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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.
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