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.