Q4 Earnings to date…
We are in the middle of the Q4 earnings cycle and have had Darden, McDonald’s, YUM, Chili’s, Starbuck’s and Chipotle so far. The bulk of the casual diners and more QSRs and a few fast casuals will be this week and next.
As usual, one must work to see if the macro sector trends and results are brand specific. The one surprise to date is Chipotle SSS was weaker but still positive, with both negative mix and traffic. This is “a turn” as we analysts call it and CMG management said they didn’t see price resistance and that value scores were still very high. More on this later. Food and labor costs are still inflationary and restaurants (especially casual diners, per the BLS) are taking substantial price increases. McDonald’s store margins will be lower and Chipotle is under the gun to get store margins up to 27%.
Interpreting Consumers is Difficult
There is an industry narrative underway in some parts that can’t be confirmed yet. That is that higher income guests frequenting casual dining, and fine dining are trading down to fast food. This narrative is driven by: (1) it happened before (2) the QSR operators are saying they are seeing an uptick in higher income guests (3) some casual diners like Chili’s and now Chipotle lost traffic. [1]
There is no evidence to date that the company-owned polished casual dining or fine dining concepts are in trouble at all.
I don’t buy this concept trade-down issue, at least not yet. For one, I know from 20 years of corporate staff and 20 years of my consulting firm experience, that restaurant brands and their vendors don’t have the budget or methodology to track guest migration from one brand to another over short periods. Over the longer term, this is possible, but costly. The mistake is assuming a higher mix of higher-income guests must be from casual or fine diners. It could just come from a higher frequency/mix. Time will tell and the numbers will lead the way to the truth.
Restaurant Analysis and M&A Calculations: What is the right base?
Soon we will have 2023 Q1 financial results and the SEC P/L format dictates that 2022 is the year-ago base. On earnings calls, S-1s, and management analysis, companies can have further disclosure. The Pandemic certainly has made some prior year displays difficult. As a result, that has been a negative factor affecting franchise and nonfranchise restaurant market sales in 2022. M&A professionals report that there is relatively nothing for sale right now.[2] Simply, the 2022 numbers look bad compared to 2021 due to the margin erosion seen everywhere.
Of course, this will change eventually; the restaurant business is cyclical. This business is always investable; there is always something to do to get ready for the inevitable future. Some latent IPOs are coming.
My suggestion in the management data display area: always show 2019 data and operating stats and then pick up the P/L with 2021, and forward. A discussion strand in the franchise M&A world is that a workable true EBITDA base is somewhere between 2019 on the low side and 2021 on the high side. [3]
McDonald’s US Franchise Relations: Hatfields v. McCoy’s Battle Conditions Persist
There is no doubt that McDonald’s (MCD) is a global restaurant powerhouse with worldwide brand recognition and strength and power. In the US, one of the most difficult markets now, AUVs have soared, marketing is right on point (IMO) and analysts believe franchisees are around $500K in store EBITDA, a good number, albeit down from the prior year.
The problem is that there has been a decade of documented bad relations between US franchisees and the US corporate staff. Somehow in my files, I wound up with some Mcdonald’s 2013 franchisee notes and I reread them. The tone of the conflicts is the same. The year-to-year catalysts change: in 2020-2021, US franchisee communication ceased for over 6 months with corporate over disputes about invoice billings, now the issue is the new contract McD is switching to and the new PACE inspection system. The franchisees point to the inadequacy of the PACE system, and its additional costs and stress on employees. And that their store EBITDA was down $100K in 2022. MCD corporate responded that the PACE system provided benefits in European markets where it was first rolled out. [4]
What is immediately notable is the bad McDonald’s franchisor/franchisee culture, the Hatfields (Corporate) v. McCoys (Franchisees) battle is still present and not getting any better. Fixing this is a core responsibility of the franchisor in my view. McDonald’s operates only 3% of its US units. Going through a contracting effort and not being sure of your workforce is a terrible thing. I was on the restaurant corporate staff for 20 years, and after a while, without the proper cultural and people planning in place, one begins thinking about “us and them”. That is not right and it constricts the proper use of the franchise model. A corporate staff invention is required.
The franchisees should recognize that everyone is down in EBITDA and most every brand would love to have $500K to cover CAPEX, taxes, new units, and the like. Also, in terms of inspections, I have seen some awful, embarrassing customer service in franchisee locations where no inspections have picked up. They should fight for useful inspections that focus on real QSC metrics.
Heard in the street… on the Subway/DAI sale, we read via Forbes that Dr. Buck’s will allocating his 50.01% of Subway/DAI proceeds to his charity could have unintended consequences in the DAI sale process which is just in its infancy. Does this mean that the Buck Charity director will get a vote on Subway/DAI restaurant matters? Not good if so. We will see.
More on Subway operations… in late January, Subway network TV and digital began advertising a BOGO buy one-foot long sandwich, get one free. An underdetermined (but significant) number of franchisees don’t accept walk-in, paper, or digital Subway coupons, period. The reason they can’t afford it as the discount is too steep and they don’t get a sales bump. With DAI just reporting Subway US AUVs up 9% in 2022, why the need right now for such expensive discounting? A very reasoned guess could be they are looking to show good sales numbers for the investor’s book. The problem is the franchisees are paying personally for those sales gains.
About the author: John A. Gordon is a long-term restaurant industry veteran and founding principal of Pacific Management Consulting Group. He works on complex restaurant operations, financial management, and strategy engagements for clients. He has 20 years of restaurant corporate staff experience, and 20 years via his consulting firm. Reach him at jgordon@pacificmanagementconsultinggroup.com, office 858 874 6626, mobile, 819 379 5561.
[1] See Nations Restaurant News, Restaurant Tradedown, February 10, 2023.
[2] Restaurant Finance M&A Panel, November 15 2022; and Rick Ormbsy, Unbridled Capital, February 2023 EWebinar. https://unbridedcapital.com/resources/season-5-episode -5- the=2023-state-franchise=ma-/
[3] Hat Tip: Rick Ormbsy, 2023, Season 5, Episode 5 Webinar.
[4] Restaurant Business Online, “ Franchisee Fear, Anger, Mount as McDonald’s Intensifies Inspections”, Jonathan Maze, February 7 2023.