IHOP finds right ingredients for turnaround, stock rebound.

JULIA Stewart admits that when she joined IHOP Corp. three years ago as president and chief executive, there was plenty of trepidation on Wall Street about how she would resurrect the stodgy pancake chain that had a 12-year track record of zero sales growth.

A 30-year veteran of the restaurant industry, Stewart brought experience from top jobs at Applebee's International Inc., where she negotiated with franchisees, and Taco Bell Corp., where she was involved in marketing.

At Glendale-based IHOP, Stewart captured the attention of franchisees by implementing a grading system that rated restaurants on a scale of A to F--based on everything from cleanliness to royalty payments--with the intent of weeding out those getting a C or below.

She also had to FOCUS convince 420 franchisees, 55,000 franchised employees, a board and Wall Street to believe they could grow the 45-year-old chain. "The brand did need to be re-energized but the company wasn't broken," she said. "The question was: Could we get franchisees to grow?"

The key was changing the business model to a traditional franchisor rather than a developer of restaurants.

After launching a new ad campaign with several product promotions, 1HOP's same-store sales, the best measure of retail performance, rose 4.8 percent in 2003 - the first increase in more than a decade--and 5.3 percent in 2004.

By mid-February, the stock jumped when Bryan Elliott, an analyst at Raymond James in Atlanta, initiated coverage with a "strong buy" rating and a $52 price target. IHOP stock has risen 30 percent in the past year, to $48.09 a share as of March 1, and is up 121 percent in the past two years.

The first IHOP opened in Toluca Lake in 1958, not far from a Bob's Big Boy, which at the time was one of the area's hottest chains. Upon going public in 1961, the company controlled a growing franchise of brands that included Copper Penny, Love's Wood Pit Barbeque, the Original House of Pies, Orange Julius and Wil Wright's Ice Cream Shops.

Leon Gottlieb, who ran IHOP's franchise operations in the 1960s and is now a restaurant consultant, said the company's success came from its proprietary pancake batter, developed by Peter Marsoobian, the second American to graduate from France's famous Le Cordon Bleu culinary school. IHOP, formerly known as the International House of Pancakes, also was identified for its A-framed buildings with blue roofs, and for leaving a pot of coffee on every table.

The chain ran aground in the 1990s because it focused on building more restaurants, which left little cash to reinvest. Many of the units were sold to franchisees, with IHOP lending the money at high interest rates.

"The company really operated more like a bank or a real estate development firm," Stewart said. "All of the things that go into a company--consumer research, marketing, research and development, training--they weren't doing because they were so focused on building restaurants."

If a restaurant churned out lousy results, IHOP would buy it back from the franchisee, which only served to put a drag on earnings. By switching to a franchisor model, the chain now has just 10 company-owned restaurants, down from 44 in 2003 and 85 in 2002. In the fourth quarter ended Dec. 31, IHOP took a one-time charge of $14.1 million for impairment and closures, and recognized a $2.3 million pre-tax gain from the sale of real estate.

With the new model, franchisees were given the mandate to raise capital themselves for new restaurants. Cash flow has since improved, attracting a following of individual investors lured by 4 percent to 5 percent dividend yields.

Last month, Stewart announced that franchisees could support 400 to 600 new units in the U.S., and the company is looking at expanding in Mexico and Canada. So far, franchise development agreements and options have been signed to open 287 restaurants.

Stewart, whose favorite menu item is Pigs in a Blanket, said new selections are being developed, including low-carbohydrate items like a salad with sirloin strips. She eats at an IHOP at least three times a week.

With more than two-thirds of sales coming from breakfast items, she said a big goal is to attract more customers for lunch and dinner. "We have some new items rolling out in May that will make consumers take notice," Stewart said.

IHOP Corp.

Stock Prices

YEAR (Dec. 31)                 2004   2003

Revenue (millions)             $359   $404.8
Total Expenses (millions)     304.8      346
Operating Income (millions)    54.2     58.9
Net Income (millions)          33.4     36.8
Earnings Per Share            $1.61    $1.70

Quarterly Net Income (millions)

SUMMARY

Business: Restaurant franchisor
Headquarters: Glendale
CEO: Julia Stewart
Market Cap: $956.1 million Dividend Yield: 2.1%
Total Liabilities: $473.9 million P/E Ratio: 29.8
Long-Term Debt: $133.8 million

Staff reporter Kate Berry can be reached at [phone], ext. 228, or at [e-mail].