessary for the next leg of outsized stock gains.

 

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