IHOP Follows Reliable Recipe for Fiscal Success

Never mind Planet Hollywood, Rainforest Cafe and those other “concept” restaurant chains that are struggling to live up to their hype--and their stockholders’ expectations. The big returns these days are in flapjacks.

IHOP Corp., which runs the decidedly un-trendy but familiar International House of Pancakes chain, is riding a two-year growth spurt that shows no sign of slowing and has investors cheering.

The stock of Glendale-based IHOP has surged 60% over the last 12 months, closing Tuesday at $40.63 a share on Nasdaq. That means the company and its chairman and chief executive, Richard K. Herzer, have generated $145 million of additional wealth for its shareholders during the year.

All this from IHOP, the blue-roofed family chain where the attraction is multiple flavors of syrup, not souvenir T-shirts?

“We’re in the pancake business, and it’s a very good business,” Herzer said in an interview. “I’m not going to give it up, and that’s why you don’t see me going to another name.”

You’ll have to excuse Herzer for speaking as though it’s his chain. Herzer, who turns 67 in June, has been running IHOP since 1983 and still owns nearly 8% of its stock, currently worth $30 million. He has no immediate plans for retirement, he said.

IHOP--celebrating its 40th birthday this year--is mostly a franchise operation. As of Dec. 31, IHOP itself ran only 71 of the chain’s 787 restaurants in the United States, Canada and Japan. About 20% of the outlets are in California.

To hear Herzer tell it, IHOP’s recent success isn’t all that complicated: A menu with tasty, reliable staples such as pancakes and omelets, a frequent rotation of new entries such as taco salads and hamburger club sandwiches, good service, competitive prices, an eye on costs and good management. The refurbishing of some of IHOP’s older, dowdy restaurants is another factor in the chain’s success.

“I don’t think there’s anything secret to it,” he said.

But in the mid-1990s, there didn’t seem to be anything special about it, either. IHOP struggled to generate enough sales growth--both from existing and newly opened restaurants--to offset its rising expansion costs and thus drive earnings sharply higher. Overall sluggishness in the restaurant business didn’t help.

The result: During three long years between 1994 and 1997, IHOP’s stock slumped from $30 a share to the low 20s, while Standard & Poor’s index of restaurant stocks shot ahead 47% and the S&P; 500 soared 61%.

In the last year, though, the stock has rallied in response to IHOP’s plans to increase its growth--and amid signs that the company is becoming more cost-efficient in its expansion, said David Trossman of BT Alex. Brown Inc. in Baltimore.

“That is what’s giving people a better sense of confidence that IHOP’s earnings growth rate can accelerate from here,” he said.

Also helping is a steady drumbeat of TV ads featuring the fictional spokesman Cliff.

IHOP’s net income and revenue both rose 13% last year, to $21 million and $216 million, respectively. More important, IHOP’s same-store sales--that’s the retail industry’s main gauge of growth exclusive of expansion, reflecting sales of stores open at least a year--rose 3.7% last year, and have climbed for three straight years.

“That’s pretty terrific considering how difficult the [restaurant] industry is in general,” said Steven Kent, an analyst at Goldman, Sachs & Co. in New York.

IHOP--whose original restaurant opened in Toluca Lake in 1958--has been opening 63 to 67 restaurants a year for the last five years. Sales for the entire IHOP system now surpass $900 million annually.

But this year, IHOP plans to open 70 to 85 stores, and, although rapid expansion can be risky, Herzer said he’s confident because IHOP has a strong network of dedicated franchisees.

IHOP uses an unconventional franchising method. Rather than just selling its name, licensing rights and supplies to a franchisee who then goes out and opens a restaurant with his or her own cash, IHOP first picks a site and builds a restaurant, gets it up and running and then sells the package to a franchisee.

“The toughest part of the restaurant business is the first 90 days,” Herzer said. “If it isn’t opened properly, it’s going to have a hard time climbing back.”

IHOP then collects a stream of rents, royalties, loan payments and supplies payments from the franchisees. IHOP frowns on absentee franchisees, preferring instead to award outlets to franchisees who own and operate their stores--and in most cases, just one store.

“The customer wants to see someone who’s responsible” rather than “just a hired hand,” he said.

It’s a formula that works, Trossman said. “Their franchisees tend to be very focused on the business of their restaurants, which means somebody in each unit is paying attention to it every day,” he said.

IHOP’s strategy of “being the developer of the outlets is also critical to their success,” Trossman said. But in recent years, the costs of developing new stores for its franchisees--which averaged $1.8 million per outlet in 1997--was growing faster than the new stores’ initial annual sales.

Lately, though, IHOP has shown it’s keeping a tighter lid on those expenses, and in the fourth quarter of 1997, “you didn’t see that their [new store] financing costs were particularly taking away from their earnings growth,” he said.

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Anything but Flat

The stock of Glendale-based IHOP Corp., parent of the International House of Pancakes restaurant chain, has risen sharply in response to signs that the company’s sales and earnings growth rates are increasing, Weekly closes on Nasdaq and latest:

April 11, 1997: $24.25

Tuesday: $40.63