Wray Executive Search – Restaurants: Rough Waters for Now

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

Negative consumer and earnings conditions in January-February:  Sorry to say, but February chain SSS results were the weakest since 2021, same month per Black Box. That was bad enough. The factors: all the usual problems at this time of year, including bad weather, negative traffic, and secular weakness at virtually all casual dining and fine dining operators. And a few factors: average check rate declines. The industry has [mostly] slowed up price increases, so much so that ticket increases are not covering traffic declines as before. However, our pricing, lower as it may be, in March was 4.5%[1]  versus 1.0% food at home. [2]  So we are still in a poor position versus grocery stores. The February Black Box index was -.6% SSS and -2.3% traffic.  [January SSS was -4.5%]

Fast casual and QSR brands were marginally positive while, casual dining and fine dining were quite negative.   Even casual dining powerhouse Darden had marginally negative SSS in all reporting groups except LongHorn last quarter.

So, with some 45 years in corporate staff and management consulting FP&A roles and engagements, I have always been known as a pricing and margin recovery guy. But with the magnitude of pricing we have taken, and the inability of the consumer to deal with the cumulative price increases taken, we are in real trouble.

Michael Halen /Bloomberg View: K Shaped Is the Word

I asked my good friend, Michael Halen, the senior restaurant analyst at Bloomberg, to provide his perspective on consumers and restaurant sales trends.  Michael noted: “ A K-shaped economic recovery [upper track, lower track] and three years of aggressive industry price hikes may fuel a greater divergence between low and higher income consumers; and quick service and full-service restaurant sales.

Year-over-year comparisons will get easier in March and should give results a lift through year-end, but cross currents will affect chains to varying degrees. Weaker low and middle-income consumers, hurt by high credit card balances and delinquencies, could pressure casual dining chains more than quick service due to higher guest checks. Fine dining sales may pick up as the segment laps over weak 2023 results and high-income spending is buoyed by rising stock, home, and crypto values.”  Thank you mhalen1@bloomberg.net

Fast Food Pricing War Redux?

McDonald’s has led the way for the last two quarters warning of the weakness of guest traffic of the $45K and under income cohort. It can be the most powerful QSR marketer in the world, and its reference power across worldwide industry is immense. It is not reacting particularly creatively to the $45K cohort problem [big discounting across the menu under $3.99 has been announced], and the risk is another fast food pricing war could be set off. It seems to me that publicly traded franchisors get paid off the top line [and comps], although it is very true to note that MCD has very difficult compares in 2024 due to a very successful 2023. A pricing war, which sets back the industry, can be averted by true leadership and creativity at MCD.

How? The industry has used variations of a HI/LO offer strategy forever. The NOA franchisee association pointed out that MCD created lower-priced wrap products and others in the past exactly at the same time of need, but MCD has ignored that input.  With all the progress the industry has made in digital and targeted marketing tactics, a fast food war would be a very disappointing outcome in 2024, in my view.

Dispatches from the California Mess 

On April 1, California AB1228 went into effect that among other things, jumped fast food restaurants minimum wage [with more than 60 national locations] to $20, a $4 immediate jump. In my experience opinion, this jump will cause compressional wage increases throughout the QSR store crews and will affect other non-QSR restaurants as well.  The implications of AB1228 have been extremely well covered by local and national press.   Publicly traded restaurant brands with a concentration of units in California noted they would employ a mix of pricing and other tactical efforts to offset the negative margin effects.

Now, we have some early data in. Our friend Lauren Silberman at Deutsch Bank published a note on April 2 (DB, California Pricin) that reported on some brand’s CA pricing actions around 4/1. For example, Chipotle increased on average by 7-8%, Starbucks increased by high single digits on average, Mcdonald’s was largely unchanged,  Shake Shack was unchanged in April [but prices taken in March], Taco Bell took 3-4% price. JACK store pricing was mixed.  No price increases at Papa John’s. Only one of five Dominos units tracked took price. Sonic (Inspire) raised prices 3.5-4.5%. Other than one menu item adjustment at Olive Garden, the casual diners did not increase prices.  No CA price increases at Sweetgreen [earlier system price of 3% on 2/21], Cava or Wingstop [yet].

And more California analysis: my friend Lisa W. Miller is tracking California consumer conditions via her proprietary research systems. She has recent data just reported. Through Q1,   66% of California consumers have pulled back on dining out due to high prices, versus, 63% of the nation as a whole. And now, diners in California have proportionally pulled back in support of higher wages versus lower dining costs (39% in CA versus 43% in total US). 65% of CA consumers are concerned that laws that force higher pay for restaurant workers will drive menu prices higher. [3]

So, we will watch California carefully, but unfortunately, the stage is set for a sales and earnings drag there. Special visibility will need to be worked for the franchise brands, as most public brands do a poor job of reporting franchise store economics.


What’s up with the rash of C-Level Turnover?

In the last two months, there has been a lot of turnover at the restaurant C-Level. Turnover has variable effects on restaurants. For some, the entire corporate focus and structure changes. It is high anxiety for staff. Of course, change is not always a bad thing per se, especially if it is a part of a new investment at the organizational renewal.  Other kinds of turnover are more telling, such as when Kelly Valade resigned after only 8 months at Red Lobster; they never were able to get another CEO again. Here is a sample of recent turnover:

  • Swig CEO Rian McCartan departed on March 29.
  • Dave Graves departed as president of Pizza Hut US, on March 22
  • Papa John’s CEO Rob Lynch departs for Shake Shack CEO opening, on March 27
  • Smashburger names Denise Nelsen, former SBUX Ops executive, as CEO
  • Francis Allen is stepping down as Checkers&Rally’s CEO, on April 4

I have a behavioral momentum/wave view of some things and thought earlier when prior Wendy’s CEO Todd Penegor was shown the door after 8 years in January that would open the turnover doors. I asked my friend, Kevin Stockslager, Partner at Wray Search for his expert analysis. Stockslager noted:

“Turnover was expected to be high in 2024. Reasons include that the industry is still reacting to the massive changes from COVID. In addition, the sophistication in industry technology has caused firms to shift to leaders capable of enhancing this area of the business. While conditions have stabilized a bit, there is still some economic uncertainty which tends to result in leadership changes. Finally, C Suite leaders operate in an environment of many different stakeholders. Differences in short-term goals and philosophy versus long-term often result in leadership changes.’’

The effects of this C-level surge will be fascinating to watch. And the old adage from the business development wizards of the management consulting industry is to give a new CEO 180 days for break-in and familiarization before making marketing calls. The same might be true here.

Mysteries of Franchising Explained: Big Money in Franchising: Scaling Your Enterprise in the Era of Private Equity

Amazon Link: https://a.co/d/8YZFwDn

My friend Alicia Miller NACD.DC, CMAA, CFE is a true master of franchising: as a former multi-unit franchisee and founder/Managing Director of Emergent Growth Advisors, she has worked and seen franchising from every angle. She is an expert on how Private Equity has entered and maximized investments in various segments of franchising. The book discusses PE firm’s motivations and management, operating partner career tracks, valuation philosophies, and motivations of investing in a whole brand versus as a franchisee of a large brand.

The book will be an excellent reader for both investors and franchise operators as each has roles in mixing in the franchise/private equity universe. I strongly recommend it, and it is now available on Amazon (see link above) or on the Emergent Growth Advisors website,  https://www.emergentgrowthadvisors.com

M&A Funnel

At the beginning of April, two casual diners, were for sale or soon to be for sale: Bob Evans (from Golden Gate) and Red Lobster (Thai Union). Both brands are in a weak position. Benihana was sold in March for 5X to The One Group.  On April 6, the WSJ drug up last year’s prior musing of the Jersey Mike’s founder that HE MIGHT LIKE TO SELL. I hesitate to report this as new news. More later no doubt.//

About the author: John A. Gordon MAFF is a long-time restaurant analyst and management consultant with 47 years in the industry. He founded Pacific Management Consulting Group in 2003 after 20 years in restaurant staff operations and financial analysis, FP&A roles. Since then, he has specialized in complex brand, earnings, and organizational investigative engagements of all types. He is a certified Master Analyst of Financial Forensics.  He can be reached at 858 874 6626, or jgordon@pacificmanaggementconsultinggroup.com.

[1]   Blended LSR and FSR, per BLS Reports in February.

[2]   Id.

[3]   Nations Restaurant News, Californians Pull Back, Lisa W. Miller, April 1 2024.

Restaurant Business – Hype Aside, is Panera Exempt From California’s Wage Bill?

News analysis: The controversy involving Panera Bread franchisee Greg Flynn may be moot, but the exemption baked into the impending fast-food wage remains unexplained.

By Lisa Jennings and Peter Romeo on Mar. 08, 2024

Legal experts say more clarification is needed on the exemption for bakeries in AB1228.

California Gov. Gavin Newsom is facing allegations that he showed favoritism to Greg Flynn, a political donor who’s also the nation’s largest operator of franchised restaurants. At issue is whether a portion of Flynn’s portfolio was shielded from a 25% increase in California’s minimum wage for fast-food workers that takes effect April 1, a (perhaps overblown) controversy that centers on a key question:

Why is there an exemption for bakeries written into the law setting the new minimum wage of $20 an hour, and who does it apply to?

Flynn has stated that he won’t claim any exemption and will ensure that employees of his 24 Panera Bread bakery-cafes in California are paid at least the new minimum fast-food wage, rendering the matter virtually moot. Yet the firestorm rages on, with a social media tag known as “Paneragate.”

It’s a byproduct of the already contentious legislation creating a fast-food wage in California, known as AB1228. In addition to setting minimum pay for most fast-food workers in the state,  the bill creates a Fast Food Council that will determine future wage increases and have a say on workplace standards. It was enacted last year after a three-year pitched struggle between organized labor and the restaurant industry. The warring parties eventually struck a compromise at the instigation of Newsom.

The bill targets limited-service chains with more than 60 units nationally. But tucked into the law’s definitions is also an exemption for businesses that, as of Sept. 15, 2023, operated a bakery that produces and sells bread as a stand-alone menu item.

On its face, the exemption appears to apply almost exclusively to Panera Bread. Early on, it was termed the “Panera exemption.”

Behind the scenes, sources closely following the legislation speculated that the carve out was designed to specifically benefit Flynn, a sometimes resident of San Francisco, where Newsom was previously a two-term mayor. Flynn has also been a donor to the governor’s campaigns in the past, and he and Newsom also attended high school together, but the governor has said the two didn’t meet until after graduation.

Flynn’s company operates more than 2,600 restaurants across the country, including units of Pizza Hut, Taco Bell and Wendy’s. His holdings include a significant portion of the Applebee’s casual-dining chain. The only limited-service brand his company operates in California, however, is Panera. Flynn Group owns 24 of Panera’s 188 locations in the state.

Individuals involved in the negotiations that resulted in AB1228 have refused to reveal what happened in the closed-door sessions. But some acknowledged they were surprised by the Panera exemption, saying it was presented to the negotiating group as a fait accompli as they started the bargaining. Indeed, the carve out was included in an earlier version of the bill, when the legislation was known as the Fast Act.

At least one participant in the negotiations expressed anger at what was viewed as special treatment for bakery-cafes and indicated that the provision was never on the table during the negotiation sessions.

Flynn has stated emphatically that he never asked for a carve out, saying his input was limited to suggestions to the governor’s staff that fast-casual restaurants be differentiated from fast-food places. He has declined requests for further comment.

Alex Stack, a spokesman for Newsom quoted in The New York Times, called the controversy “absurd,” saying the governor never met with Flynn about the bill.

Immediately after signing AB1228 into law, Newsom was asked why an exemption for bakeries was included in the legislation. The Democrat dismissed the provision as an example of “sausage-making” and moved on to the next media question.

State Republicans, however, see it differently. Last week, a group of lawmakers sent a letter to California Attorney General Rob Bonta asking for an investigation of what they described as a “pay-to-play” deal. Bonta’s office reportedly acknowledged receipt of the letter but did not immediately respond.

“If the governor helped exempt one of his largest political donors from a bill that harms small businesses, the people of California deserve to know,” Republican Assemblyman Josh Hoover said in a statement. “Our leaders cannot be allowed to hide behind the veil of legislative ‘sausage making.’ They must be held to a higher standard.”

Newsom’s spokesperson said the governor’s legal team had reviewed the bill and that Panera Bread would actually not likely be exempt from the law because the fast-casual chain makes its dough off site and ships it to units for baking. Yet the bill says California will rely on the definition of a bakery that’s included in a voluminous description of most U.S. business types by the federal government.

That characterization essentially says a bakery is a place that produces bread, without defining “produces.” Elsewhere in the code, a retail bakery is defined as a place that produces or processes bread.

Panera officials did not respond to questions about the bill or its bread-baking procedures.

Observers in the legal world agree the legislation is ambiguous.

Los Angeles employment law attorney Anthony Zaller said the governor’s office is likely taking the stance that Panera is not exempt in part to move on from the issue.

“There could be an argument that ‘producing’ does not mean that the establishment needs to take all of the steps in making bread,” Zaller said. “But given that AB1228 does not define the term ‘producing,’ it would ultimately be left up to the courts to define the scope of this term, unless the legislature amends AB1228 to provide further clarification.”

Others say the issue is a potential pain point for Panera Bread, a part of the larger Panera Brands group that’s expected to be sold to the public possibly later this year. Panera has been a leader in shifting to less processed and fresher menu options.

“One issue is, as there is more discussion about this, the ‘secret’ about Panera’s bread will get out,” said consultant John Gordon, principal of Pacific Management Consulting Group in San Diego. “Panera has fresh dough manufactured somewhere else and then shipped in to each store. It begins to knock down the ‘fresh bread quality’ moniker a bit.”

Wray Executive Search – Restaurants: 2024 Comes Into View

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

Happy New Year to all! 2024 has begun and everyone has been looking to the new year and the future for restaurant planning and operational execution for some time. Corporate budgeting begins in earnest in August typically, and marketing event planning has to stay 2-3 windows ahead at all times.
We still have Q4 2023 earnings to hear, but based on surveys, conversations, and reports at ICR 2024 that just concluded, we have some idea of what is coming. Master Card Spending Pulse reported restaurant sales were up 7.8% year over year, for the period November 1 through December 24, 2023, the highest in their survey category mix.  This does not strip out price or mix inflation of course, but there is reasonable hope that the traffic residual was positive. The last week of December was also reported to be strong. US stock companies reported demand resilience, notably Darden (DRI).  The exception was Jack in the Box (JACK) which noted mixed consumption trends at lower income cohorts breakfast and robust competitive activity.[1]
In Q4, International does seem to have the cluster of downside reports, with MCD, SBUX, and PZZA calling out Middle East, China, and Europe softness. PZZA noted international was -6%.[2] In the US, past January 1st, we understand that the first week of January sales were softer. [3]
Is Optimism Warranted?
The overall operator and investor tone at ICR was one of cautious optimism. Brand operating margins are creeping closer to 2019, and food commodity costs are believed to be moderating after two extremely different years. Some brands, both Domino’s (DPZ) and now Papa John’s (PZZA) have announced new operating models (PZZA) or marketing partnerships (DPZ) that will be meaningful in my opinion.
Supporting this optimism, consumers are feeling better about inflation. The Federal Reserve Bank of NY reported last week that consumers believed the median 2024 inflation increase would be 3%, down from 6.8% in mid-2022.[4] And of course, the FED has signaled its intent to move to lower interest rates.
To be sure, the beginning of the year optimism is nice. The industry challenges remain, including the disconnect between our prices taken vs. food at home (grocery story inflation). And years of cumulative labor inflation are baked into the store economics model. In California, the utter disaster of AB1228 [see more discussion below] is about to hit  QSR operators with a directed $4 wage hike all at once by April. Judging by the JACK management commentary at ICR, they do not yet have a sophisticated solution. As one PE investor noted, today’s interest rates are up 5 full percentage points over 2022 and earlier, but the industry has managed much higher interest rates than this in the past. [5] “These rates are not all that bad”, said Amy Forrestal, Managing Director at Brookwood Associates. “ We got used to a period of low rates”.  That is a very good point.
Operators simply must engineer superior brands with great economics to cover the  CAPEX buildout costs [which are up 30-40% from 2019]. Franchisors must be adept and flexible enough to create variable unit prototypes to maximize market-specific ROI for franchisees who will always be sensitive to the initial buildout.
ICR 2024 was full of stories of individual brands, both public and still private, that were making use of their values [not only prices] but experiential benefits and new organizational and marketing alignments. More notes on that in the next issue.
Restaurant IPO and M&A Notes
Despite the higher interest rates, much M&A activity can be seen already. Pinstripes, a 13-unit chain of food and bowling centers entered the NYSE on January 2, via a SPAC acquisition vehicle. It is expecting 2024 revenue of between $185M to 195M and adjusted EBITDA of between $30-33M. It presented strongly at ICR. Then, later in the year, FAT Brands has solid interest in the IPO of its highly profitable and growing Twin Peaks, casual dining brand.
Then, in a surprise move announced Tuesday, January 16, Burger King franchisor RBI announced it would acquire long-time public franchisee Carrols (TAST) for $1 billion and sell the stores to smaller franchisees in the market area. This strategy was mentioned recently by Executive Chair Patrick Doyle, to get franchisees closer to their stores.

And in a final divestiture move announced Tuesday [not so much of a surprise, really], the operator of Red Lobster, Thai Union Group, has signaled that it plans to exit its Red Lobster minority ownership, citing,” prolonged negative financial contributions to Thai Union and its shareholders via the Red Lobster investment.  Red Lobster has recorded a $19M loss to date and a $530 M non-cash impairment. Thai Union paid Golden Gate Capital Group $575M for a minority stake in 2020.   [6]  

Food Price and Commodity Cost Details for 2024

Definitely better news in 2024. Most US food forecasting starts with the USDA, Economic Research Service. Here is what they had to say about 2024:

     “In 2024, all food prices are predicted to increase 1.2%…Food at home prices are expected to fall .6%… while food away from home prices is expected to rise 4.9%.” These are decreases from the 2023 levels. [7]

In December, the food at home actual was 1.3%.  Full-service food away from home was 4.5%, and limited-service food away from home was 5.9%. So this is where our “value gap” may be coming from—along with reminders everywhere to tip!

Our last “normal “ year was 2020, when both food at home and food away from home rose about the same, 3.4%. Perfectly in balance then. Since then, the gaps have been huge.

My preferred Commodity Analyst friend and partner is Datum FS, Mr. David Maloni. He tracks and provides commentary on all major foodstuff and supply chain topics. Right now his December and January 2024 food market basket value is tracking just below a year ago.   Suggest you follow his newsletter for weekly commentary.

Hotspot Highlight: Not California Dreamin’   

While the wage inflation (AB1228) targeting ‘fast food’ restaurants in California will hit officially in April 2024, some operators have moved more quickly in implementing the $20/hour minimum wage. Expect that there will be wage compression throughout these restaurant chains: more tenured employees now making $20 or more such as shift supervisors or culinary will feel they need an upward adjustment. Therefore it will be more than just entry-level employees being affected. And it is entirely likely that other restaurant chains—fast casual and casual dining operators –will feel upward hiring restaurant wage pressure from this as well. The true authors of AB 1228—two Labor women from California targeted fast food because they disliked franchisors and franchisees so intently and believed they were abusing workers—but did not care if there would be spillover effects.

Several things are tragic about AB1228 developments. One is that the Governor approved spiking the wage from $4 at once to $20, without any adjustment period. [8]This was a result of the egging of SEIU and even the collaboration of the IFA, Matt Haller, personally, and the National Restaurant Association. IFA/Haller and the NRA were brought in as “color” to prove the restaurant industry as a whole supported this “deal” with the Governor. Nothing could be more false. No California franchisees except two McDonald’s corporate franchisee ‘friends’ were involved.   So this was a midnight deal.

The Governor is materially to blame, as are SEIU and the California Labor Women. [9]The Governor has owned restaurants in the past and still owns a winery. Certain Democratic legislative members blindly followed SEIU’s pressure. IFA’s upside in this midnight run is impossible to understand.

The other tragic thing is that jobs and the tax base will be lost. Two Pizza Hut franchisees have already notified they will terminate over 1100 employees.  New restaurant construction can’t possibly hit the required hurdle rates with all these negative factors underway.      

The outsized negative impact on JACK as a consequence

Unfortunately, Jack in the Box  (JACK) will receive the chief negative consequences from this. With app. 100 company units in California, they will see company margin hits, so they are motivated to take price actions and use technology to improve labor scheduling and the like. They will need to model this because franchisees typically follow what the company has tested and proven—one of the reasons why company stores are needed in any franchise organization.

The issue at the moment is JACK reported weaker trends in lower income cohort breakfast spending at ICR.  And it is still dealing with a messy acquisition of the Del Taco brand. It just announced [unbelievably in my view] that the Del Taco franchising would be decremental to earnings until 2027. The reason is the company stores they are selling to franchisees made more money than the royalties they will be getting. Until 2027 they project.  And they are raising capital spending in 2024. So JACK management has its hands full.

More to come…….

About the author:  John A. Gordon is a long-term restaurant industry veteran with 47 years of operations (6 years), corporate staff—financial planning and analysis (20 years), and 21 years via my founded restaurant consultancy, Pacific Management Consulting Group. Pacific works complex brand, financial analysis, and organizational reviews. John can be contacted anytime at 858 874 6626, jgordon@pacificmanagementconsultinggroup.com.

[1]   Sourcing Hat Tip: Sara Senatore, Bank of America Note, January 10, 2024.

[2]    Sourcing Hat Tip, Lauren Silberman, Deutsche Bank, Note, January 12, 2024

[3]   Hat Tip: the great Michael Halen, Restaurant Analyst, Bloomberg.

[4]   WSJ, January 12, 2024.

[5]   Hat tip: Amy Forrestal, Managing Director, Brookwood Associates.

[6]   Restaurant Business Online, Jonathan Maze, January 16 2024.  

[7]   USDA ERS paper, December 21, 2023, Morgan S. Sweitzer, Analyst.

[8]   Most governmental cost mandates have a phase in period, not here.

[9]   Contact me directly if you want to more about this story.