Fast Food Restaurants Have Right Menu for Recession – Research Recap

Fast Food Restaurants Have Right Menu for Recession

As the U.S. restaurant industry struggles through the economic downturn, quickservice operators such as McDonald’s, Burger King and Wendy’s may enjoy a comparative advantage that helps them navigate the weakness better than their competitors in the casual-dining and higher-end segments, according to Moody’s Investors Service.

“Fast-food restaurants have a lower average check, greater convenience and increased food choices that resonate well with today’s financially stressed consumer,” says Moody’s VP-Senior Analyst William Fahy.

However, one threat to quick-service restaurants (QSRs) is the option of eating at home, or “trading out,” which is almost always less expensive than dining out. “As more consumers choose to eat their meals at home, QSRs will be negatively affected, but to a lesser degree than casual dining,” said Fahy.

With a lower price point and an increased emphasis on healthier food options, QSRs should be better-positioned to satisfy the consumer’s desire to dine out and save money. This will help QSRs better weather the “trading out” effect, the report says.

In addition to these operating advantages, QSRs also benefit from their predominantly franchise-based business model, which should reduce earnings volatility and capital spending. Yet amid a weak economy that shows little sign of near-term improvement, QSRs are not immune to reduced traffic, forcing them to cut costs and offer promotions or discounts to stay competitive and attract customers in order to stem deterioration in operating leverage.

Further, a recent history of generous share repurchases and dividends across the industry —- often funded with debt and other non-operating cash flows —- has placed greater pressure on restaurant operators to manage debt loads and maintain credit ratings as the economic downturn persists.

Key points of Moody’s report:

• Lower average cost of a meal at quick-service restaurants is an advantage as consumers become ever more frugal.

• Conveniences like drive-thru windows and late-night hours remain a competitive advantage over casual dining.

• New menu options at fast-food restaurants increase appeal for consumers that are more health-conscious.

• Franchise-based business model should provide greater stability to earnings.

• Discounting and promotions become key marketing tool to bolster traffic but squeeze margins.

• Many restaurants, including some quick-service operators, face weaker debt-protection metrics and eroding covenant cushions due to weaker operating performance.

A recent analysis by restaurant industry consultant John Gordon showed a mixed picture for fast food restaurants, with McDonald’s (MCD), Chipotle (CMG) and Steak N Shake (SNS) faring better than Yum Brands (YUM) and than Darden’s (DRI) Red Lobster and Olive Garden. All were faring much better than fine dining , where sales are down some 15% from a year earlier. Gordon also questions the wisdom of Wendy’s/Arby’s (WEN) following a multibrand strategy which has not worked well, with the exception of Yum Brands (KFC/Taco Bell).

Technorati Tags: (BKC), (CMG), (MCD), (SNS, (WEN), (YUM), Burger King, Chipotle, Darden, fast food, mcdonald’s, quick-service restaurants, restaurants, Steak N Shake, Wendy’s/Arby’s, Yum Brands

BK suit highlights franchisee friction – Nation’s Restaurant News

BK suit highlights franchisee friction

Ron Ruggless | Nov 30, 2009

The fight within the Burger King system over the $1 double cheeseburger could have far-reaching repercussions in a franchising world rife with value deals.

The lawsuit filed Nov. 10 in U.S. District Court for the Southern District of Florida by Burger King’s franchisee association claims that Miami-based Burger King Holdings Inc. does not have the authority under its franchise agreements to dictate maximum prices. It stems from a $1 double cheeseburger limited-time offer that began in October, which franchisees claim is forcing them to lose a dime or more per sandwich.

“This case, if you take the allegations in the complaint as true, is about whether a franchisor can impose on a franchisee the obligation to sell a product below that franchisee’s cost,” said Michael Dady, a partner in the law firm of Dady & Garner in Minneapolis. “The principle scares me. It has broad negative implications for other franchisees and dealers.”

In a statement, Burger King said it “believes the lawsuit is without merit.” The company noted that a U.S. 11th Circuit Court of Appeals earlier this year ruled that Burger King “has the contractual right to require franchisee participation in its BK Value Menu program.”
Still, the lawsuit has escalated frictions within the BK system—and others are watching closely.

A day after filing the suit, the Atlanta-based National Franchisee Association, or NFA, sent a letter to Burger King’s board, stating, “Your management team has pushed the franchise community to the brink.” The NFA represents about 80 percent, or 5,200 locations, of Burger King’s U.S. franchise base. Burger King has more than 12,000 stores in 74 nations.

Days later an e-mail from Charles Fallon, president of Burger King’s North American division, to some franchisees was leaked to the media.

“This negative publicity is detracting all of us from running our business and, just as important, lowering the value of our individual businesses,” Fallon’s e-mail warned. “Bankers, landlords, suppliers and potential new franchisees are watching and listening—potentially leading to less lending, at higher rates and increased equity participation.”

Dady, who specializes in franchise law, likened the case to an auto manufacturer requiring auto dealers to take a loss on every vehicle sale but to make it up on volume.

“I don’t like the equities of a manufacturer or franchisor setting a maximum retail price that forces the franchisee to sell below cost,” Dady said. “It’s a bad idea. There might be some short-term pleasures for the consumer, but there will be long-term pain when those car dealers or hamburger purveyors go out of business.”

The lawsuit concerning the $1 double cheeseburger is the second class-action lawsuit that NFA franchisees have initiated against their franchisor this year. In May, the NFA filed lawsuits against Burger King and its soda vendors over the diversion of soda machine rebates to corporate advertising. In the past, the franchised restaurants had used those rebates for repairs.

In addition, franchisees had twice since mid-summer rejected the $1 double cheeseburger promotion, saying they would lose money. Competitor McDonald’s had raised the price of its double cheeseburger late last year amid franchisee dissent that the item was not margin-friendly.

Burger King looked to a value-driven promotion to combat sinking sales—same-store sales fell 4.6 percent in the September-ended quarter. The $1 double cheeseburger promotion, which began in October, had improved traffic trends at Carrols Restaurant Group Inc., which is Burger King’s largest franchisee. At a securities conference in October, Carrols officials said sales were strong in the initial weeks of the promotion.

But other Burger King franchisees said they are losing on average between 10 cents and 15 cents on every $1 double cheeseburger sold.

“You could conservatively indicate that it costs us between $1.10 and $1.15 per double cheeseburger that we sell with all of our fixed and variable costs being covered,” said Dan Fitzpatrick, a Burger King franchisee from South Bend, Ind. “So when your revenue is only a dollar, it’s pretty clear that we’re not making money.”

The sandwich usually sells for between $1.89 and $2.39.
“The action that we took here is regrettable,” Fitzpatrick said. “When you look at what the management team has attempted to do with these two actions, they have fractured the relationship between themselves and the franchise community.”

The broader issue “is that the Burger King Corp. maintains that they have the right to set prices for our products,” Fitzpatrick added. “They imposed a $1 maximum price on a double cheeseburger. They could have just as easily picked other products on our menu. We reject the notion that they have the authority, either through our franchise agreement or otherwise, to force us to charge prices for products of their choosing.”

The case, Fitzpatrick said, could affect other franchise systems.

“When the franchisor crosses the line and begins to bully the system the way Burger King has done, it becomes concerning,” he said. “Our franchisor has a franchisee-revenue driven model. They make money when we ring up sales. We make money when we wring costs out of the revenue and make profit. When the franchisor crosses that line and says, ‘We’re now going to sell products at a loss, and we’re going to force this on your business model,’ and we have to deal with it, it gets to be very difficult.”

Steve Lewis, a former NFA chairman from 1998 to 2001 and a Philadelphia-based Burger King franchisee, said he was disappointed with Burger King’s deteriorating relations with its franchisees.

“In the past, we have been able to work through our differences in processes that worked very well,” Lewis said. “This particular management team, for one reason or another, opted away from that.… We believe they are so wrong in what they have done. And they forced us into this action. This is truly unfortunate that we are at this point. We should be trying to slay the competition, not each other.”

Julian Josephson, a former NFA chairman from 2001 to 2004 and a San Diego-based franchisee who has units in California, Texas and New Mexico, was concerned that the sale of items below price of cost could violate state statutes.

“There are quite a few states in the country—somewhere north of 20, and I’m in one of them, California—where it is illegal…to do this,” Josephson said.

John A. Gordon, the principal of the Pacific Management Consulting Group in San Diego, said he was surprised to see Burger King roll out the $1 double cheeseburger offer after such intense pushback from franchisees. However, he said September and October were the best months of the year to push value messages, before the interference from the Thanksgiving and Christmas holidays.

Costly promotions are risky, he said.

“Promotions involving big discounts and big portions of the product mix often need a 5-percent-to-10-percent traffic increase just to get back to gross margin breakeven, let alone pay for the incremental marketing,” Gordon said. “A key goal of any discounted offer is that customers will trade up or buy more add-on items when in the store.”

Joseph Buckley at Bank of America Merrill Lynch noted in a report that he was surprised at the level of discord within the BK system.

“In a soft QSR sales environment, BKC’s double cheeseburger promotion is ‘working’ and near term earnings implications are good, but franchisee relationships are in bad shape, in our view,” he wrote. “The latter is difficult to quantify but is a real-world issue that needs to be addressed for the Burger King system to prosper long term.”

Contact Ron Ruggless at rruggles@nrn.com.

Wendy’s parent interested in Krispy Kreme? – Nation’s Restaurant News

Wendy’s parent interested in Krispy Kreme?

Elissa Elan | Nov 23, 2009

An item in Briefing.com, as reported by Barrons, said that the parent of the Wendy’s and Arby’s fast-food brands was considering acquiring the 548-unit Krispy Kreme chain.

Denny Lynch, a spokesman for Atlanta-based Wendy’s/Arby’s, said the company does not comment on market rumors. Representatives for Winston-Salem, N.C.-based Krispy Kreme did not return calls for comment by press time.

Wendy’s/Arby’s has hinted in the past that it may be interested in acquiring a third brand, and with investor Nelson Peltz as its non-executive chairman, has a history of mergers and acquisitions. In June, Wendy’s/Arby’s closed on an offering of $565 million of senior unsecured notes, and the company said part of the proceeds could be earmarked toward the acquisition of another restaurant company.

Wendy’s/Arby’s itself is the product of a merger between Wendy’s International Inc. and Triarc Cos. Inc. That deal, which closed last year, was valued at more than $2 billion.

John A. Gordon, a financial consultant with San Diego-based Pacific Management Consulting Group, a group that focuses on the restaurant industry, said that the timing may be right for a merger between Wendy’s/Arby’s and Krispy Kreme.

“If you go back to Wendy’s last two earnings calls, there was discussion that led you to believe something could happen,” Gordon said. “It seems to me, and this is pure speculation, that Wendy’s unit economics is on the road to getting fixed; there’s been a lot of G&A reduction and, most significantly, their new product pipeline problems have been rectified.”

Wendy’s has been faring much better than sister brand Arby’s in the economic downturn. For the September-ended third quarter, same-store sales dipped 0.1-percent at Wendy’s North American stores. Same-store sales fell 9 percent at Arby’s. Wendy’s/Arby’s operates or franchises 6,608 Wendy’s units and 3,739 Arby’s locations.

Krispy Kreme, meanwhile, has been struggling to turn itself around after years of battling legal problems with executive management and sluggish sales at its doughnut stores. In its August-ended second quarter, the company nearly broke even with a net loss of $157,000, compared with a loss of $1.9 million in the same quarter a year earlier. Krispy Kreme pointed to lower commodity costs and a 5.9-percent increase in same-store sales at corporate stores.

Contact Elissa Elan at eelan@nrn.com.

The Indianapolis Star – Steak n Shake Merger Big for CEO

IN $22.9M DEAL, CHAIN TO BUY WESTERN SIZZLIN, WHICH BIGLARI ALSO LEADS engineering,” said Gordon, of Pacific Management Consulting in San Diego. “In terms of ongoing business streams, I’d be looking for any synergies, but I don’t think there will be. These STEAK N SHAKE WHAT: Full-service, casual-dining restaurants famous for Steakburgers and shakes. HEADQUARTERS: Indianapolis. HISTORY: Gus Belt started Steak n Shake in 1934 in Normal, III. EMPLOYEES: 20,000 (2008). CHIEF EXECUTIVE OFFICER: Sardar Biglari. LOCATIONS: 490 restaurants in 21 states; 70 locations in Indiana. 2008 NET SALES: $610 million. 2008 NET INCOME: ($23 million) loss. WESTERN SIZZLIN WHAT: Known for their flame-grilled steaks and fully stocked salad bars. HEADQUARTERS: Roanoke, Va. HISTORY: Nick Pascarella opened his first restaurant in 1962 in Augusta, Ga., and began franchising four years later. EMPLOYEES: Not available. CHIEF EXECUTIVE OFFICER: Sardar Biglari. LOCATIONS: 125 locations in 19 states. None in Indiana. 2008 NET SALES: $17.2 million. 2008 INCOME: ($6.3 million) loss. Biglari was fresh from the takeover of Western Sizzlin in 2007 when he launched a proxy fight for control of struggling Steak n Shake. The young investor, then 29, spent more than $16 million to amass a block of stock used to force out the Indianapolis company’s senior executives and place himself at the top in June 2008. Since then, Steak n Shake has trimmed its menu, focused on burgers, introduced lower-priced meals and begun sprucing up its white-tile eateries. The company earned $2.2 million in the quarter ending April 8 after running up losses totaling $22.4 million over the previous nine months. Reflecting the uptick in profits, Biglari’s annual salary rose in June to $900,000 from $280,000. But the bigger payoff could come in the merger. Under the terms of the deal, each share See Steak, Page A9