This Is No Time to Bet on DineEquity

What better time to refocus on risk than in the wake of an enormous six-week
rally? The market has come a long way since early October, sparking huge moves
in countless stocks that were on the ropes not so long ago. Investors might be
feeling better as a result, but that doesn't mean it's safe to take your eye
off the ball. Europe remains an accident waiting to happen, leaving open the
possibility of a meaningful slowdown in growth in the year ahead. If the
recession scenario does in fact play out, companies that have little financial
wiggle room are likely to see their stocks obliterated. As a result, this is no
time to take a chance on stocks of companies with excessive levels of debt.
DineEquity (NYSE: DIN ) is a prime example of a stock that could be vulnerable
to a sudden downturn in growth. It seems un-American to pan the stock of a
company that brought us the Rooty Tooty Fresh N'Fruity, but the owner of the
IHOP and Applebee's chains is in a tenuous position. The company has a massive
debt load of $1.5 billion due to its leveraged buyout of Applebee's in 2007,
which dwarfs its annual free cash flow of $177 million. The company has been
actively reducing debt by moving to a franchise model, but more than 95% of its
restaurants are now franchised indicating that this strategy is nearing its
limit. Click to Enlarge Notably, DineEquity has the 20th-highest debt-to-equity
ratio (14.8) of all publicly traded U.S. stocks, according to ycharts.com, and
it is seventh among those with market caps of over $500 million. It also is the
highest in the restaurant sector, ahead of Sonic (NASDAQ: SONC ) at 10.3 and
Morton's Restaurant Group (NYSE: MRT ) at 4.8. DIN shares are down 11%
year-to-date, while Sonic is off 28% and Morton's has fallen 22%. Sales at
Applebee's and IHOP fell 0.3% and 1.5%, respectively, during the third
quarter, and the company lowered its forecasts for 2012. Because of its focus on
the low-end market, both chains are primed for further weakness if the economic
backdrop worsens in the months ahead. With food costs rising and a large debt
load to maintain, DineEquity can ill afford slower top-line growth. During the
last recession, the stock fell from a peak near $70 to a low in the mid-single
digits indicating the potential danger of owning this stock when economic
growth is weak. DineEquity shares might look tempting now that they're off
over 25% from their high for the year, but with so many stocks to choose from in
the casual dining sector, there's no reason to shoulder the risks that come
with owning this name. Naturally, there also is the distinct possibility that
Europe will manage to contain its problems and we will ease into an environment
of slow, steady global growth. In that scenario, DineEquity and other heavily
indebted, higher-risk stocks likely would provide investors with robust returns
in 2012. In addition, DIN has a high short interest (14.2% of shares outstanding
on Oct. 31), providing some added fuel if there's better-than-expected news.
But why take the chance? At a time when the "tail risk" is substantial,
there's no sense rolling the dice on a stock with above-average downside
potential. As of this writing, Daniel Putnam did not own a position in any of
the aforementioned stocks.