Merry Christmas and Happy Holidays forthcoming!

So I am back from the Restaurant Finance and Development Conference. 3300 people attended, the most ever. There were two other major restaurant events in the world that week.  I had the high honor to moderate the M&A Panel: What Are Conditions Now and How to Close More Deals in 2023. The Four-panel members were outstanding and laid out that and more. Panel member Susan Miller laid out the highly anticipated current M&A multiple ranges for business types by maturity. [1]

Current View of the Business for 2023

To be clear, the restaurant business is dynamic and optimistic. It does go through cycles. A down cycle at one point in time is not permanent, history shows it will reverse soon!  Do not despair at a down point. There is always something to do, plan, strategize and improve current operations in the restaurant business.

2023 v 2024 business recovery was the question du jour throughout the conference.  My takeaway:  While there is latent deal activity (including IPOs) waiting for better conditions, 2022 M&A activity died off because of poor multiples and higher interest rates. And, QSR consumer activity weakened throughout the second half of 2022, while higher-end casual dining and above-sit-down segment consumer activity was more positive. 2024 will be better than a mixed 2023.

The overall view is that food and labor inflation will continue in 2023, albeit at lower levels. Interest rates and cost of new buildings will be a problem, and most of my consumer research friends feel sales demand won’t fully recover until 2024.

While QSR same-store sales were up around 5% in late 2022, that is nowhere near enough to cover the increasing food and labor costs. As a result, restaurant margins and profits have remained below their 2019 and 2021 thresholds. Managing pricing will be one of the company operator and franchisee’s biggest challenges. 2024 will be better once the mild recession ebbs.

After surveying 300 finance executives – including 60 consumer and retail leaders – accounting giant KPMG released its 2022 inflation report, which shows that retailers and consumer brands are taking a proactive approach to combat inflation.

“After months of passing on rising costs to resilient consumers, consumer and retail companies are looking to strike the right balance between pricing strategies and profit margins,” the report says. “To achieve cost efficiencies and optimize space, [consumer and retail] companies plan to evaluate their physical, office, and retail locations, seeking to reduce or restructure their real estate footprint. From a technology or digital transformation perspective, respondents expect investments in those initiatives to stay on track as they seek to extract actionable, data-driven insights.”

Company-owned fast casuals, meanwhile, are gobbling up available real estate to build or expand drive-thrus, even with volatility around customer traffic, and food and labor inflation. He notes that 2022 QSR traffic was modestly negative verses 2021 and 2019, and should remain so in 2023. Most of all sales gain, in roughly the 5-6% range, will come from price and mix. Many QSR guests are rather price-sensitive now, so adjustments must be made strategically. Creative marketing, new news, and digital expansion are essential. McDonald’s notably has made headway.

On the QSR margin side, many raw foodstuffs are now falling, with chicken completely lower. Experts say some food and paper items will remain inflationary in 2023, but less so than in 2022.  On the labor front, the average wage rate of a new employee hired increased from 5 to 10%. Depending on sales, check and inflation, the store EBITDA margin could drift 1 to 1.5 full points lower in 2023, he adds, but far less than the dramatic falloff in 2022.

While franchisors will continue to push for more store development, franchisees may feel emboldened to push back based on costs and ROI. Some franchisors have done an excellent job in putting new store prototypes out in circulation which will help. Loan underwriting will be tighter in 2023.

Labor Outlook Improving 

On a more positive note, the labor outlook for restaurants is improving. A late 2022 survey by Bank of America restaurant analyst Sara Senatore found that restaurants are in a better position to find employees, emphasizing “more staff means better service for customers and less of a need to raise wages, which in turn helps the bottom line.”

A December Restaurant Business Online article echoed that optimism. Highlighting data from the Bureau of Labor Statistics, which shows an upward trend in hiring among restaurants and bars, the article reported that 62,000 jobs were added in November versus 36,300 in October, “which itself was an upward revision from previous estimates,” the publication wrote.

Factors Muting 2023

Many attendees at this year’s Restaurant Finance and Development Conference were focused on how the industry will fare in 2023 and 2024, examining key aspects of doing business such as operating profits, sales outlook, cost of construction, cost of equipment, frequency of traffic, and average ticket targets. Virtually all analysts are convinced the average ticket will continue to be higher, and that customer traffic will be negative in 2023. Every tracking report shows some effect of a real or perceived slowdown or mild recession now hitting US consumers.

Positive signs for the future will be clear once food costs, commodity pressures, and labor pressures as we’ve seen in 2022 begin to reverse themselves, With the current inflationary pressures, our best guess is that consumer demand will be muted until later in 2023 and recover more fully in 2024.

Management Notes: How to Take Advantage of the Ex-CEO

Reading in detail lately about the drama of the short-lived CEO tenure of Bob Chapek, the hand-picked CEO successor of Bob Iger at Disney there was one interesting background point: Iger after his retirement as CEO was NOT on the Disney (DIS) Board of Directors. The same circumstance was true in Howard Schultz’s most recent retirement before coming back to work at Starbucks (SBUX) for the third time in 2022. Odd board rotation practices leaving David Brandon still on the Dominos (DPZ) board after so many years were also seen in 2022.

The job of a CEO certainly isn’t easy these days. For any restaurant company, the flame out of a CEO has enormous significance. I discussed how firms might better utilize outgoing CEOs, with our own Bob Gershberg, CEO of Wray Search, who works restaurant board search and consulting engagements. “ No doubt, the skills, and knowledge of the former CEO are valuable”, said Gershberg. “A desirable outcome might be to name the Ex-CEO as Executive Board Chair, for a finite period.”

This could process the ex-CEO’s wisdom and opinions efficiently. Interestingly, one situation where this scenario did not work, perhaps because the ex-CEO was not named Executive Chairman, was McDonald’s. Jim Skinner, then CEO, retired to a regular board seat in 2014, only to have the next two CEOs, Don Thompson, rotated out after a few years and Steve Easterbrook terminated in a spectacular scandal.

Heard and Seen:

Through the end of Q3 earnings, I am seeing little evidence of the long-anticipated “trade down” of fine dining and casual dining guests to fast food in the numbers. We do hear discussion of less frequency and trade down of mix within the $75K income cohort within a brand, which is two different things. In fact, the “the sit-down space” has gradually strengthened the last few months per the data I’ve seen.

Jack in the Box (JACK) posted very difficult earnings in November, for both  Jack in Box and Del Taco, with margin pressures. I traced back through the original documents that JACK actually paid 15X EBITDA for Del Taco versus their “7.6X synergy adjusted EBITDA number”. So they goofed. Worse, the Del Taco synergies won’t arrive mostly until 2024. Now they have to refranchise quickly. Is there franchisee demand? CNBC said it: “Jack in the Box is indeed in a Box”[2]

McDonald’s Franchisees in the Know point out continuing equipment acquisition and quality problems, including buying fryers and grills, and failures of compressors. (Hat Tip: McFranchisee (McDTruth). The long effect of supply chain problems continue.

Interesting to see only Starbucks (SBUX), and YUM (YUM) on the WSJ/Drucker Institute Management 2022 Top 250, published on December 12. Drucker has a whole series of weighting factors, including customer satisfaction, employee engagement, innovation, social responsibility, and financial strength. The cutoff value was 55.5 points. There was one restaurant holding company that should have been close in my opinion, Darden (DRI).             

About the author: John A. Gordon is a long-time restaurant industry veteran, with experience in financial planning and analysis corporate staff roles (20 years, QSR and steakhouse chain ) and 20 years via his own niche consulting firm, Pacific Management Consulting Group. He does complex operations, financial assessment and feasibility and strategy engagements for clients. His website is www.pacificmanagementconsultinggroup.com, office 858 874-6626.

[1]   Email us for the numbers !  jgordon@pacificmanagementconsultinggroup.com and smiller@morgankingston.com

[2]   JACK Earnings Day CNBC Video, November 22 2022

The Bottom Line: Executives argued that “synergies” made the deal more palatable. But it’s taking a while for those cost savings to take hold. Investors have responded accordingly.

By Jonathan Maze on Nov. 29, 2022

Link to article below:

https://www.restaurantbusinessonline.com/financing/jack-boxs-del-taco-deal-was-more-expensive-it-seems

Link to the article below:

https://www.orlandosentinel.com/business/os-bz-restaurant-ceo-changes-orlando-20221117-qyybq54xe5h4ple6eyymccxvfa-story.html

An evening or two of watching cable television ads gives you some sense of what is happening and will be affecting consumers going forward. You see endless QSR 2 for $5 or 2 for $3 themes returning, along with ads for vacations, cruises, and exotic vacations. The 40/60 economy seems clear:    Consumers with household income over $100K seem to be OK but under that are varying degrees of price and frequency struggle. Cutting back on restaurant visits is that old standby; but I’d bet with all the time and waste of shopping and cooking factored in, cooking on every occasion is more costly in the long run. But it has hard to dislodge conventional wisdom. Going into the fall, the conventional wisdom was that the 40%–the better-off component of the consumer base was relatively unaffected. Turns out that may be wishful thinking.

Inflation’s rising toll

Listening to the publicly traded chain restaurant earnings calls, one develops a sixth sense about what the CEO or CFO is trying to politely say honestly, without being too dramatic. Early this year, there was discussion of no impact or little impact via menu mix trade down by lower income guests challenged by gasoline or other forms of inflation that were starting up. Some brands, like Chipotle, said they had no lower-income consumers.

Non-aligned consumer research company reports are now reporting that inflation sensitivity is spreading. On October 25, Morning Consult reported “ higher-income adults are also now facing budgetary tradeoffs, which are coinciding with a period of rising core inflation and dwindling real incomes. Looking ahead, Morning Consult’s Purchasing Power Barometer “points to the likelihood that real consumer spending growth is going to slow further. Consumers at all income levels reigned in spending in September.”[1]    

On the positive side, the price change in restaurant meals—menu board price changes, or food away from home has been less than grocery store inflation by a wide margin every month as we have pointed out. We just wish there was more creative agency marketing to enhance this message.

Implications of rapid changes to planning and profit execution: What Walking between the raindrops means at the concept level

“Walking between the raindrops” is a corollary to Mayor Mike Bloomberg’s post-2000 business planning philosophy: be flexible and lean. Be thoughtful about potential outcomes beforehand and ready to move out of issues quickly. Have one backup plan.  Don’t get caught in red tape.

Looking ahead, for us, none of these restaurant challenges or outcomes are all that shocking, frankly. We are always going to be challenged by food and labor cost increases and how to pass on our costs effectively so as not to shock guests.  We will always struggle to some degree to attract and retain staff. We will have competitors to beat and too expensive buildings and investments to amortize. We know or should know our base customers, our aspirational guests, and with whom we’d like to increase frequency.  We are always going to struggle to make money.

If we don’t know the proforma profitability between dine-in, delivery, and take-out channels, that is a quick must-do fix. If we don’t know how much our digital guests over-index in frequency or ticket versus other guests, that must be documented to make the marketing plan more effective.  [I’m mentioning this because I just discovered one of my most analytical clients still did not have these metrics in place].

Read the Chipotle, Mcdonald’s, Starbucks, and Darden earnings calls and investor day presentations and transcripts for a good sense of strategy.

And a standard marketing concept that hasn’t been discussed much for some time: “the high low concept”. The brand varies preplanned price media themes aligned for the time of year and the established average check tolerance. Working on loyalty, digital, and delivery programs of course.

Earnings notes…intelligence is that MCD US same-store sales are still rising, up mid-double digits in October. This is on the strength of Halloween premiums and the 2-for $3 platform, as well as adult toy premiums from early October. Placier AI indicated the Adult Happy Meal got a mid to high teens traffic uplift post rollout in mid-October.  Chili’s (EAT) company restaurant margin, unfortunately, hit a new low in its Q4 report, at a 6% EBITDA margin. Chili’s has been battered all year with food and labor cost problems.  While many are waiting for trade down guests from full-service restaurants to fast casual and QSR concepts, it does not appear to have happened yet.

2023 Forecasting….. I’m doing a worldwide benchmarking review for a client, and broadly speaking, peer companies sort out into several groupings: (a) good SSS momentum, moderate food, and labor cost inflation (b) flat sales, moderate food and labor cost inflation (c) negative sales, moderate inflation.  Some US brands and several Old Continent brands are in category C, with a harsher recession expected there. In the US. With a hat tip to my friend David Maloni, a longtime industry expert, foodstuffs themselves are coming down (as we have noted in these pages) but the problem is freight, diesel, wages, and other transportation and indirect costs are still inflationary. Therefore food will still be up in 2023, just less so. Labor wage rates will be up again, likely a bit less so (hat hit: Sara Senatore, B of A Restaurant Analyst, staffing model).

Looking forward to seeing you…. At Restaurant Finance and Development Conference, November 14-16, at the Wynn Hotel in Las Vegas. I’ll be moderating the M&A Panel on Tuesday at 130p. Please stop by!

About the author:  John A. Gordon is a long-time industry analyst and expert, with 45 plus years, in unit operations, 20 years in restaurant corporate staff roles (financial planning and analysis), and 20 years via his founded consulting firm, Pacific Management Consulting Group. He works with complex restaurant investors, operations and economics review, and litigation engagements among others for clients. He is always reachable at 858 874 6626, or jgordon@pacificmanagementconsultinggroup.com.

[1]   Morning Consult, October 25 2022, Measuring the Impact of Inflation on US Consumer Spending.

So, being a restaurant operator, and allied industry member, such as employee, investor, vendors, analysts, consultants and others, it has been a wild ride since February 2020. Two black swans since then: the Pandemic itself in March 2020 and then the War in Ukraine in late 2021 have affected global society and business. These factors are still kicking us every day.

I’m afraid we will soon have another bad swan upon us, the FED, which is bound and determined to raise interest rates to lower an artificially constructed index that may not be correct. That may cause a recession. [1]Another thing we operators, investors, employees, suppliers and analysts can’t control.

THE INDUSTRY INFLUENCES AND PARTIALLY CONTROLS MANY BUSINESS FACTORS.

In preparing a recent project for a client, I looked at industry pricing and food cost percentage changes all the way back to the 1980s. There were a couple of irregular periods, but generally pricing as measured by both ticket and BLS survey rose about 3 to 3.5% from 1981 to 2019. Food cost percentage and BLS inflation—food away from home also typically rose around 3%. There were some tight spots, but restaurants acted liked a machine, spitting out price increases. In fact many chain restaurants, preferred not to price for labor, leaving that to volume efficiencies to cover. The problem was, labor costs in both QSR and full service rose in the 00s.

Doubts about the restaurant model

Lately several operators and investors have mentioned that in this current environment, little is actually controlled by the restaurant brand operator.  I disagree. In the post pandemic world all of the challenges can be reacted to. The challenges, while overwhelming are really nothing new other than the dual food and labor cost inflation we have seen in late 2021-2022. There are many business functions restaurant brands and operators still do control.  Here’s two:

Pricing actions in this new world are controlled by Restaurants

Restaurants now have to look through their total product mix and store mix creatively to cover all costs. Every restaurant brand controls its pricing. Franchisors provide reviews and recommendations to franchisees who set their own pricing, except for two QSR brands who insist on predetermined prices. [2]   But yet, we have reports from polling agencies  that consumers are blown away by high restaurant prices. Many analytical questions remain: what type of customers? On what type of offers? Where? There is growing evidence that there is a gap of retail and restaurant acceptability between upper income guests and lower income guests.[3] That will produce challenges for Marketing staff and agencies.  But this is what segmentation studies were invented for. Get them.

We will know progress is being made when we see reports of and implementation of unit by unit pricing variation. With 60 years of POS and management technology, we know a lot about our units.

Brands control CAPEX and remodeling/new unit design, too.  

We all know that store level operating profit dollars after tax and G&A; the CAPEX, the actual size of the investment buildout over time; and the interest rate charged by the lender are among the most important financial variables defining success of the restaurant investment. While we are struggling to control Pandemic problems, this CAPEX factor is under our control whether we are franchised or not.

Starbucks, Wendy’s, Outback, Darden, and many other brands have moved out smartly post pandemic with transformative store prototypes. Starbucks for example is still in the middle of a massive store base transformation.

Having watched ROI by remodel class and brand over the years, I can say that remodels and upgrades typically get a sales lift for some time thereafter. Usually, not always. The length of time varies, but year one and two are typically greatest. Once the entire market is done there is a uplift effect on brand ratings. Of course, QSR and full service units get different uplifts. It is interesting to note that exterior remodels scored  ROIs in both QSR and full service, supporting the notion that one value of the remodel is to advertise the value of the brand to the outside community via the look of the unit.

Franchisors are often going to have issues “selling” the value of the new unit or remodel to its franchisees quickly. That is what company units and good proformas are for.

Lately, its been difficult to get all the parts necessary for remodel completion. Hopefully, the external remodel portion can be completed first to get those benefits.

Heard and Seen in the Restaurant World

M&A and the Restaurant Finance Conference: I’m honored to be moderating the M&A Session at the RFDC in Las Vegas on November 15 at 130p at the Wynn Hotel. We will have 4 great industry experts to discuss trends and outlook. So there is latent M&A demand waiting for conditions to improve but conditions are depressed right now. Please attend to hear more for your 2023 planning.

The Starbucks ($1B plus) and Burger King ($500M) OPEX and CAPEX investments  were huge and will require multi year tracking to see the ROI. In the Burger King US case , the brand was behind its peers to say the least. For a client, I recently found that BK US and one other brand were the only two major US burger brands that had flat AUVs for 9 years, 2012-2020.

Food Commodities have peaked when looking at the very beginning of the US food supply chain. See BLS tracking However, the issue looking ahead is there are manufacturer issues, distributor issues etc. Driver wages, fuel, distributor outages and errors than drive up costs. Sysco just had a strike imposed. 2023 will be less inflationary than 2022 by half, many are estimating.

On the more positive side, casual dining staffing levels are returning to a somewhat more normalized pre-2000 level. Hopefully this will improve service levels and moderate wage growth. Hat hip: Sara Senatore, Bof A Restaurant Analyst.

MCD US sales momentum in October appears to be brisk due to premiums moved and marketing activity. Franchisee intelligence and in store visits point to the success.

About the author: John A. Gordon is a restaurant analyst with 46 years in the industry. He had early experience in restaurant operations, 20 years at restaurant corporate staff roles (Finance Planning and Analysis) and the last twenty years via his founded restaurant management consultancy,  Pacific Management Consulting Group. Pacific works complex analysis and investigative projects for operators, investors, franchisors, franchisees, litigation support engagements, attorneys and others. Call him with questions or business issues at 858 874 6626, or 619 379-5561, email, jgordon@pacificmanagementconsultingroup.com.

[1]   See https://www.cnbc.com/video/2022/2022/10/13/short-if-the-fed-waits-for-core-inflation-to-hit-2 percent-itll-drive-economy-into-depression-says-jeremy-siegel-htm

[2]   Neither of these two brands have had positive SSS results in the last four year. Source: their 10Ks.

[3]   The weakness in lower in guests has been discussed in the last Brinker and McDonld’s (EAT and MCD) earnings calls. In addition, Bank of America credit card data showed $125K as the critical toggle point where luxury sales increased 10% and fell 13% in Q3 2022.

The longer one spends in the restaurant space, veterans should be less shocked when adverse actions happen. After all, the restaurant industry is a versatile industry, surviving, World War II, desegregation, multiple gas shocks limitations and lines, 9-11, overbuilding, 23% interest rates, the Great Recession, and other periodic turns, and the effect of them, the Pandemic, which is still biting us years later. But this last week governmental actions took center stage.

The California AB257 Mess… Will cause confusion and trouble and likely will raise wages. Let’s face it,  politics in government regulatory matters a lot in the 50/50 Blue/ Red state America we are set in. While CA Governor Newsom greatly improved an awful original bill written solely by an SEIU lobbyist, he signed a recast bill called the FAST Act. New is a Committee composed of 10 unelected restaurant, union, franchisee, and franchisor reps, to review and recommend wages, wage theft, and needed work conditions improvements. This process subverts the will of franchisor companies and contract/budget requirements. Yes, the legislature can strike the Committee work later, and the Committee needs to be authorized by voter signatures.

And yes, in 2023 wages can be increased to a max of $22/hour. And 2024 higher on the 2023 base. Could happen. Not will happen. The current CA min wage maximum is $16, with surely some employers starting employees higher. The problem of course is restaurant margins have fallen off 300-400 bpts since 2020/2021. The CA politicians didn’t check for that. Several wickets have to fall before the wage increases, namely the committee work.

So, the discussion in CA is there will certainly be wage compression costs but in some urban markets starting wages at $20 anyway. There will be litigation (such as… I’m not a fast food operation). I think in terms of financial impact, a pretty good QSR operation might now be $3M AUV vs. $2.5M. More on this later.

New Federal Joint Employer Regulations Are Out.  The doomsday heralded by the IFA for years. But, did you know that…   Practically speaking, the Joint employer regs will change every time the party in power changes. The NLRB regs ARE NOT federal law, federal judges and the states are free and do ignore NLRB language all the time. The US Labor Code and FLSA can only be changed by Congress! State and Federal circuits have already taken pro and con joint employer positions over the years which are binding precedents in court decisions. NLRB rulings affect only a small percentage of total labor issues. So investors and employers, use common sense, but this is not the end of the world.

Restaurant M&A Sightings:  I am honored to moderate the M&A Panel: What Will It Take to get a Transaction Done in 2023 at the Restaurant Finance and Development Conference in Las Vegas on November 15, 2022, at 130p. You are invited via the Conference! So I am watching the M&A market very closely as usual. So M&A has really fallen off in 2022 what with general inflation, uncertainty with the FED, and lower restaurant margins. It is not dead, however. Last week, there was an 8-unit restaurant IPO, a ramen operator, Yoshiharu, YOSH, on NASDAQ.  In addition, Darden (DRI) seems to be slowly looking for a great acquisition, and another holding company is soon to announce a two-brand acquisition.   So M&A is not dead, and more to come.

Industry Notables: The announcement that RBI Burger King Corp. is putting $400 million of its own money to upgrade the Burger King brand in the US is a positive sign and testimony to new BK leadership. That BK is historically weak in the US goes back decades and scores of CEOs. It also indicates that nothing good happens in a brand unless store-level sales and cash flow (EBITDA less taxes and capital spending) is positive and growing…Private equity…in discussions with franchisees with brands that have been acquired by private equity funds, the number one complaint is that rolling CEO turnover exists—every 1.5 years or less destroys morale and momentum. On my part, I can see the difference in exit multiples with companies with higher CEO turnover.

Starbucks Investor Day:  Like everyone else, we look forward to seeing the grand plan for the future. From an investment standpoint, I wonder how much all these investments have added to the shop’s annual breakeven levels. Howard and Co. are convinced investing in partners equals improved sales and ROI. It should.    

Seen and Heard: While in Phoenix lately for a franchising conference, I toured a Portillo’s (PTLO) unit as well as a deep dive at a Dutch Bros (BROS) unit with an investor friend.  The Portillo’s unit is a big buildout (watch that) but the most amazing variety of food types under one restaurant roof. The realistic average ticket per person was $12-15. It has some beer and wine, and a drive-thru of course.  I had a burger and entrée salad, and both were high quality. The staff was beyond friendly and helpful. The investment question I have is how effective can digital and local store marketing be to drive awareness in those new markets so far from Chicago to drive sales and profits.

The Dutch Bros unit was in the heart of the ASU campus on the main road. It got tremendous walk-up and drive-thru traffic. The DT traffic drifting into the main road is a major problem of course. It is on a lot with parking, fortunately. The staff, about 5 on board at 6p, were friendly. They indicated they loved working there, with casual dress and atmosphere. Its pathway is solid and will compete with Starbucks, indies, and Dunkin to a lesser degree. Especially for sites and employees.  Their guests are young and price sensitive, but the drink profile is targeted.

About the author: John A. Gordon is a long-time restaurant industry veteran, with 46 plus years of experience in restaurant operations, corporate staff (Finance FP&A, 20 years), and 20 years via his restaurant analysis consultancy, Pacific Management Consulting Group. He works complex operational and financial analysis projects for operators, investors, attorneys, and others. Contact him at 619 379-5561 or jgordon@pacificmanagementconsultinggroup.com.

Link to article below:

https://www.orlandosentinel.com/business/os-bz-red-lobster-thai-union-financial-assistance-20220901-syt3vieyavhm3fxaalrwqtf7ca-story.html

WHAT’S IN A NUMBER OR A CALENDAR VIEW?

Plenty. We restaurant types live and die by numbers all the time.

For example, in the restaurant M&A business, the calendar and numbers matter a lot in plotting the attractiveness of a transaction. In 2020-2021, QSR brands in particular were coming off of an early 2020 sales recovery, run-up of average ticket per transaction, closed dining rooms, higher drive through, and higher digital (think: higher average ticket as a result). Food and labor inflation had not yet hit.

Contrast to now, where restaurant level margins (of both QSR and sit-down restaurants) continue to be hit by rising food, paper, and labor rates. Restaurant operators everywhere are griping about margins 400-500 bpts lower than last year. Since the current year EBITDA base (adjusted or not) is now down, operators are finding their businesses are worth less, using the traditional earnings multiples and the current year EBITDA dollar base. That has caused selling to freeze up. Some small acquisitions have been noted. IPOs and the really big acquisitions are affected by interest rate declines, fear of a recession, prior deals, and intraday stock volatility.

What to do? I strongly recommend in your presentations you focus on multi-years (to not get caught in a downturn year) and also move away from EBITDA! EBITDA even as adjusted is awful, move it to free cash flow, which is a far more meaningful economic measure. Otherwise, wait, do due diligence, and strengthen your business.

MORE ABOUT REPORTED PRODUCT MIX TRENDS

One thing that is happening in the QSR space is that there is a reversion of product mix as we have gotten further away from the Pandemic. Recall then that digital traffic rose, dining rooms were closed, people ordered en masse for several days and average baskets—number of food items per transaction—grew. That is now slightly reverting to normal as we heard from Starbucks (SBUX), Chipotle (CMG), and McDonald’s (MCD)[1] just this week. So is this bad or good for us?

I recall being asked this question by investors during the Pandemic who were coming at from the context that eventually consumers can’t afford those big baskets of purchases forever. I told them then, and now, that I didn’t think affordability was the issue as the purchase was being spread out over a mass of people.

I believe this is mostly bad for us but we should be able to tolerate the normal mix moves guests make. Anytime we get our revenue more efficiently we like it but that is the joy of serving guests. They do what they do.

FOOD COMMODITIES ARE TRENDING DOWN BUT….

Looking for what we have all been waiting for, and yes, many world commodities have begun to shift downward. My friends at Restaurant Research recently published a chart in their weekly newsletter that showed downward producer price index costs noted for most of the vital food commodities, along with fuel oil and gasoline. That is great news!

However, it is going to take some considerable time for the shifts at the top of the supply chain to make their way through to the restaurant FOB back door pricing. One issue is that all the other costs in the supply chain have to be applied….manufacturing, driver wages, storage, transportation, markup, etc. And then the most important…all of the older, more costly inventory has to be used before the full effects of the less costly new inventory are used.

For restaurant chains who “contract out and lock in a price” this can be problematic when raw material costs finally fall. Restaurants need the assured product at a good cost. Experienced supply chain professionals know when there is a hint the cost begins to weaken, they will ease off on the contract amounts. But it is a dual-edged sword as you can see. Expect food commodity costs restaurant backdoor to fall later. McDonald’s is still talking about continued cost inflation for example, but later easing in the US.    Restaurant analysts often ask the question “ are you contracted out” but in reality, the proper question is, “are you contracted out for the proper amount of inventory on contract and where do you think the cost market is headed”?

RESTAURANT HOCKEY STICK UNIT DEVELOPMENT MENTALITY

I saw that family office Nierenberg Investment Management Company has taken a 10% ownership stake in Potbelly (PBPB) the 450-unit sandwich chain.  Potbelly has had difficult times and several CEOs and at least one activist battle that I can recall in the past. Current management is better but unfortunately mentioned the “hockey stick” development goal, e,g, we can be at 2000 franchisee units in 10 years. That is very difficult. The number of franchisees is down to about 46 system-wide and store-level margins are sub-par. That is where management must devote its priority.

IMO, it is just so critical for “activists” like Nierenberg to understand how the restaurant business really works before another inevitable cycle of management change is forced.  New franchisees want strong concepts before they join, with store-level margins 18% plus with royalty embedded.

About the author: John A. Gordon is a long-time restaurant industry veteran, with 45 plus years of experience in operations, restaurant corporate staff roles (FP&A), and management consulting. He is an IU graduate and a Master Analyst of Financial Forensics. His founded management consultancy, Pacific Management Consulting Group has been working on complex operations, financial analysis, and organizational assessment engagements since 2003. Contact: 619 379 5561, jgordon@pacificmanagementconsultinggroup.com.

[1]   SBUX Quarter One Earnings Call, Chipotle and McDonalds Earnings Call on July 26 2022.

I was in New York City last week to attend the Piper Sandler 2022 Restaurant Summit and to meet with clients and friends. Going to meetings is so refreshing now; people are so glad to see other people after the long Pandemic pause. The City was full of tourists; restaurants were generally busy. Some new stars there are beginning to climb the staircase toward greater visibility and expansion. The Bloomberg Pret Traffic Counter tool which counts heads on the street showed Midtown traffic counts still only at 65% of 2019 however but slowly improving.

Recession Talk Everywhere

Every macro view economist has an opinion when the next recession will hit: we are already in one; Q2 next year, etc. Going to the traditional definition that a recession is  2 quarters of decline in GDP, we might be close: we did have a small GDP decline last quarter and this quarter looks like a mess. The yield curve inverted Monday, which is telling. Still, we restaurateurs don’t need that talk, but we need to plan for such outcomes. This is on top of the multiple black swans that have hit us since March 2020.

The reality is that The Fed has the tool of adjusting interest rates to “pop the bubble” leading to the supra inflation now underway, and every indication is that they will do so this week with a 50 to 75 bpts interest rate increase.

Jack in the Box itself caught in a Box?

Franchisors are in a difficult position on earnings calls because they are “asset-light” and are mostly reliant on the franchisees, using their injected capital and debt to power unit development.  They can talk about new product and concept enhancements, franchisee health and backlogs, and marketing initiatives of course. Unless the brand operates a significant number of company stores, the recurring headline operating metrics are same-store sales/traffic/check, SDAs signed and the amount of net unit growth.

New JACK CEO Darrin Harris can be seen to be in a box himself as seen at the June 6 2022 Goldman Sachs Conference. [1] The Harris team has brought in new ideas and perspectives but has thus far been able to post positive net new unit growth. During the conference, Goldman analyst Jared Garber asked the inevitable question de jour: when is JACK going to post unit growth? Harris noted with margin compression underway and difficulty of construction, 2023 was “the year” that growth would happen. He admitted his team underestimated franchisee demand to get going earlier.

My note to JACK Management is that franchisees think about the marginal ROI of the actual new investment at that time, given today’s margin outlook and CAPEX costs. It doesn’t matter so much whether the franchisee has 20 units or above or over $5M in EBITDA or low leverage. Franchisees have lived through the bad times and want that new investment to better their conditions.

More free advice to JACK

So, get the company unit expansion kicked off. This will be beneficial. It will get the company flag out into expansion markets, and franchisees can follow.

Restaurant Margin Recession Underway 

Unfortunately, the march of the effect of double food and labor wage rate inflation continues to depress restaurant-level margins. There is discussion again of 6 or 8% store-level EBITDA margins, which is of course unsustainable. Rick Ormrbsy, CEO of Unbridled Capital[2] discussed a lenders survey on his webinar June 14, in that 40% of lenders noted current operating conditions were negative and worsening, while 40% noted conditions were negative and improving. Rick, who mainly works with QSR brands M&A noted “the value you thought the business was….just isn’t the same now.”  Pizza, Burger, and Chicken brands were least preferred by lenders.  [3]

Taking the longer view…..price v. traffic v. cost inflation

We restaurant types tend to live and think by fiscal quarter. It is understandable, it is how we were educated.  Looking more broadly, it is incredible how much the industry has recovered since we “got through to the other side” of the Pandemic. Jonathan Maze’s excellent article “ Restaurants Recover From the Pandemic but Things are Far From Normal” in Restaurant Business displays that in terms of sales and traffic. [4] Jonathan notes that only 10 public chains are below 2019 levels, with 26 above 10% higher, with steakhouse operator STKS leading the way. The recovery has absolutely come from higher prices. The BLS national statistics[5] show that along with the earnings call transcripts where price and check are broken out. Traffic is down. Jonathan suggests that the 3-year decline is 2.6%. [6]

I’m not at all sure that is abnormal for a Pandemic effect. The art of counting guests is problematic except in casual diners and above, where an entrée can count as a proxy for a guest. And the Pandemic changed meal habits everywhere. With ticket going up, we have to overlay convenience and other guest rating metrics.  Speaking as an analyst, we do need more analysis. Unfortunately, the tendency on some public company calls is to cut detail, which is not long-term healthy for telling to brand’s story.

Timing is Everything: Management Must Act to Protect Margins

In May, full-service restaurant prices rose 9.0%, fast food prices rose, 7.3%. Fortunately, grocery store prices rose more, 11.9% on a year-over-year basis.[7] As I’ve noted before, in my opinion, that is our saving grace for now. Unfortunately, the margin compression that CEO Darren Harris at JACK referred to is present in every brand. This run of inflation is not transitory in our business. We have to cover costs as smartly and as timely as we can. Guests will not forgive the cold shock of a year or more of accumulated price increases that we didn’t take waiting for conditions to “normalize”.

About the author:

John A. Gordon is a 45-year restaurant industry veteran. Now a restaurant analyst and management consultant, he has prior experience in units, 20 years in corporate staff roles (Finance FP&A roles), and 20 years via his founded firm, Pacific Management Consulting Group.  As a Master Analyst of Financial Forensics (MAFF), he works on complex operational, financial management, and strategy topical engagements. Typically, investors, operators, franchisees, and attorneys seek him out at (858) 874-6626, jgordon@pacificmanagementconsultinggroup.com.

[1]  https://kvgo.com/gs/jack-in-the=box-june-2022

[2]   https://unbridledcapital.com

[3]    Footnote 1, Id.

[4]   restaurantbusinessonline.com/financing/restaurants-recover-pandemic-things-are-far-normal, Jonathan Maze, June 14 2022.

[5]   https://www.bls.gov/news.release/cpi.nr0.htm

[6]  Footnote 2, Maze, Id.

[7]  Foodnote 3, Id.

Pricing and Customer Considerations at the Top of the List

Pricing and Fear of consumer reactions continued to take top billing in the restaurant space. On May 11, BLS reported[1] grocery store prices [food at home] rose 10.8% in April which is good news for restaurants.

Food away from home, [restaurants] rose 8.7% in April at full service and 7.0% at limited-service restaurants.  That is yet another month where restaurant prices have risen less and thus have gotten a break—and an opportunity to take some mind share.

CNBC on-air talent is saying no US consumer discretionary companies are signaling trouble [2]. Casual dining brands and fine dining brands have been doing well, especially The One Group (STKS), Ruth Chris (RUTH), and Bloomin Brands (BLMN). QSR US brands are doing less well.  McDonald’s (MCD) SSS was plus 3.5%, Wendy’s (WEN) plus 2.4%, and Burger King (QSR) .5% from their last earnings calls, for example.

In terms of pricing reaction spots, McDonald’s noted lower-income guests are trading down in terms of PMIX; WEN noted sales softness among Households under $75K income and  Dutch (BROS) noted a wave of sales softness hit in March after gasoline prices spiked. More on BROS in a bit. But that largely has been the summation of restaurant company comments to date.

Restaurant Margins have been awful, almost everywhere. That is the effect of double food/paper and labor rate inflation.

Stacked Comps and Profit Comparables

When researching and trying to isolate a trend, I am appreciative of companies and analysts that are posting sales and company store margins (at least) to a 2019 base, a 3 “three” stacked comp. The way I see it, the company cares enough to lay it all out. This is all the more relevant in 2022 with a pre-pandemic base (2019), and generally, poor quality 2-year stacked base (2020) and the usual year over year base (2021).  Companies might pick the base that makes them look the best; I would think it odd for companies to make references to 2020 now. A reference to 2019 is useful as it shows the company SSS or profit growth over the pre Pandemic base, always constructive.

Timing is Everything: Risk of Waiting too Long on Taking Price

Dutch Brothers (BROS) the 2021 IPO star ran into some trouble as evidenced in their May earnings call. They experienced a classic “turn” in which the rate of sales growth fell off, company restaurant margins fell off due to food, paper, and labor inflation, and guidance was pulled back. [3]Predictably, the stock took a huge hit. Dairy was the big commodity mover. Forensically, BROS had last taken only 1.1% price in November 2021. The preopening expense effect of opening so many stores as they are is negative. BROS also noted that sales fell off in March coinciding with the latest band of gasoline price increases. 55% of BROS guests are under 25 years of age per their research.

The effect of the sales slowdown in March is that BROS calculates that they are not getting their normal Q1 seasonal sales pickup.   In addition, the company store’s contribution margin fell to 18.3% versus 26.8% in 2021. With the sales softness, Senior Management has no plans for price increases “at this time”.

Dutch BROS is a very good brand. They can work themselves out of this situation. Still, the lesson for all might be to take small disciplined price increases where warranted and not be in a situation where big catch-up price increases later might be necessary.

Franchisor CEO getting the toughest question on earnings call recently…..

The CEO of an international QSR franchisor was stretched to respond to a question asked about franchisee profitability recently. A review of the call was telling in three ways.  Here is a lightly edited recap of the total exchange, editing out only the Brand CEO and CFO name.

Chris O’Cull:

Thanks, good morning, guys. CEO, how are U.S. franchisees reacting to the margin pressure and even rising interest rates? I’m just trying to understand how these factors might affect the willingness to open new units or even just make investments in the business.

CEO, Brand X

Yes. No, as you think about the partnership that we’ve always had with our franchise community, it’s really tight. And we’re regularly meeting with them to make the right calendar adjustments, to make sure that we’re still focused on our one more visit, one more $1 strategy. So we’ve got that good high loan calendar in place, continue to drive folks into our app, and really partner with them to drive a lot of profit enhancement actions along the way. What we need to do on price, how we continue to hold in there nicely on mix, how we trade folks up with great innovation in the rest of the daypart as well as breakfast. And then a lot of work to really take out some of the complexity in the back of the house of the restaurants, and we continue to drive op simplification to make sure that we manage the profitability story. As CFO Brand X  said earlier, we’re starting to build margin. He talked about P3, we talked about additional pricing actions in the – into Q2. And as we think about the last 2 years, we’ve had a lot of momentum in our business. We talked about record profits in 2020. We’re collecting our franchise financials right now, and I’ll let CFO Brand X talk through that.

CFO, Brand X

Yes. CEO, we have preliminary financials. We will finalize it at kind of show the full detail at Investor Day, but the headline is record profit for the U.S. franchise system in 2021. That’s positive. Leverage ratios on their balance sheet are basically unchanged. And as we look at our benchmarks, our franchises are less levered than the industry benchmarks. As a result of it, we feel comfortable that we’re really going into clearly a tougher time with very healthy balance sheet, record profits and therefore, it’s still a confidence in the growth algorithm for our brand and for our system.

CEO, Brand X

So net-net, Chris, what you’re really seeing is that we’ve had some great momentum on the unit development in Q1. We’re still comfortable with the strong pipeline that we have in place and the commitments that we have to deliver on the new restaurant openings this year that our franchisees are in a position to get to that 5% to 6% net unit growth during the course of the year. Supply chain is a little more challenged, and the team has done a great job really getting ahead of making sure we’ve got all the components to get to those openings this calendar year.

So now, three observations…

Observation One: Brand X CEO really cares about that 5 to 6 % net unit growth metric. I got the impression the franchisor would move heaven and earth to make those goals. Guidance given? Investor expectations?

Observation Two: The CEO is thinking in 2021 terms, not 2022 terms. Note the CFO is now doing the annual prior-year franchisee profit and balance sheet survey. Okay, but what about the sharp margin declines in 2022? And interest rate hikes.  They need a more current FY data sampling system.

Observation Three: Brand X is thinking about units in the pipeline, already funded with 2021 cash or loan contracts. CEO doesn’t answer Chris question which was about 2022 unit level franchisee economics which will be lower as their current call results demonstrated. [4]   Those finances will matter and affect those new units going forward.

Bottom line, running a franchised system is a lot of work.  

About the author:

John A. Gordon is a restaurant industry veteran with a background in operations, corporate staff roles (Financial Management), and via his founded management consulting firm, Pacific Management Consulting Group. He works complex analysis projects for clients such as brand organizational diagnosis, investor support, and litigation projects. He is reachable at 858 874-6626, email jgordon@pacificmanagementconsultinggroup.com.

[1]   https://www.bls.gov/news.release/cpi.nro.htm

[2]   CNBC Sara Eisen, The Recession Debate, May 16 2022, https://www.cnbc.com/video/2022/05/16/you=could=build=a=case=that=the recessions=already-started.

[3]   See Dutch BROS Investor Relations Web Page and presentations.

[4]    Brand X Earnings Call Transcript, as captured by Seeking Alpha, www.seekingalpha.com, May 2022.

Last month we discussed the increasing frequency of global black swan events [1] (consider 2001 (9-11); 2008/2009, (Great Recession) 2020-2021 (COVID), 2022 (Ukraine War) that are making life difficult for us. The results are cumulative and spillover to our sector. Fortunately, there will always be a food fulfillment need, social need, and business case for restaurants, and restaurants are always investible. There are few easy ways outs out of these problems. But surely, we must keep up with the developments of the day to help build our plans.

Menu Price and Food and Labor Cost Inflation Locked in for FY-22

There was some hope earlier that food and paper inflation were to moderate later in 2022. The war in Ukraine and its impact on grains, oils, and gasoline has ended those hopes. Jonathan Maze reported on Bank of America’s Sara Senatore survey of publicly reported chain restaurants’ food commodity cost inflation for 2022. QSR chains such as McDonald’s expect 8% in the US, Dominos 8-10%, and Wendy’s 8-10%. Fast-casual El Pollo Loco expects 18% in Q1, while Portillo’s expects 13-15% in 2022. Full-service operator Texas Roadhouse is expected to rise 12 to 14 %, while IHOP and Applebees are expected up north of 10% [2].  Keep in mind these are the rate variances only of the raw material; the total food cost percentage of sales change will be less.

Restaurant operators routinely work with changing commodity conditions as well as consumer preferences to arrive at attractive, penny profitable menus. Much more of that is needed going forward. From my own corporate staff experience, you have heard me speak about the critical value of restaurant product and concept development staff…and the management systems that feed their work.

It’s all about price and inflation right now

There are many indications now that restaurants just can’t take unlimited price increases, especially with both the current consumer food and gasoline price inflation shock underway.  A March 2022 Technomic survey identified cutting back spending potential on limited-service and full-service restaurants were identified. However, the negative sales impact is more seen in full-service restaurants. [3]    Restaurant Research Journal the same, especially, trade down from full service to QSR eventually. [4]

However, on the positive side: grocery store inflation (CPI food at home) exceeded restaurant price inflation (CPI food away from home) by over 200 pts in the last BLS report, for March  2022. [5]  That gives us cover to take some price, and let’s hope that trend continues.

The BLS reported restaurant menu inflation took a 40 year high in March, with full-service restaurant prices up 8.0% and limited-service up 7.2%. Grocery store prices rose 10%.

How much longer is this sustainable? I tell my operating clients there is nothing more complicated than sales/menu mix/gross profit planning and even if you think you are optimized, you are not. One issue is despite 50 years of evolution, the POS system is giving store operators or corporate analysts what they need.  What is needed is a “tiger team”—an old concept with a big ROI—to get the required systems and tools into the right places.

Waste in SKUs, waste in discounting, and overly complex controls can be found in many places that reduce effective revenue yield. For example, there are three national restaurant chains, all franchisors, that do not allow variable pricing by unit.  Many consider DMA level pricing.  What about pricing by geo cluster? In Chicago, isn’t the North Shore suburban market different than the Southwest suburbs? You see my point.

Howard v. 3.0 and what it says about management succession

As we all know, Starbucks is lucky in time and sequence to be able to have an enthusiastic Howard Schultz ready to come back to work. And in a little over a week, he has halted cash buybacks (to some on Wall Street’s displease—stock down 6%), fired his General Counsel, hired a Strategy Director with an employee communications background,  began listening tours, and fired back at the unions. What occurred to me however is that he has had to come back two times as CEO in Residence. Starbucks is a wonderful global brand and they have plenty of G&A resources. Why is it that they cannot grow waves of CEO internally? Recall in 2004, McDonald’s (MCD) had three new CEOs in a year, with two of them dying in 7 months in April 2004-February 2005. Jim Skinner emerged as the healthy CEO and served until 2017. The point is they had then[6] the bench strength to recover from two CEOs dying. In March and April 2022 to date, we have seen a slew of restaurant CEO turnover, we can see the strategic importance of the management succession issue.

So here is yet another thing for the to-do list. Truth be told, it has been there for some time.

McDonald’s Global Earnings Issue Forthcoming

With quarterly earnings approaching, an unfortunate reckoning will happen sometime soon: given the developments in the Ukraine War to date, McDonald’s will announce large losses from both Russia (850 units) and Ukraine, 111 units) divisions. Earlier, McDonald’s provided guidance on the Russian division loss of $50M per month, but no guidance on the Ukrainian loss.[7] The Russian units are virtually all company-owned and the Ukrainian units are 100% company-owned. No doubt we will hear more.

The question going forward is given the Dictator Putin’s attitude and the souring of the US/Russian relations, what will happen to the Russian McDonalds units and commerce. Looking forward, some of the Ukrainian McDonalds units could reopen but on very good belief are not anywhere close to Russian AUVs and store margins. Given the MCD $50M/month number, net income for the year would decline somewhere around $600M or 8% on a 2021 base. We’ll see how MCD and the sell-side analysts treat this. The loss is as extraordinary as it gets but is a real cash loss.

About the author:  John A. Gordon is a long-time restaurant analyst and management consultant, with 45 years experience; 5 years plus in units, 20 years in restaurant corporate staff roles, and 20 years via his founded restaurant analysis and consultancy, Pacific Management Consulting Group. He does complex analysis and projects, and his website describes him and his background. Email: jgordon@pacificmanagementconsultinggroup.com, office 858 874-6626, website: www.pacificmanagementconsultinggroup.com.

[1]   Those infrequent events that cause great difficulty in society and business going forward.

[2]   https://restaurantbusinessonline.com/financing/heres-how-much-supply-chain-costs-are-increasing-year, March 28 2022.

[3]   Technomic’s Take, Skyrocketing Gas Prices, March 17 2022.

[4]    RR Insignts Journal March 2022, https://chainrestaurantdata.com/rr-insights-journal-march-2022/

[5]   BLS, CPI Summary for March 2022, released April 12 2022.

[6]   Of course, the Board’s due diligence bet on Steve Easterbrook didn’t work out so well later, when it discovered he did have a tendency for fraternization before promotion to CEO. Per Wall Street Journal, and BusinessWeek press reports.

[7]   McDonald’s Corp. Datasheet provided, March 2022.

Triple inflation currently

As an industry, we were hoping to be on the other side of the Pandemic mess by now, but its effects continue in several ways that we are too familiar with: sales variability, supply chain inflation affecting, food, paper, equipment, and building elements; and the labor availability/people effect, ultimately caused by the Pandemic in the first place. As a result, the industry has triple inflation now: COGS, labor, and CAPEX [1]all at the same time. And we have to learn and reorient to changing consumer behavior, and honestly, reeducate our guests, too to what we can do for them to meet their needs.

Added to this mix unfortunately is the current threat of a major land war in mid-Asia which could kick off at any moment as of writing this week. Most of Europe[2] and Central Asia are franchised, but disruptions like this will affect global US franchisors and local national franchisees. This gets us back to my comment last month: what chain restaurant operator would have been planning for a Central Asian War in late 2021? Of course, none. Planning post-Pandemic has to have a faster cycle time, risk-based module included as part of the function.

The necessity of pricing actions and building pricing power

Listening to the Q4 2021 earnings calls to date, the very clear forecasts of 2022 cost inflation are seen. McDonald’s for example noted a 2022 food and paper inflation forecast of 8%. It noted that 2021 store wage rates rose 10%. [3] We will have more earnings this week but casual diners seem to be forecasting food and labor in the mid-single-digit zone each. It’s clear now that supply disruption chain and COGS pressure[4] will continue through 2022 and that pricing actions to protect margins must occur.

The question then reverts to pricing power and what are operators doing to maximize it. Certainly, great product new news does it along with reaching out to the guest in an individualistic way (loyalty, digital) that builds traffic, frequency and ticket. We need only look at Starbucks and Panera’s programs post-2010 and how they dug out of the Great Recession. We are now seeing the same words from McDonald’s in terms of the value of their loyalty program. [5]  Good-looking stores and QSC builds pricing power, too. They built a different guest mix over time.

Every brand has an aspirational guest mix they do not have yet. It takes time and money to get them. With the absolute need to pass on price increases, CEOs have a go signal to begin programming their guests away from silly discounts. In my opinion, there is no need for “Dancing Dollar Kings” [6] or even 20 under $2 menus[7] unless accompanied by a parallel upper-tier menu item in the marketing creative plan.

Lately, there has been a lot of self-expressed admiration of Chipotle and Starbucks ‘ pricing power factor. They have it easier because they never did deep discounting.

Reading SSS and Financial Results in 2022

Staying with our be flexible theme, we financial analysts need it too. So, we have finally lapped over 2020, the worst, most irregular year in restaurant financial history. In 2021, some publicly traded highlighted their financial results in change versus 2019 in commentary and side schedules while the core income statement and balance sheets reflected 2021 v. 2020. Most companies and sell-side analysts talked one year and two-year results.

In analysis going forward, there is a great need to look beyond the simple one-year SSS year over year change. There is no perfect base. 2021 is infinitely better than 2020.  2019 is a good pre Pandemic base. Parts of 2021 were influenced by reopening, which affected casual dining. And government stimulus payments flowed into the economy and restaurants in the spring/summer, causing some sales spikes. The point is, you might well need to refer back to 2019 to test the true trend.

Following is a Restaurant Business/Jonathan Maze article on same and my additional comments via Linked In: https://linkedin.com/john-a-gordon-67569aa/recent/activity/shares

Favorite Investor Question: What Will Happen to the Higher Mix?

Throughout 2021, I got many questions from investors wondering when the surge of additional items per food transaction that all of the QSRs and fast casuals reported in 2020 and 2021 would end. Some were afraid that purchasing behavior would end and those same-store sales will plummet as a result.

Well, we are just rolling out of 2021 and into 2022 and don’t have that many readings yet. One who reports all the sales components we do, however, is Starbucks (SBUX). SBUX reported the larger basket size consistently through 2020 and 2021 as a higher average ticket. In many of those back-year quarters, the average ticket was significantly positive and traffic was significantly negative.

In SBUX FY 22 Q1, in the North American zone, Starbucks stores reported comp sales of plus 18%, driven by a 12% increase in transactions and a 6% increase in the ticket. [8]  So, while the price was taken it seems that most of the prior year mix behavior—the higher number of items sold per transaction—seems to have been built into the base. And transactions were considerably higher albeit over a still recovering Pandemic 2021 base. So, we’ll have to watch it, but it seems we have a winner on our hands and people are repeating their post Pandemic behavior.

About the author:

John A. Gordon is a long-time restaurant industry veteran who loves the unpredictability and never-ending complexities of our business. He has unit-level experience (6 years), 18 years of corporate staff experience, and the last 20 years as a complex situations restaurant analyst and management consultant via his founded firm, Pacific Management Consulting Group. He is a certified MAFF, Master Analyst, Financial Forensics, and works special investigations for investors, new concepts business planning and assessment, proforma development, franchisee support, expert litigation actions, and more. He can be reached anytime at 858 874-6626, email, jgordon@pacificmanagementconsultinggroup.com.

[1]   One good resource to check US construction cost inflation is the R.S. Means Company.

[2]   Except McDonald’s, which has company operated units in Europe.

[3]   But noted this was some form of a “catch up” wage action by franchisees. MCD does not forecast 2022 franchisee wage actions.

[4]   Proteins and paper items most commonly noted. On February 14, the US suspended all Avocado imports from Mexico after a threat to US inspection personnel.

[5]   McD Earnings Call, January 27 2022.

[6]   Burger King US TV feature summer/fall 2021

[7]   Current Del Taco primary marketing feature.

[8]   Starbucks Earnings Call and press Release, February 1 2022.

by John A. Gordon, Principal and Founder, Pacific Management Consulting Group

More Questions Than When We Started.

Typically, by this point in mid-January, we would have some idea what the restaurant operating tempo[1] for the year beginning jump-off point is going to be. We would have entered January, always the slowest month in restaurant sales and traffic in the Northern Hemisphere.  We would have good summary indicators through Restaurant Finance and Development Conference (which came off beautifully, live in November) and the ICR Conference (which unfortunately reverted to virtual earlier this month).  Frankly, none of this gave us a warm and fuzzy feeling.

Are Conditions on the Ground Clearer?

Unfortunately, not. Conditions on the ground in the field are quickly changeable. Consider:

Starbucks notifies all of its customers on January 14 electronically that US store hours, openings, business platforms, and product availability are apt to change due to the effects of COVID/supply chain issues.

The FACTEUS FIRST Report on consumer spending showed very gradual transaction count softness in QSR credit card transaction counts and full-service brands following in December and early January. [2]

Two restaurant analysts coming out of ICR mentioned their perception that companies seemed to talk “90% staffing” as the new staffing best point for now. Several companies noted the loss of sales due to closed units/early hour closes.[3]

Per my monitoring of company presentation of company presentations at ICR, I found little talk about supply chain/COGS inflation as “transitory”. [4]

Restaurant Research reported that the all-important sales to investment  ratio have declined (unfavorable movement) as higher construction costs/times to build have more than offset AUV growth. [5]

So after hearing all this, my key January-February watchpoints are (1) supply chain food commodity analysis (2) US social sensitivity/reaction to this new wave  (3) restaurant employment/staffing indicators, units closed early (4) restaurant operator marketing execution (5) unit margin contraction and impacts on franchisee new unit development in 2022-23.

No more hockey sticks please on Unit Development Guidance

I’m mentioning these observations to note that restaurant external communications, planning, and internal control must take on a new dimension this year. The days of spending monstrous blocks of expensive staff and executive time on a theoretical future 3 year/5 year plan are misplaced. The planning function has to be more current-focused and analytical focused on current drivers and then logical flex point options that can be adopted quickly. That is hard enough to get right. What I  recommended is to get the budget year set with detailed operations options and alternatives (including CAPEX, G&A, dividends, etc.) and simply flow 2-3 outyears from the most likely scenario.

For IPOs, new funding rounds, new brands, debt issues, etc.: investors typically focus on how many new units can the brand open and sustain over some time. I get questions from investors all the time about the original S-1 numbers restaurants have stuck with. 2021 has seen some very attractive young new brands go public for example.  But remember these claims of new unit count potential—5000; I just saw two fast-casual publicly-traded brands still backing 6,000 total units—that growth rationale is a tremendous burden to maintain. At the very least, those counts should be qualified as total world count up front in the book running process to allow for some time cushion.

Assessing New Concepts  Post 2020

COVID-19 and March 9 2000 changed everything of course, but business is still business. What’s always been important in this business (good food, good margins—see Gordon Ramsey quote in Time Out, January 14, 2022[6] ). COVID has caused some emphasis shifts as I can describe below:

1. It is essential to build or bake into the company DNA where staff engagement and involvement at all levels of the company—from the store level to the office of the CEO. This includes franchisees, the ultimate grey zone that is rarely handled well.
2. Being engineered to be on point with targeted and aspirational guests and the right revenue channels is key to finding the right sites. The hunt for sites is ever-present. The landlord win factor—and outyear rent factors are key to consider.

Management Lessons: Bill Marriott

I admit it: in the late 1980s, I was interested to join the Marriott Corp. in Washington DC. At the time, you recall, they ran several restaurant chains. Another opportunity in DC came up that I took and shortly thereafter, Marriott divested the restaurants. I did continue to follow Bill Marriott. Mr. Marriott is still executive Chair of Marriott and is active on social media, Marriott on the Move. Recently I came about “Bill Marriott’s 12 Rules For Being a Successful Manager” and thought it would be good to cite here. [7]

Several make sense to note here:

Number Five: Do it and do it now. Err on the side of taking action.

Number 6: Communicate by talking to your customers, associates and competitors

Number 7: See and be seen. Get out of the office, walk the talk, make yourself visible.

Number 8: Success is always in the details.

—

About the author: John A. Gordon is a long-time restaurant industry veteran with 45 plus years in operations, corporate financial planning, and analysis and the last 20 years via his founded firm, Pacific Management Consulting Group. He works complex operations and financial analysis projects as well as strategy assessment reviews for clients. He can be reached throughout at 858 874-6626, email, jgordon@pacificmanagementconsultinggroup.com.

[1]   Or OPTEMPO, a word that represents the pulse of activity of the business.

[2]   https://bit/ly/3fm99uk

[3]   YUM, LOCO, JACK.

[4]    Transitory is a  Wall Street CYA word copied from the Fed Chair, and in my opinion, does not apply to the restaurant space now.

[5]   https://chainrestaurantdata.com/new-unit-investment-2021/

[6]   https://twitter.com/JohnAGordon

[7]   https://skift.com/2014/02/26/bill-marriotts-12=rules-for-being-a-successful-manager/