Denver Post – Noodles & Co. looking to defrost after a frigid winter

By  | The Denver Post

PUBLISHED:  | UPDATED: 

The Broomfield-based chain blamed a tough winter for sales that fell short of expectations and sent its shares plunging to the lowest price since last summer’s initial public offering.

A slew of public companies have played the cold-weather card to explain disappointing performance.

But fast-growing Noodles was hit harder than many because its restaurant mix is weighted in Northern and Eastern states that were pummeled by heavy snow and freezing temperatures. About 80 percent of the locations are in the Rocky Mountain West, upper Midwest and mid-Atlantic.

“Maybe there’s a sense of fatigue in discussing the cold weather,” said Kevin Reddy, CEO of the chain whose specialty is pasta prepared in a dozen different styles. “But it’s true. It was one of the harshest winters ever.”

Not coincidentally, Noodles is focusing some of its growth plans on warmer states such as California and Florida.

The company recently reported first-quarter revenue of $89.5 million, falling short of analysts’ expectations of $92.2 million.

More telling of the cold-weather malaise, Noodles said sales at restaurants opened for more than one year fell 1.4 percent. It marked the first time in five years that the company failed to show an increase in the important financial metric of same-store sales.

Investors were shaken. Shares of Noodles plummeted 14 percent percent April 30, the day after earnings were reported. That was the lowest level since Noodles launched its IPO last year at a price of $18 a share. The stock closed Friday at $33.25, well below its high of $48.30 reached in October.

Yet analysts are largely positive about Noodles’ future. They say that winter performance aside, the chain shows well. Sales and unit growth are on upward trajectories. The sensational rise in share price shortly after the public offering, they note, unduly raised investors’ expectations.

“Fundamentally, there is still nothing wrong with Noodles,” said restaurant analyst John Gordon of San Diego-based Pacific Management Consulting Group. “They just have to continue to grow stores and sales to equal the stock value. That takes time.”

Noodles often is compared to its Denver-based peer in fast-casual dining, Chipotle. The similarities stem from the chains’ common geographic origins and the fact that Noodles’ top two executives — Reddy and chief operating officer Keith Kinsey — are alumni of the management ranks at Chipotle.

“But Noodles is not the next Chipotle,” Gordon said. “That’s an unfair comparison.”

Chipotle, in business since 1993, operates more than 1,600 restaurants. Noodles opened its first unit in Cherry Creek in 1995 and now has 398 locations.

Chipotle’s share price has risen from $22 at the start of its 2006 IPO to $547.09 Friday.

Chipotle is strong in the younger adult demographic, while Noodles targets families with children.

The two chains also differ dramatically in executive compensation.Chipotle recently made headlines when shareholders voted to reject the company’s pay plan, which last year gave co-CEOs Steve Ells and Monty Moran $25.1 million and $24.4 million, respectively, in total compensation.

Noodles’ Reddy last year made $3.7 million in total compensation, including a $1 million bonus related to the launch of the IPO.

Reddy said Noodles defies comparison to any other fast-casual restaurant chain. The company often refers to itself as “a category of one.” No other mass-market eatery, officials say, offers pasta prepared in a variety of ways encompassing American, Indonesian, Italian, Japanese and Thai flavors. The menu also includes soups, salads and sandwiches. Customers order at the counter, then are served at tables with china and silverware.

The chain receives mixed reviews for its nutrition profile.

Nutrition Action Healthletter recently gave Noodles a “Food Porn” rating for its Barbecue Pork Mac dish, in which a regular-sized serving weighs in at 1,270 calories and 29 grams of saturated fat.

“Basically you’re looking at a big bowl of white flour, meat and cheese in most of their dishes,” said Jayne Hurley, senior nutritionist at the Center for Science in the Public Interest. “The number of healthy choices on the menu is dwarfed by the number of unhealthy choices.”

However, Hurley gives Noodles credit for giving customers a choice between smaller- and regular-sized entrees, and for prominently listing calorie counts on the menu.

“If you’re careful, you can get a decent meal,” she said.

Reddy said Noodles seeks a balance between good nutrition — with items including whole-grain pastas and vegetable add-ons — and indulging customers’ tastes.

“The strength of the brand is that we create choice,” he said. “We’re not preachy about (nutrition). We’d rather not tell people what they should be eating.”

New initiatives include providing table service in which restaurant staffers offer beverages, appetizers and an expanded menu of desserts to customers tableside. Noodles also is launching catering for business and social events.

Reddy said he expects catering to produce a material boost to revenue and earnings.

Restaurant analyst Darren Tristano of Chicago-based Technomic said Noodles is likely to overcome its first-quarter financial stumble through a continued emphasis on store growth and appeal to consumers.

“If you go out with your friends or family, somebody can get mac and cheese, and somebody else can get Italian. Customers appreciate the diversity,” Tristano said.

“The brand is very strong,” he said. “There’s nothing wrong with what they’re doing.”

The Deal Pipeline – Sandell Asset Management’s Plans for Bob Evans Farms May Include M&A

Restaurant chain’s BEF Foods could be worth $450 million in a sale,
analyst says.
BY RONALD OROL
Oct 24, 2014 4:01 PM EDT

With four nominees on the 12-person Bob Evans Farms Inc. (BOBE) board, Sandell
Asset Management Corp. expects to see significant change in the restaurant
operator’s financial performance. Absent that, look for the activist fund’s manager
Thomas Sandell to return in 2015 with another board slate, industry analysts said.

Though Sandell Asset Management fell short of getting its full eight-person slate
elected at an August meeting, the partial win resulted in the separation of the role of
CEO and chairman earlier this month.

Sandell, a 7.6% stakeholder, has demanded that New Albany, Ohio-based Bob
Evans split up its restaurant business from its packaged goods unit, BEF Foods, to
unlock shareholder value hidden in real estate on the restaurant side of the business
by engaging in a substantial sale-lease back of its 562 company-owned locations.

The dissident has also raised concerns about faltering revenue growth and “bloated
corporate overhead” as well as “inordinately high SG&A expenses.”

Analysts are at odds over whether it makes sense to sell BEF Foods, which sells
sausage, bacon and other processed meat, and macaroni and cheese through
grocery stores, as well as whether the sale-and-leaseback plan makes sense.

Bob Evans is more likely to consider selling BEF Foods than doing a sale-leaseback
deal, said Miller Tabak analyst Stephen Anderson.

The remaining management-backed directors have top board subcommittee
chairman positions and are likely to push back on a major sale-lease back deal, citing
tax and leverage-hiking consequences, new escalating rent costs and a lack of an
economic buffer for hard times, he said. He also noted that incumbent director Eileen
Mallesch, continues to chair the audit committee, and remains an obstacle to
Sandell’s efforts.

Nevertheless, Anderson said Bob Evans could receive in the neighborhood of 13 to 13.5 times
trailing Ebitda — between $425 million and $450 million — to sell BEF Foods.

Sandell suggested in September that potential buyers were looking to make an offer. In a
securities filing, the activist fund manager noted that he was contacted by a private equity firm
interested in discussing an acquisition of BEF Foods as well as “several” investment firms
interested in a transaction involving the company’s real estate.

A company spokesman declined to comment on whether it has been approached by potential
buyers but the company noted that a key responsibility of its recently formed finance committee
is to take a “fresh look at ideas from all of our stockholders.”

And while Sandell didn’t return calls, Anderson suggested that the most likely buyer for BEF
Foods would be Pilgrim’s Pride Corp. (PPC) because an acquisition of the Bob Evans unit
would allow it to diversify away from poultry and extend it into the breakfast market, where PPC
doesn’t currently compete. Anderson also suggested that compared to ConAgra Foods Inc.
(CAG) or Pinnacle Foods Inc. (PF) , Pilgrim’s Pride has a stronger balance sheet and can take
on more debt than the others.

John Gordon, founder of Pacific Management Consulting Group, agreed that Bob Evans should
spin off BEF Food — calling it “imminently spinoffable,” — and would help Bob Evans cut debt
and make shareholders happy.

He also suggested that Pilgrim’s Pride could be interested after it punted on efforts to buy
Hillshire Brands Co. (HSH) , which was eventually acquired by Tyson Foods Inc. (TSN) for $8.5
billion. “From a traditional M&A point of view they would be the most interested and the one that
investment banks would most likely pitch a deal to,” said Gordon. “They had a funding
commitment to buy Hillshire, which makes this deal easily doable.”

Another rival, Hormel Foods Corp. (HRL) , would probably not be interested because a
combination with BEF Foods could face potential antitrust issues over high concentration in the
pork-products market, Anderson said.

However, Oppenheimer & Co. analyst Brian Bittner said he doesn’t see any benefits to selling
the food products business at “currently depressed earnings” levels. He added that
Oppenheimer’s analysis of a sale-lease back doesn’t imply that it would be “value accretive”
given the new rent cost for Bob Evans that would come with the real estate separation.
“We have done deep analysis on this. Don’t fool yourself,” Bittner warned.

Sandell has argued that the packaged foods division generates very little synergies with the
restaurant division while management contends that it produces brand and advertising
synergies, as well as supply chain savings and operational efficiencies.
Anderson said that even though Bob Evans does not have a great deal of long-term debt it has
borrowed substantially against its credit line and may want to evaluate a transaction to help pay
down debt.

“When this is considered as a measure of the company’s debt load, its debt-to-capital ratio is
55% as of the end of the July quarter,” Anderson said. “I think this could be an argument for a
sale-leaseback though I still believe that a sale of BEF Foods is more likely and the proceeds
from that could be used in part to strengthen the balance sheet.”

Nevertheless, there is reason to believe that a restaurant real estate separation could happen at
Bob Evans. Anderson said a compromise could be worked out where Bob Evans sells 141 of its
562 units to franchise owners in fringe markets such as the mid-Atlantic states as part of a saleleaseback
arrangement. He said these kinds of transactions are likely far less extensive than
the measures that Sandell wants the company to consider, but the deal could generate pre-tax
revenue of $255 million and suit both sides.

However, he said he believes that if there isn’t any movement in either area Sandell may be
back next year to launch another proxy battle to seat more directors, and it could happen earlier
than the restaurant chain’s annual meeting, which is expected in August. Anderson noted that
Sandell could seek to hold a special shareholder meeting in advance of the annual meeting,
something he would need the backing of 25% of investors to do, according to Bob Evan’s
bylaws.

Some observers have questioned why Sandell hasn’t pushed the company to conduct a tax-free
REIT spinoff of the real estate assets, a financial engineering tactic that a number of insurgents
in other campaigns have sought to do.

Activist investor Starboard Value LP succeeded in taking over the 12-person board of Darden
Restaurants Inc. (DRI) , in part so it could work on a spinoff of the company’s real estate into a
tax-free REIT.

Gregg Feinstein, managing director and head of M&A at investment bank Houlihan Lokey, said
that a sale-leaseback at Bob Evans may make more sense than a REIT spinoff because the
restaurant chain has a smaller pool of real estate than Darden and as a result it would be less
attractive as a standalone REIT.

Anderson agreed, noting that there are no restaurant REITs in the U.S. and that Bob Evans’ real
estate is too small an asset to work in a REIT structure, especially with an additional corporate,
general and administrative expense overhead that would have to be built at the REIT

Hartford Courant – Fast-Food Workers Demand $15 An Hour

September 04, 2014|By MARA LEE maralee@courant.com

HARTFORD — Before 13 fast-food workers from Connecticut and Rhode Island sat in the road and before the police escorted them to a prisoner van, about 150 supporters marched down Park Street in Hartford, chanting and drumming about the “Fight for 15.”

Some were carrying signs: “We’re worth more” and, in both English and Spanish: “A fight for $15 and a union.”

Kathy Mundo, who was watching from a bus stop, had never heard of the Fight for 15 movement, though this is the seventh demonstration since the push for higher wages and unionization began in New York two years ago.

Mundo, who earns less than $9 an hour at a supermarket where she has worked for two years, said that of course she supports higher wages. But could they get $15? “The way the economy looks, not really.”

Dozens of the protesters crowded into a McDonald’s just off Park Street at about 11:30 a.m. with a bullhorn, first chanting, then listening to fast-food workers who have become activists.

“I can’t tell you how many times I’ve had to work off the clock,” Jelani Burrell, 24, of Bloomfield told the crowd. He said while it only takes a few minutes to take out the trash or put something in the sink, that time adds up.

He told them that he was fired from his part-time delivery job at Papa John’s in Bloomfield when his boss found out he was going to these demonstrations, and that SEIU and the National Labor Relations Board helped him get his job back. The crowd cheered its approval.

He is paid $8.70 an hour, the minimum wage, but with tips and a portion of delivery fees, he earns $11.50 hourly on average. He has to pay for his own gas.

The Service Employees International Union has spent more than $10 million on this national push, according to The New York Times. There were at least as many SEIU members — primarily home health care aides, who earn $12.75 an hour — as there were fast-food workers at the Hartford protest.

Burrell, who works a second job at UPS and is a college student, was one of those arrested. He said they were charged with disturbing the peace and given a summons to go to court on Tuesday. Police gave the fast-food workers the chance to clear the street and avoid being arrested, but they remained.

Katelin Smith, a Dunkin’ Donuts worker in Hartford, stopped to take pictures and gawk at the protest and blocked traffic. Smith, 22, of Middletown, has worked at several Dunkin’ Donuts over the last six years but had never heard of the fast-food workers’ strikes. She was conflicted about the goals of the movement. It’s hard to keep up when it gets busy, and she thinks they deserve better pay, said Smith, a part-time college student who lives with her parents. And, she added, her co-workers who have their own apartments find it hard to pay rent.

But, she added: “Minimum wage is going up anyway. It doesn’t make sense.” She said she would never join such a protest. “I can’t be out here just screaming,” she said.

John Gordon, a restaurant analyst who works in California and advises both national chains and franchisees, said few hourly fast-food workers stay for even one year in the same place, which is a huge barrier to organizing a workforce into a union.

“I believe the unionization threat is near zero and I very strongly believe that,” he said. But he said the protests are a way to apply pressure to politicians to raise the minimum wage around the country.

Rep. Edwin Vargas, D-Hartford, also spoke to the crowd in the restaurant. “It’s corporate policy that has kept the worker down,” he said, as protesters responded: “That’s right.”

“You cannot be a giant vacuum cleaner, taking every dollar out of our community,” he said.

In an interview outside, he said, “I think most consumers would gladly pay an extra 10 or 15 cents.”

About half the fast-food workers at the protest work at Wendy’s.

Gordon said the average customer’s bill at Wendy’s is $7. A Wendy’s purchase will have to increase by 15 cents each year over the next three years for a restaurant to pay Connecticut’s scheduled $10.10 minimum wage and still preserve the typical $80,000 in annual profits per location, Gordon said.

But $15 is impractical, Gordon said. If a Wendy’s franchise paid hourly workers $15 an hour, the customer’s average bill would climb to $8, because labor costs are only a portion of a restaurant’s expenses. But in poor neighborhoods, he said, it’s not clear that customers would pay that. They might buy fewer drinks or items, or come in less often.

Heather Sirbrian, a customer who was eating at McDonald’s when the protesters arrived, said she had heard of the movement before and doesn’t support it.

“Fifteen dollars for a worker at McDonald’s is ridiculous,” said Sirbrian, who lives in East Hartford and works as a line cook at a sit-down burger restaurant. After working 20 years in restaurants, she said, “I don’t even make $15 an hour!” She makes $12.50.

The Columbus Dispatch – Analysts skeptical of Bob Evans’ bet on broasted chicken

Bob Evans Farms, long the home of pancake and sausage breakfasts, sees its salvation in dinner. The New Albany-based restaurant and prepared-foods company hasn’t seen a gain in same-store sales in five quarters and reported on Tuesday that the key metric declined 2 percent in its most recent quarter.

Bob Evans Farms, long the home of pancake and sausage breakfasts, sees its salvation in dinner.

The New Albany-based restaurant and prepared-foods company hasn’t seen a gain in same-store sales in five quarters and reported on Tuesday that the key metric declined 2 percent in its most recent quarter.

Bob Evans officials, though, are counting on a return to “high-single-digit” increases in same-store sales later in this fiscal year, and they pointed to a new dish as leading the charge: broasted chicken.

Analysts appear skeptical of the company’s outlook.

“I am still having a tough time picturing the high-single-digit same-store sales growth in the second half,” Brian Bittner, an analyst with Oppenheimer, said during an earnings call yesterday. “How do we get to the high single digits?”

Bob Evans CEO Steven Davis believes test results in Cincinnati show great promise for the marinated, pressure-fried chicken. Broasting is a term coined by Broaster Co., a Wisconsin company that sells the frying equipment.

It was so popular, Davis said, that stores in Cincinnati often sold out of the product. In the test market, broasted chicken surpassed the Rise and Shine breakfast as the best-selling menu item and generated as much as 12 percent of sales.

Broasters are being installed chain-wide, with full implementation in November.

One glitch, though, could be that even with broasted chicken, Cincinnati stores posted just a 0.4 percent increase in same-store sales in Bob Evans’ first quarter. That beat the chain’s other restaurants but was hardly spectacular.

Davis attributed the low growth to a lack of advertising around discounted pancake dishes. The discount “did not drive foot traffic; it simply reduced sales,” he said.

The idea that broasted chicken – and a focus on driving lunch and dinner sales – will turn around Bob Evans’ sales isn’t feasible, said John Gordon, principal of Pacific Management Consulting Group.

“To get a change in overall sales trend, they would have to really increase dinnertime traffic and not lose anyone at breakfast or lunch,” Gordon said. “That’s tough to do.”

He added that building the brand around broasted chicken, not pancakes and sausage dishes, won’t happen overnight. Gordon thinks Davis is grasping for life preservers as Bob Evans’ performance slump has deepened.

Bob Evans has battled activist investor Thomas Sandell over the same period. Sandell gained four seats on Bob Evans’ 12-seat board of directors at the company’s annual meeting last week. At the time, analysts wondered whether Davis’ tenure would be short-lived.

The decline in same-store sales started in the summer of 2013. The most recent results showed that sales dropped in May, June and July, and the drop accelerated each month.

Bob Evans, which operates 562 stores in 19 states, also is counting on a milder winter, much better holiday sales in its prepared-foods division and an easing of record-high sow costs. A lot has to go right, Gordon said.

Jumps in same-store sales of close to 10 percent are hard for restaurants to achieve and fleeting, Gordon said.

Same-store sales growth at Wendy’s hit 3 percent last year after it introduced the mega-hit Pretzel Bacon Cheeseburger.

“You can count them on one hand,” Gordon said. “They are very rare. The bump doesn’t last long, either.”

jmalone@dispatch.com

Ad Week – What’s Slaying the All-American Burger?

After 5 years of steady growth, chicken comes home to roost

Could the hamburger, the long-reigning, all-American favorite, finally be toast?

Beef burgers made their name as a workingman’s meal during the Great Depression—before evolving into the symbol of American corporatism and cultural hegemony that they have become. The Economist, singing the praises of the burger, once called it “a symbol of the reassuring predictability, the pre-packaged straightforwardness, the sheer lack of pretension of American life.”

But move over, burger—chicken is having a moment.

For the first time in a century, Americans are gobbling up more of the humble bird—much of it in the form of fried chicken drumsticks, crispy chicken sandwiches and chicken nuggets—than double cheeseburgers, sliders and T-bones. Chicken consumption, after growing steadily over the last five years, last year finally paced ahead of beef, according to the USDA. This, as a four-year drought in Texas, which produces the bulk of our beef, has forced prices skyward and triggered a beef shortage. On the flip side, there is such tremendous demand for chicken that this is shaping up to be the most profitable year ever for chicken producers, as Bloomberg reports, with a surge in wholesale prices boosting profits for giants like Arkansas-based Tyson Foods.

It’s little wonder, then, that fast-food chains like Burger King are jumping into poultry in a big way, even as a couple of heavy hitters already well-known for their bird—Popeyes Louisiana Kitchen and Chick-fil-A—are enjoying a growth spurt. “As we see a systemic decline in beef consumption, relatively inexpensive and easily available chicken is turning into the universal protein,” notes John Gordon, analyst and principal at Pacific Management Consulting Group.

Just how hot is chicken? Last year, U.S. sales at limited-service chicken chains shot up 4 percent, while comparable burger chains saw less than half that growth, with a 1.5 percent bump, per Technomic. Particularly revealing, Chick-fil-A became the No. 1 fast-food outlet in the U.S. in per store sales as of 2012, tallying $3.1 million per location, versus $2.6 million for McDonald’s and $1.2 million for Burger King. Even Domino’s—in the process of phasing “pizza” out of its name—has caught chicken fever, launching its Specialty Chicken line in April with a national TV campaign from lead creative agency Crispin Porter + Bogusky. The new menu offering consists of a dozen chunks of breaded chicken breast covered with sauce, cheese and assorted pizza toppings. “This is a one-of-a-kind product that reinvents the way chicken is served in our industry,” boasts Russell Weiner, Domino’s CMO. “Our pizza expertise inspires items like this outside of the traditional pizza category.”

TV spots promoting Domino’s concoction focus on how the company isn’t afraid to take risks and, in keeping with its recent marketing messaging, how it sometimes fails. “We are proud to be known as a pizza company, but Specialty Chicken shows we are not afraid to step out of our comfort zone,” says Weiner. “We encourage our team members to keep trying to get better. Failure sometimes shows itself on the road to success.”

Burger King, stinging from a 1 percent dip in U.S. sales in 2013, recently debuted its Chicken Big King sandwich and dusted off its legendary “Subservient Chicken” campaign, created by Crispin and The Barbarian Group a decade ago. It relaunched the website subservientchicken.com, which made advertising history by putting an actor in a chicken suit who seemingly performed stunts on command. (In reality, numerous possible reactions were filmed.) This time around, the site sports a video about the fabled “chicken man,” claiming he’s gone MIA. As part of the campaign, the fugitive chicken shows up in unexpected places, prompting Twitter sightings.

The South Rises
Leading this charge are two chains based in the Southeast, a region where fried chicken is taken as seriously as football, iced tea and God.

Last year, Chick-fil-A—which lately has earned headlines not so much for its food as for its outspoken, conservative Christian CEO Dan Cathy—strutted ahead of Kentucky Fried Chicken in total sales, even though Chick-fil-A has only 1,800 U.S. outlets to KFC’s 4,500. And Chick-fil-A is in rapid-expansion mode, with outlets slated for the West, Midwest and Northeast, including New York City (where it currently boasts but one location, inside a dorm at New York University in Greenwich Village). The chain plans to be a presence in 41 states by this fall.

While its fried chicken sandwich with pickles on a soft, buttery bun made it a legend, last month Chick-fil-A got serious about becoming the healthy choice among chicken joints, replacing its char-grilled sandwiches with three grilled chicken items. “This is the largest investment we’ve made in a product launch,” says CMO Steve Robinson. “We’ve been working for years to get this grilled product right, even inventing our own grill. It’s all part of our commitment to be the better-for-you fast food.”

Next up for Chick-fil-A: persuading more consumers to choose chicken for breakfast, with items such as chicken and waffles on the front burner.

One thing that will remain a constant at Chick-fil-A is its distinctive marketing from Dallas-based The Richards Group. The centerpiece of the advertising is an anthropomorphic cow wearing a sandwich board that urges consumers to “Eat Mor Chikin.” Campaigns encompass TV and out-of-home as well as a broad line of merchandise, including a cow-of-the-month calendar. (In newer markets, the chain has been known to run the original ads that kicked off the cow-themed campaign 19 years ago.)

Popeyes is right on Chick-fil-A’s heels. With 1,721 locations in 47 states, it has run national TV spots since 2008. To solidify its brand position, the urban fried chicken-and-biscuits brand underwent a major makeover five years ago and became Popeyes Louisiana Kitchen, adding a handful of Cajun-themed dishes. The restaurants are currently being remodeled so they are centered around a giant spice rack that represent all the spices that go into its New Orleans-style menu offerings. The redo was the brainchild of CEO Cheryl Bachelder, who joined Popeyes in 2007 after serving as president of KFC.

“Americans often associate Louisiana with good food, according to our research, so we decided to talk about our Louisiana heritage with gusto and specificity,” explains CMO Dick Lynch, a Bachelder hire. Advertising is anchored by a fictional character called Annie, a middle-age, African-American woman from Louisiana who likes to cook. Aside from promoting the chain’s latest special offer, Annie explains the nuances of Cajun cooking to audiences largely far removed from the Big Easy.

The company also runs a cooking program in New Orleans for its most successful franchise owners. The Louisiana Heritage Culinary Institute introduces the franchisees to Cajun and Creole dishes such as rice fritters and New Orleans barbecue shrimp. “We will always be Louisiana—we lean into it,” as Lynch puts it. “As we expand in both big cities and suburbs, we want to win people over to our culture.”

Whither KFC?
Despite its heady new status as the meat of choice, no one ever said selling chicken to the masses was easy.

Photo: Michael Clinard

In the U.S., KFC outlets have struggled in recent years, as the company focused more on its breathtaking growth in China. Average U.S. sales per store in 2012 were an anemic $957,000—less than one-third that of Chick-fil-A and less than half that of Popeyes. Last year, sales at KFC tanked 6.7 percent, even as its rivals were cooking. “There is no fast fix for KFC,” David C. Novak, CEO of parent Yum Brands, told industry analysts last year. (Since then, food-safety issues put a damper on the chain’s expansion in China, and Taco Bell CEO Greg Creed was tapped to run Yum Brands, replacing Novak.)

In a stab at turning things around, the world’s most famous purveyor of fried chicken is getting creative—and in some cases, downright wacky. In October, it introduced the KFC Go Cup, fried chicken and fries served in a cup that fits in most car cup holders. More than 20 million were sold in the first three months, according to spokesman Rick Maynard. Other products are so over the top that they became instant catnip for social media—among them, the Double Down, a sandwich constructed of slabs of fried chicken substituting for bread, and a drumstick-festooned corsage just in time for prom season, which spawned a promotional video designed to build even more buzz. Meanwhile, KFC is attempting to reinforce its identity as “the brand that’s a family meal solution,” as Maynard puts it. To that end, the chain is kicking in a free chocolate chip cake with the purchase of every 10-piece chicken meal.

The biggest restaurant brand of them all, McDonald’s—which in the early ’80s made Chicken McNuggets a staple of the American fast-food diet—has had its own challenges when it comes to chicken. It had egg on its face this past February after the rollout of its Mighty Wings spicy fried chicken item, whose sales were so limp that the company got stuck with 10 million pounds of unsold wings, languishing in the freezer and speeding toward their expiration date. McDonald’s was forced to mark them down by 40 percent.

Naturally, a marketer as savvy as McDonald’s doesn’t launch a new product without exhaustive research. As it happens, McDonald’s test marketing in the Chicago and Atlanta markets indicated that the chain had a major hit on its hands—overlooking the fact that wings happen to be disproportionately popular in those cities. In other towns, as it turns out, customers balked at the dollar-a-wing pricing, found the spices intimidating and were annoyed by the bones. The media had a field day over the rare McDonald’s flop. (What was lost in the reportage was that, while 10 million pounds may seem like a lot of bird, McDonald’s initially bought 50 million pounds of wings, selling 80 percent of the inventory at the premium price.)

Making People Fatter
Another key factor driving chicken’s rise is the perception that it is a healthier choice than beef—forget that much of that chicken comes battered and deep fried. “Fried chicken has more calories and fat than beef, and the shift from burgers to fried chicken won’t help our obesity problems,” says Jennifer Harris, director of marketing initiatives at Yale University’s Rudd Center for Food Policy.

In fact, the growing popularity of chicken could make us even fatter. One need only compare a Burger King cheeseburger with a Popeyes fried chicken breast to find that the chicken boasts some 40 percent more calories and greater than twice the saturated fat, cholesterol and sodium of the burger.

Chick-fil-A’s new grilled menu offerings aside, the chicken chains could do a better job of making healthier choices available, as Harris sees it. “If these places really wanted to sell healthy chicken, grilled chicken would be priced better, any chicken sandwich would come with grilled chicken automatically unless people ask for fried, and the grilled items would be advertised more extensively than the fried variety. Plus, counter displays and menu designs would favor grilled over fried items,” she says.

That said, our collective fingers will likely just get greasier.

Going back to the hamburger, it harkens back to a time when America and American tastes were more homogeneous, as analyst Gordon sees it. “Fast-food chains could serve [the same] mass-market items, such as burgers, to everyone,” he explains.

Chicken heralds not just a culinary but also a societal shift. “Our country is not so ‘mass’ anymore. We are broken into many social strata and different locales,” says the analyst, who declares that the rise of chicken—whether grilled or deep fried, in a bucket or on a bun—is no mere fad. “It reflects a fundamental change in our culture.”

What Does Restaurant Refranchising Mean?

In 2014, McDonald’s (MCD) announced it was to refranchise up to 1500 units out of the United States. In 2013, Wendy’s (WEN) announced refranchising of 450 units in its non core markets. In 2012, Burger Bing (BKW) and Jack in the Box (JACK) kicked into serious refranchising, so much so that Burger King now only owns and operates the 50 plus units in Miami out of a 130000 unit total. Even Starbucks (SBUX) is finally in franchising for its flagship Starbucks brand, refranchising stores in the UK and Ireland. It franchised its non premium Seattles Best Brand for some time. YUM has been furiously refranchising since 2009 but intends to keep China company operated.

To be sure, some brands have been defranchising—buying franchised stores back. Red Robin Gourmet Burgers (RRGB), Noodles (NDLS), Qdoba (JACK) and Texas Roadhouse (TXRH), among others. Chipotle (CMG) wont franchise—it would destroy its culture and they make more as company operated stores.

The debate in restaurant circles about the proper mix of company and franchised units has been legendary. In the 1970s and 1980s, the trend was towards company owned locations. In the 1990s, as return on invested capital (ROIC) and awareness of the free cash flow expanded, refranchising picked up.

Refranchising means the company can make more on the royalties, maybe rent spreads (if it owns the real estate) and reduced G&A and capital expenditures (CAPEX) associated with its former units. In almost every case, refranchising involves weaker stores beyond a certain profit or EBITDA point or weaker brands or geographies.

Benefits of refranchising 

Refranchsing can be a stock catalyst, some new news, particularly if it funds increased dividends or buybacks, or if it is associated with more debt that can fund dividends or buybacks. That what McDonalds is doing.

Optical improvement: refranchising takes the lower stores out ofn the base, and optically makes restaurant sales and margins improve, as both WEN and JACK have noted.

Refranchising should lower debt, improve credit ratios to allow for special dividends

Boost ROIC: with units sale proceeds and capital investment falling lower or to near zero if no real estate is involved, it provides a bump to ROIC.

It can help out franchisees, as large franchisees have a need to get larger (WEN example)

And, in some cases, if the company can’t operate stores well, refranchising is a type of outsourcing of the problems. See: YUM’s KFC, Burger King (BKW)

Limitations with refranchising 

The ultimate problem is the company becomes an outsourced restaurant provider—no expertise in running restaurants. Franchisees site “no skin in the game” as a perennial problem in brand management.

Adaptability/Flexibility: franchised concepts take longer to get new products to market and keep the physical plant remodeled and renewed. In the US, Starbucks will always have an advantage over McDonalds as it can make decisions and implement market change quickly, while in McDonalds case it takes years to attain buy in and effect market change.

Unit level economics: while there is the perception that franchisees run a tighter P&L,than company operations, franchisees do have to pay a royalty and are generally territory constrained. In addition, the availability of funds and cost of debt for franchisees typically are unfavorable versus that of the franchisor . This implies higher cost of debt and missed opportunities. Franchisees have higher debt to EBITDA ratios. For example, the McDonalds US franchisees debt/EBITDA is appx. 5.4 X, versus 2.2X at MCD corporate.

Company structure; good franchisors run their company units as a training and development ground for franchisees. If the company store base is deteriorated or nonexistent, quality development staffing comes at risk.

Once the refranchsing is done, that arrow is no longer in the quiver. What next?

Cultural bifurcation, franchisor v. franchisee conflicts.

Red Lobster Levers

To any close observer of the ongoing Darden (DRI) conflict as it has unfolded with its opponent activists Barington, and Starboard since late 2013, a Red Lobster sale to private equity was not a shocking outcome.

Consider: 

• Private equity has dry powder–unallocated funds– available that it must put to use to earn a fee. Golden Gate had owned three restaurant brands and continues to own one, California Pizza Kitchen.

• Darden, which was in trouble since at least 2007 trying to hit a 15% EPS model with the mature Red Lobster and Olive Garden restaurant brands, bought a lot of restaurant concepts at high price in 2008-2013, and wound up with a lot of debt. As the rate of casual dining traffic decline fell after the Great Recession, (Darden noted the casual dining overall space traffic fell 18% versus the peak) and core earnings fell, it had both dividends and buyback demands going up at the same time. A true cash flow squeeze resulted.

• Darden had remodeled the entire Red Lobster chain by 2013 and needed to get some money out of its investment. (Why it remodeled Red Lobster first versus Olive Garden is a fascinating question.)

• Red Lobster had underlying real estate that could be levered to lower the effective Golden Gate purchase price.

The question, is what now to do with Red Lobster? What are the “Lobster Levers”?

On the positive side, the brand ratings are not weak. It ranks roughly in the middle of the pack via the 2014 Brand Keys Customer Loyalty index but near the top of the 2013 Q4 Goldman Sachs Brand Equity Survey. The downside is there are no other national seafood players to steal market share from. Bonefish (Blooming Brands, BLMN) is just growing and Joe’s (Ignite Restaurant Group, IRG) has built its own crab niche.

It’s not going to work its way out of trouble with more $10 television advertising that it has been pounding way with this week. It’s going to have rent to pay. Darden has noted Red Lobster’s customer base indexes older and lower income than the most desirable casual dining peers; it’s got 706 units in an overbuilt US restaurant space. Keeping the same units and doing the same thing won’t solve anything.

But what is can do is the following:

Close some units. Now that it is private and protected from the intense investment community focus on every metric, it can examine its store base. Note that American Realty executed sale leasebacks on 500 of the 706 units. A number of units were excluded for a reason, some were leased, some undesirable to do so.

Red Lobster reached its unit count peak in the US in 1996, at 729 units. It then closed 75 stores over the next four years, to arrive at 654 units in 2000, to then slowly grow again until 2013. The natural US unit cap seems to be much smaller than 700. A privately held company can work this.

With a rather low 9% reported adjusted brand EBITDA, the law of large numbers is that must be a number of units that are in the lower profit quadrant that upon closure, could result in positive cannibalization, and will improve the overall brand average profile.

Test and rebred. Maybe because it was part of the central heritage of Darden, other than remodeling or wood grilling, there has been no real new concept ideation for years. A self serve Red Lobster lunch platform and Red Lobster/Olive Garden combo stores were tested recently and were a total waste of time and money. Such poor quality tests are indicated of a big concept ideation problem. Too much seafood on the menu and a very low level of alcohol sales are indicative of the problems.

Work international. All of its peers are. Darden just began a brief foray into ex-Canada international and franchising in 2013. As late as 2013! Missing the international opportunity was a great strategic flaw. The US is filled up with restaurants. Can’t Red Lobster work internationally, somewhere?

Work franchising, joint and limited partnerships. Darden’s problems with franchising went all the way back to a failed franchised venture in the 1970s. Franchising is difficult, well funded and capitalized franchisees have to be found. Darden said they didn’t have the expertise. But it can be found. A new management mindset embracing franchising has to be developed. It can work in casual/fine dining: Ruth Chris (RUTH) has had 50% of its stores franchised to solid players forever, and Cheesecake Factory (CAKE) is working franchising and joint venture partnerships to get its international growth jump started. The Cheesecake founder, restaurant operator, David Overton “got it”, but Clarence Otis, who didn’t have the restaurant operations baked into his DNA, didn’t apparently.