Wray Executive Search – Restaurants: The Need to Look Under Every Rock

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

Moving now into the seasonally higher sales Quarter 1 period, all things considered, the restaurant industry has recovered well. Consider that three years ago we were at a dead stop; only a few drive-thru concepts had any traffic; we were in the process of laying off the vast majority of our workforce; and some brands were almost out of money. Now, the industry is mostly solid, with some spot softness in pizza and some recovering brands.  However, a legacy of problems from the Pandemic follows us today and leaves us with imperatives for action.

Clear Imperatives Looking Ahead: I’ve termed this as the need to “look under every rock” first, versus going to price first. This is not a foreign concept to some. Some examples follow:

Price/cost/consumer/food at home relationship:   We experienced [worldwide] restaurant margin dollar and percentage erosion from Q4 2021 on due to double food and labor rate inflation. This rate of cost increase is forecasted to moderate in 2H 2023. But our advantage versus grocery store inflation, solid since 2021, is quickly eroding. This means that we have to get more out of the P&L and CAPEX efficiencies quickly other than price.

Capital Inefficiencies are predominant now: With Interest costs up 500-600pts over the last year, construction and transportation labor costs up and shortage of raw materials for equipment have driven up costs of restaurant new builds and remodels. On its recent earnings call,  Darden noted restaurant construction costs, especially, FF&E, were up 25% vs. 2019.  That means that site and proforma planning must be spot on no one can be stuck with a bad site with high a high cost and a bad ROI.  This also has implications for franchisors trying to meet a pre-set development target with franchisees that may or may not have funds or financing.  Some leading franchisors have done work in developing alternative store prototypes and even dedicated, lower-cost backstopped loan pools.

More work in marketing messaging, testing, and product execution is needed: Unfortunately, there are many hidden costs with the marketing discipline, predominately that discounting is not a P&L line item and that marketing campaigns and strategies done badly are only broadly apparent over the long haul.  For example, a Tier 2 QSR operator spent vast sums from their marketing fund and franchisee OPEX gearing up for a heavily discounted chicken sandwich, that flopped for operational complexity and timing reasons. No one saw the immediate costs. These costs can be avoided, and it lowers P/L stress on both the franchisor and franchisee.

Rebuilding and Leveraging The Staffing Model  After the mass cuts of 2020, studies show we as an industry burnt relationships with a lot of our laid-off staff, both hourly personnel and junior staff management. Later polls showed they would not consider coming back to work for us. Some brands, notably, Darden, built relationships and continued benefits for both hourly and temporarily laid-off corporate associates. Darden flexed back to full staffing much more quickly.

We still have holes to dig out of. As Restaurant Business Online reminded us in Late March, many restaurant brands count the value of a stable, high-performing unit general manager as the number one factor that explains store profitability more than any other factor, including location. So, coaching, motivating, and designing new plans for GMs is vitally important. At the same time, keeping a promotion window for GMs and having a good quality learning work environment is important for retention. While all are important, some needs are more critical than others, and creative spillover benefits.

HEARD, AND SEEN:  Chapter -11s and Small Acquisitions both picked up in April. X Burger King Zees, 1 MCD, 1 PLK Zee. And Corner Bakery all file Chapter 11. Small acquisitions show some money is available: Main Squeeze Juice. Port of Subs acquired by PE. MCD’s huge HQ consolidation is not clear even today, but US field offices are now all virtual. The subway/DAI sale/auction is still underway. Note from an insider: interest and reaction to date has been less than hoped; families are willing to settle for a lower price than first hoped.  Total EV might be $7B or less, versus the $10B initial goal. The Subway US unit count declined again.  Darden’s strength in the casual dining segment sets the curve.

More: waste of marketing ads/GRPs seen in some hours on cable TV where 4-6 identical spots run in 30 minutes. That is the fault of ad-buying shops that can’t manage the spot inventory.

 

About the author: John A. Gordon is a long-time restaurant analyst and management analyst, with 45 years in the industry. He is a Master Analyst of Financial Forensics (MAFF) and works in complex operations, managerial finance, and brand strategy/investigation for clients. He routinely supports investors, restaurant operators, franchisees, Wall Street entities, and attorneys in many roles. Please call him at 858 874-6626, or jgordon@pacificmanagementconsultinggroup.com.

Nation’s Restaurant News – Is The Pizza Industry In Trouble Or Normalizing After A Long Pandemic?

Papa-John_s-Shaq-a-Roni-Pizza.jpegPapa Johns
Both Papa Johns and Domino’s are struggling with sales and traffic, though Pizza Hut’s traffic has spiked recently: is anyone really winning the pizza wars?

Joanna Fantozzi | Mar 17, 2023

Pizza — the unofficial food of the COVID-19 pandemic — experienced an explosion of sales growth in 2020 and 2021 as the go-to delivery food of choice. But what goes up, must come down and by 2023, two of the pizza industry giants — Domino’s and Papa Johns — are now struggling with faltering traffic and sales.

At the end of 2022, both Papa John’s and Domino’s reported just-barely-positive same-store sales (around 1% each), with negative traffic boosted mainly by increased menu prices. With tales of food inflation woes, delivery driver shortages, and lack of demand as people head back to dine-in restaurants, the pizza high has come back down to Earth. But does this spell trouble for the pizza industry in the long-run, or is it just a normalization after a period of unusual activity?

“The big pizza players got a lot of same-store sales growth in 2020 and 2021 and they’re trying to hang on to it as much as they can,” Peter Saleh, restaurant analyst at BTIG (which works directly with Domino’s Pizza) said. “As the economy normalizes and consumers get back to their regular routines and start going out to eat more [things will change]. I think that’s what we’re dealing with rather than a function of ‘something is wrong in the pizza space.’ They had really strong gains for two years and maintaining that is challenging.”

Looking at the big picture, the major pizza players have all seen major growth since the start of the pandemic: Papa Johns saw the most change at 30% same-store sales growth over the past three years, Domino’s was up over 14% since the start of the pandemic, and Pizza Hut’s sales grew more modestly at approximately 8% on a three-year basis, despite the brand’s comparatively strong fourth quarter in 2022.

Though it’s likely too early to tell, it’s not out of the question that Domino’s status as top dog could eventually slip, especially since Pizza Hut had relinquished its market share as top pizza chain to Domino’s only six years prior. The process of Pizza Hut slowly losing market share to Domino’s digital omnichannel capabilities occurred over the course of nearly a decade.

Over the past several quarters, Domino’s former CEO Ritch Allison and new CEO Russell Weiner have pointed toward delivery driver shortages as one of the top concerns for the company. Domino’s has historically differentiated its brand from competitors by resisting the urge to partner with third-party aggregators: a decision that has resulted in slower delivery times, overworked stores, and a renewed company focus on carryout (like the early 2022 deal that offered customers $3 back on their next visit if they picked up their pizza rather than option for delivery).

But now, Domino’s is not just blaming the staffing shortages: During the company’s fourth quarter earnings call last month, Russell Weiner pointed to softened delivery demand, and rolled back the company’s earnings and growth expectations for the rest of the year, which analysts did not take a good sign of the company’s near-future.

“It was incredible and somewhat surprising when I saw that Domino’s had pulled back its earnings and new unit growth projections,” John Gordon, founder of Pacific Management Consulting Group said. “[…]It was a very large shift, but in some ways a logical conclusion, looking at some of their trends over time.”

If Domino’s delivery woes continue in future quarters, could they bite the bullet and start partnering with aggregators? The jury is still out on that and analysts appear to be split on the issue.

“Domino’s made a strategic decision not to partner with aggregators but I think they remain open to changing their minds,” Sara Senatore, securities analyst with Bank of America (which has worked with all three pizza chains) said. “[…] There can be no question that aggregators have been one of the best solutions for operators. It’s a model that works so well.”

Both Papa Johns and Pizza Hut have touted their third-party delivery partnerships as a boon to their financial performance. Quarter after quarter, Papa Johns CEO Rob Lynch has credit third-party aggregators with helping to boost some of the post-pandemic staffing shortages and helping them to keep up with delivery demand. However, just like Domino’s, Papa Johns traffic has been struggling recently, even as sales are bolstered by menu price increases. This could simply be a case of Papa Johns settling into a new normal after successfully climbing out of the John Schnatter-sized hole in 2018 and 2019.

In fact, Sara Senatore thinks that right now, Papa Johns might be “winning” the pizza wars, even though all three brands are in it for the long-haul.

“Papa Johns has done a great job of partnering with aggregators,” Senatore said. “Cumulatively, they seem to be the one with the most assets and are staying abreast of where the consumer is. […] The momentum of Papa Johns has faded a little bit now as the third year-removed from their comeback story.”

But what about Pizza Hut? Although Yum Brands’ U.S. performance is typically bolstered by the strong Taco Bell, Pizza Hut’s Q4 same-store sales were up 4%. The boost in sales and traffic for the third-place brand could be tied at least indirectly to Pizza Hut’s expansion of its third-party delivery partnerships and delivery promotions through aggregators in Q2 and Q3, which gave Pizza Hut a much-needed boost.

“Aggregators serve two purposes: they are helpful in getting operators to meet demand, especially when the labor market is tight, but it’s also a marketing platform,” Senatore said. “The customer ordering on aggregators is different than the customer going straight to the mobile app or website. The aggregators bring in new customers.”

However, one successful quarter is not long enough to tell if Pizza Hut is taking back share from Domino’s. In fact, it is too early to tell what the long-term successes or failures of all three brands will be, especially given the current macroeconomic uncertainty. If the U.S. heads into a recession, as predicted, we could be right where we started with pizza reigning as king. Instead of people staying home because of a pandemic, they might be staying home and ordering pizza delivery to save money by dining on (relatively) cheap comfort food.

If Domino’s wants to keep their crown as number one pizza in the U.S. moving forward, they probably should focus on two things: value and menu innovation. Last year, Domino’s raised the price of its iconic $5.99 Mix and Match deal to $6.99 and changed its $7.99 carryout deal from 10 wings to eight and made it online-only.

“That’s not a very attractive price point, and the carryout $3 tip deal is great advertising for their carryout business, but the $3 is only given to you on your next visit,” John Gordon said. “For a deal like that, the customer should have gratification immediately.”

The other crucial aspect of keeping consumers’ interests alive is both menu and tech innovation, the latter of which had been Domino’s differentiator for a long time. According to Sara Senatore, Domino’s has been pretty candid about not investing in menu innovation as much as they could, while their competitors have been thriving with new pizza categories like Papa Johns Papadias and Papa Bowls, and Pizza Hut’s launch of Melts last fall—a new menu category meant to lure younger customers and compete with Papa Johns. Though, that could be changing with Domino’s new loaded tater tots (similar to “totchos”), which just launched this quarter and have already been popular with customers.

“The pizza game in the United States has always been a zero-sum game,” Gordon said. “You’re essentially just trading market share from one player to another.”

Whether the pizza industry is normalizing or real change is afoot, it might soon be time for Domino’s to swallow their pride and make the call to DoorDash.

Contact Joanna at joanna.fantozzi@informa.com

Bloomberg – McDonald’s Faces Franchisees Decrying ‘Destructive Path’

2023-03-16 21:01:17.880 GMT
By Leslie Patton

(Bloomberg) — McDonald’s Corp. is facing rising unrest
among certain US franchisees — a potential stumbling block as
the burger chain plots aggressive expansion.

Please click the link to see the full article:

https://www.bloomberg.com/news/articles/2023-03-16/mcdonald-s-mcd-faces-fed-up-franchisees-decrying-destructive-path#xj4y7vzkg

Restaurant Business – A Deep Dive Into Subway’s Recovery And Sale

A Deeper Dive: Restaurant consultant John Gordon joins the podcast this week to discuss changes at Subway, its potential sale and who will buy the fast-food sandwich chain.

Who is going to buy Subway?

In case you haven’t heard, the fast-food sandwich chain is on the market. In this week’s episode of the Restaurant Business podcast A Deeper Dive, I speak with John Gordon, a restaurant consultant out of San Diego, to discuss the chain.

Subway has hired JP Morgan to help find a buyer. Reports suggest a host of large private equity firms, including Goldman Sachs and Bain Capital, are looking at it, with a price tag of $8 billion or more. John and I discuss that sale and the price tag. We also talk about the numerous changes Subway has made over the past two-plus years and how they are influencing the company and the sale process.

I also give my thoughts on Bojangles, Wendy’s and Sardar Biglari.

Check it out.

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CNN – Why Pizza Hut’s Red Roofs and McDonald’s Play Places Have Disappeared

New York (CNN Business)For decades, bright, playful and oddly-shaped fast-food restaurants dotted the roadside along America’s highways.

You’d drive by Howard Johnson’s with its orange roofs and then pass Pizza Hut’s red-topped huts. A few more miles and there was the roadside White Castle with its turrets. Arby’s roof was shaped like a wagon and Denny’s resembled a boomerang. And then McDonald’s, with its neon golden arches towering above its restaurants.
These quirky designs were an early form of brand advertising, gimmicks meant to grab drivers’ attention and get them to stop in.
As fast-food chains spread across the US after World War II, new roadside restaurant brands needed to stand out. Television was new media not yet beamed into every single home, newspapers were still ascendant and social media unimaginable.
So restaurant chains turned to architecture as a key tool to promote their brand and help create their corporate identity.

Pizza Hut's red-roof restaurants have come down, replaced by sleek new designs.

But the fast-food architecture of today has lost its quirky charm and distinctive features. Shifts in the restaurant industry, advertising and technology have made fast-food exteriors bland and spiritless, critics say.
Goodbye bright colors and unusual shapes. Today, the design is minimal and sleek. Most fast-food restaurants are built to maximize efficiency, not catch motorists’ attention. Many are shaped like boxes, decorated with fake wooden paneling, imitation stone or brick exteriors, and flat roofs. One critic has called this trend “faux five-star restaurants” intended to make customers forget they are eating greasy fries and burgers.
The chains now sport nearly identical looks. Call it the gentrification of fast-food design.
“They’re soulless little boxes,” said Glen Coben, an architect who has designed boutique hotels, restaurants and stores. “They’re like Monopoly homes.”

Googie architecture

Fast-food restaurants developed and expanded in the mid-twentieth century with the explosion of car culture and the development of interstate highways.
Large companies came to dominate highway restaurants through a strategy known as “place-product-packaging” — the coordination of building design, decor, menu, service and pricing, according to John Jakle, the author of “Fast Food: Roadside Restaurants in the Automobile Age.”
Fast-food chains’ buildings were designed to catch the eye of potential customers driving by at high speeds and get them to slow down.
“The buildings had to be visually strong and bold,” said Alan Hess, an architecture critic and historian. “That included neon signs and the shape of the building.”
A leading example: McDonald’s design, with its two golden arches sloping over the roof of its restaurant, a style known as Googie.

A historic 1950's McDonald's restaurant in Downey, California, shown in 2015. It's the oldest McDonald's still in existence.

Introduced in California in 1953, McDonald’s design was influenced by ultra-modern coffee shops and roadside stands of Southern California, then the heart of budding fast-food chains.
The two 25-foot bright yellow sheet-metal arches that rose through the McDonald’s buildings were tall enough to attract drivers amid the clutter of other roadside buildings, their neon trim gleaming day and night. McDonald’s design set off a wave of similar Googie-style architecture at fast-food chains nationwide.
Well into the 1970s, the designs were a prominent fixture of the American roadside, “imprinting the image of fast-food drive-in architecture in the popular consciousness,” Hess wrote in a journal article.

‘Visual pollution’

But there was a backlash to this aesthetic. As the environmental movement developed in the 1960s, opposition to the conspicuous Googie style grew. Critics called it “visual pollution.”
“Critics hated this populist, roadside commercial California architecture,” Hess said. Googie style fell out of fashion in the 1970s as fast-food style favored dark colors, brick and mansard roofs.
McDonald’s new prototype became a low-profile mansard roof and brick design with shingle texture. Its arches moved from atop the building to signposts and became McDonald’s corporate logo.

Opposition grew to garish structures like this Jack in the Box in 1970.

“McDonald’s and Jack in the Box unfurled their neon and Day Glo banners and architectural containers against the endless sky,” the New York Times said in 1978. They have been “toned down with the changing taste of the 60’s and 70’s.” And with the growth of mass communications advertising campaigns, brands no longer relied on architectural features to stand out –they could simply flood the television airwaves.

Fast-food goes upscale

In the 1980s and 1990s, companies began introducing children’s play areas and party rooms to draw families — additions to existing “brown” structures, Hess said.
The rise of mobile ordering and cost concerns since then altered modern fast-food design.
With fewer people sitting down for full meals at fast-food restaurants, companies didn’t need elaborate dining areas. So today they’re expanding drive-thru lanes, increasing the number of pickup windows and adding digital kiosks in stores.

A Wendy's in 2020, an example of the modernization of fast-food design.

“We have a lot of red-roof restaurants” that “clearly need to go away,” a Pizza Hut executive said in 2018 of its classic design. The company’s new prototype, “Hut Lanes,” helps to speed up wait times at drive-thru locations.
The new fast-food box designs with their flat roofs are more efficient to heat and cool than older structures, said John Gordon, a restaurant consultant. Kitchens have been reconfigured to speed up food preparation. They’re also cheaper to build, maintain and staff a smaller store.
But in the effort to modernize, some say fast-food design has became homogenized and lost its creative purpose.
“I don’t know if you’d be able to identify what they were if they had a different name on the front,” said Addison Del Mastro, an urbanist writer who documents the history of commercial landscapes. “There’s nothing to engage the wandering imagination.”

Wray Executive Search – Restaurants: Pondering Earnings

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

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.

Wray Executive Search – Restaurants:  The 2023 New Year’s Look

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

Personnel and M&A Moves Now Abound

So, with the New Year upon us, some personnel and M&A moves are now upon us. Both McDonald’s and Wendy’s signaled people changes and new corporate reorganization charts, targeted at reducing the number of reporting pillars. It looks like the US  and International pillars will be targeted, at least at headquarters.  The CEOs indicate it will increase efficiency and improve time to market. As always the devil is in the details and we will see.

In M&A news, the earlier reported news about Darden (hat tip: Austin Fuller, Orlando Sentinel) came true: CEO Ric Cardenas noted at their ICR appearance that they were looking for a new brand acquisition. Darden itself is in fine shape, they seem to be looking for a brand to position the portfolio to changes in the consumer marketplace. So they will be looking for the best and this won’t be a rushed process.

Further, Andy Weiderhorn and FAT Brands confirmed the desire for a properly priced casual dining brand: multiples of 10X are too high.

As noted last month, there are several latent IPOs, waiting for the right market conditions.  One of the very first will be Fogo de Chao. They have desired a reentry ever since 2020 and have been waiting for market conditions. They are a strong company.

ICR 2023 Observations

I was delighted to get back to my 17th face-to-face conference attendance a the  ICR Conference, the midmarket investor, and M&A-themed gathering in Orlando. 24 publicly traded restaurants attended, with 19 pre-IPO or smaller restaurant companies presented briefly. Fitch, a ratings agency attended also. They are keen to monitor sales, free cash flow, and debt, but did not seem to have obvious restaurant sector worries.

Ric Cardenas of Darden was the obvious CEO star, who has a masterful command of the facts and the breakout room. And, GJ Hart is back and CEO at Red Robin and presented in dramatic style what went wrong there and his plan to fix it.

Operational themes noted: numerous operators are making equipment upgrades in 2023, all intended to boost BOH efficiency. Many of the smaller growth brands that presented had burger or taco themes. Third-party delivery has finally turned margin neutral, thanks to operator price increases. While dine-in sales generally are improving, fast casual companies like Café Rio and Shake Shack are working in drive-thrus where they can. [1]

What is hanging heavy over 2023 prospects is the impact of the real or supposed recession. That there has been inflation across the US consumer space is unquestioned; it’s just that it matters more to certain population groups than others. Restaurant full-service price inflation continued to be plus 9% in December’s report, while QSR was about 7%. Grocery store (food at home) pricing was still higher. [2] Via my research, I expect moderate and varied revenue results by brand and continued but deaccelerating cost pressures in 2023.  But there is more.

Interest cost  and new unit buildout cost increases are a concern to 2023 new unit development:  what to do about it

Beyond the P&L, there are other cash costs associated with new unit development and remodeling that the restaurant community needs to be concerned about. First, the supply chain has not been fixed in terms of providing new restaurant equipment. When senior McDonald’s franchisees are routinely speaking of it over time, you know there is a problem. Significantly, as confirmed at ICR and the recent Restaurant Finance and Development Conference, the cost of new unit builds is up some 10 to 15%.  And the absolute kick in the pants is that given general economic uncertainty is that the cost of funds is up nationally by 300 to 400 basis points.   This puts a strain on both company and franchisees trying to develop new units. The margin optics are poor if one compares to 2021 as a base, which had much better store results. Restaurant percentage margins are down app. 300 basis points in 2022 (versus 2021) because of the food and labor inflation that just could not be covered by more pricing or more sales.

What can franchisors do to encourage development?  

Franchisors will be challenged by this one-two punch to maintain development targets. However, there are proactive things that can be done. As Alicia Miller, Partner at Catalyst Insight Group and a true expert in franchise management optimization told me recently,

“Incentives to get a better enterprise valuation in 2024-2025 via IPOs or PE acquisitions require investments now. Franchisees need reasons to believe. Franchisors need to offer incentives to offset this additional development cost.  Otherwise, franchisees will delay, pursue lower-cost concepts, or possibly retire as options. Franchisee thirst for development is not a bottomless well.”

Some proactive moves have been untaken, such as smaller and variable-sized units (Wendy’s example), dedicated loan pools (Burger King example), and vigorous cost reduction task forces working (Jack in Box).  But I sense more will be needed to get through the 2023 squeeze.

All economic conditions change, and if the Fed and macro economy cooperates, I sense 2024 will be better.

 

About the author: John A Gordon is a long time (45 plus years) restaurant industry veteran. His management consulting firm, Pacific Management Consulting Group was founded in 2003 to work complex restaurant operations, managerial finance and strategy engagements. See more about him on his website, www.pacificmanagementconsultinggroup.com, call him at 619 379-5561 anytime.

 

[1]   Restaurant Business, 10 Takeaways from ICR, January 11, 2023.

[2]   https://www.bls.gov/news-release/pdf/cpi.pdf