Bringing Home the Bacon at IHOP?


By Christopher Palmeri It's an American icon with enough cachet that people sell its merchandise on eBay. Its triple-stack pancakes -- not to mention the four different kinds of syrup -- are the ultimate comfort food. But for years, IHOP Corp. (short for the International House of Pancakes) had struggled with finding new ideas for growth: Its ads were unremarkable, its menu uninspired, and its profits steady but unspectacular.

Into this mix last year came Julia Stewart, an energetic, 47-year-old restaurant-industry veteran, who worked as an IHOP (IHP) waitress one summer during high school. Since becoming IHOP's chief executive in May, 2002, Stewart has sought to reenergize the pancake chain by revamping its marketing, menu, and franchising model.

Her ultimate goal is to unseat Denny's (DNYY) -- with 1,700 units to IHOP's 1,100 -- at the top of the morning food chain. "There's no question we'll be No. 1 in family dining," Stewart says, with the conviction that comes from years in marketing. "We'll have more locations than anybody else. Our training, our operations, our advertising will be the best."

"THE RIGHT THING." So far, however, Stewart hasn't exactly brought home the bacon. IHOP's 2002 earnings were flat, at $40 million on $365 million in sales, and they're expected to fall this year. And the stock has been on a roller coaster since Stewart took over, falling from $36 a share to $21, before bouncing back to its present price of $31.

Because she failed to meet her own profit targets, Stewart didn't get a bonus last year. She blames the poor results on the bold changes she's making. "People ask me: 'Why are you trying to do all this now?'" she says. "I say it's the right thing for the company long-term."

Her most important move took place well out of range of most diners, who don't much care who owns the local IHOP as long as the coffee is hot and the pancakes fluffy. Stewart has revised the way franchising is handled.

SWEETENING THE STOCK. Beginning in the mid-1980s, IHOP lent entrepreneurs most of the $1.9 million it generally takes to open a new restaurant. That's an unusually enticing arrangement in the restaurant business, but it was cooked up at a time when IHOP was so poorly regarded that it had no other way to attract franchisees. It worked, too: IHOP doubled the number of its locations in the 1990s.

The strategy hardly offered a sweet return on capital, though. Now, Stewart is taking a more traditional tack: Franchisees have to borrow the money somewhere else. This will mean fewer new restaurants -- perhaps 80 this year, down from 96 in 2002, she estimates. But, Stewart adds, the switch will help IHOP grow faster in the long term because it'll be leveraging other people's capital.

To make the stock more appetizing in the interim, Stewart is channeling excess cash flow into dividends and a share-buyback program. She initiated a dividend that works out to $1 per share earlier this year and says she'll buy more than 10% of IHOP's shares.

CHEESE TOAST. The tack has investment analysts scratching their heads, however. "People buy restaurant stocks to get earnings growth," says Michael Smith, an analyst at Fahnestock & Co. "These are not utilities." Analysts Greg Schroeder and Amanda Bryant at Fulcrum Global Partners have put a sell recommendation on IHOP, citing its price-earnings ratio of 16 times this year's estimated earnings and Stewart's risky change in the franchise model.

Stewart knows the long-term key to pleasing investors and franchisees lies in keeping IHOP's restaurant revenues growing. Here she's borrowing a trick honed through her years at chains like Taco Bell, Burger King, and Applebee's International. She's introducing new, limited-time-only menu items and backing the launches with big marketing campaigns.

Her most talked-about dish so far: French toast filled with cream cheese and topped with whipped cream, powdered sugar, and fruit -- coming in at some 900 calories and a price starting at $3.99. To promote it, she persuaded franchisees to buy the first national TV ads. The commercials featured a policeman pulling over a Volkswagen Beetle stuffed with kids -- and then joining them at IHOP.

"PARADISE" PANCAKES. The ad seemed to click: IHOP's same-store sales increased 2.2% in the first quarter, the largest jump in almost five years. "It was one of the most successful promotions in the history of IHOP," says Robert Sharp, a Fairfax (Va.) franchisee.

What's next? Stewart is now planning new lunch and dinner items, none of which she'll reveal. Meanwhile, IHOP's Glendale (Calif.) headquarters was recently decorated with scenes of palm trees and sunsets to promote the latest concoction: "paradise" pancakes, with pineapples, bananas, and

macadamia nuts.

So far, Stewart has support where it counts, among large shareholders. "We're very pleased with Julia," says O. Mason Hawkins, chief executive of Southeastern Asset Management, IHOP's largest investor with a nearly 16% stake. "Long-term, we think she's a terrific CEO." Now if IHOP can just get through the short haul. Pancakes, anyone? Palmeri is a correspondent in BusinessWeek's Los Angeles bureau


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