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Restaurants: Hoping for a Better 2025
by John Gordon
As observed at the outstanding Restaurant Finance and Development Conference (RFDC2024) last week, the question de jour was of course, what does 2025 look like. Without question, the restaurant lending community, which was present in force, was cautiously optimistic. Many felt that the concluded election, a now cumulative year 75 basis points decline in the Fed Funds Rate, the building impact of some weaker restaurant locations being closed via bankruptcies, more positive signs from lenders, and improved October sales via Census Department’s Advance Food Service Sales tracker is setting the stage for an improved 2025.
The upcoming ICR Conference will tell you more. Here, 25-30 public restaurant brands are present, along with 10-15 up-and-coming brands. I will attend as usual and will report more about brand outlook for 2025.
We as an industry want it and need a better 2025. We have continued backwash from the 2020 Pandemic. We lost a full year of normalized sales in most casual dining brands, raging double impact food and labor cost inflation, especially in 2022-2023. The industry, both in the US and international markets finally had our cumulative price increases catch up with us. We now have a negative reaction worldwide. And now, to no surprise, we have experienced a dramatic US price war, especially centered in the QSR sector. This was led by McDonald’s, which talked about sales softness for three quarters, and then finally rolled out a $5 “Mead Dea” which improved the US traffic trend, but did not generate material positive SSSs and profitability.
Fortunately, of the US publicly traded brands, we have a “Magic Six” brand group that continue to do very well: Texas Roadhouse, Chipotle, CAVA, Dutch Bros, and Wingstop. Chili’s is entering the group, with its sales momentum.
Weaknesses have been present in casual (over a lengthy period of time) and fine dining (beginning in early 2023) brands (The One Group (STKS) and Darden’s Capital Grill are the most readable results.) The weak upper end steakhouse results are contrary to prior weak periods, which illustrates the widespread nature of the negative consumer price effect.
So, to get to a better 2025, in my view, we need material catalysts. These can be more improvement.to restaurant operations, execution, service, menu complexity, and more attention to the middle of the P&L (to avoid need for more price increases).[i] We need better advertising.[ii] And more perspective to new unit placement and capital spending. Debt is higher than in the last ten years and construction and equipment costs are up over the 2019 level. Finally, better restaurant reporting metrics, by both company and franchised brands, beyond SSS and unit openings. SSS as the primary industry “bumper sticker” does disservice to the many other fundamental brand improvements underway.
Notable Notes from RFDC2024
· The debt interest rate index you have matters. Prime rate indices will reflect downward Fed interest rate changes, while a SOFR index base will not: Cristin O’Hara, Bank of America.
· Further on lending environment: “I am not going to say it is the go-go days. But we are back to banks wanting to put money out: also, Cristin O’Hara.
· Franchisee operator valuations were down in 2023 and 2024 to date. Dennis Geiger, the restaurant analyst at UBS, noted the new range is 4X to 7X EBITDA. He listed top view valuation brands as Taco Bell (number one), McDonald’s, Wingstop, Wendy’s, Dunkin Donuts and Popeye’s.
· “The period of restaurant multiples of 10-12X EBITDA are over” -- Kevin Burke, Franchise Equity Partners
· On casual dining: “The casual dining space got deeply, deeply over built.” Per Greg Flynn, CEO of the largest US franchisee group. But “There will always be a large market for sit down dining with liquor.”
· For those restaurants who are in a tight position and cannot remodel or fix equipment: “You need an account” per Dan Dooley of Morris Anderson, the restructuring firm. Dan was referring to a restricted cash account, subset of total cash on the balance sheet.
· New lingo for most desirable franchisees: a “MUMBO”—multi unit, multiple brand franchisee.
· Restaurant valuation deal multiples are” down about 30% from 2019” per Shaun Coard Bremer Bank.
· Having an OPCO/PROPCO business entity structure for a sale should yield higher multiples, per Glen Kunofsky, STNL Advisors. [iii]
· M&A Panel: for sellers, more than 50 units is desirable. This follows the traditional logic that multiple units operating in multiple markets, and EBITDA of $5 to $10 million is desirable.
October Sales Results Preview
The always useful Census Department Advance Sales for Foodservice was published last week while we were at RFDC. This is based on consumer surveys, including non-restaurant food service sales, and is seasonally adjusted. The current month advance sales are updated next month. This is a good report, on top of what Black Box, Revenue Management Systems (RMS), Placer.ai and Technomic. Black Box and RMS provide a wonderful of detail. Technomic’s research is for paid clients, but they do publish a “TINDEX” index. [1]It is a measure of foodservice activity, based on transactions, consumer visit tracking and distributor sales information.
The Census numbers generally tell good news stories for restaurants:
Table One: Census Foodservice Sales
Line Item | Oct. vs YAG | Sept. vs. YAG |
Vs. Year Ago, Month | Plus 4.3% | Plus 3.9% |
Vs. Prior Month | Plus .7% | Plus 1.2% |
Focusing on the year to changes, price increases or increased number of items ordered ran 3.8% in October and 3.7% in September. Comparing these values to the Table One year over year numbers, we actually gained 2% in September and .5% in October. That is an apparent traffic gain, small but positive.
All this is based on surveys. No chain or independent restaurants have reported sales yet. But still, as we have moved away from 5-6% price increases, things are trending better. The long-time historical Census and BLS food away price increases have trended in the 3.0 to 3.5% zone for literally decades. As we get closer to 3% and improve our execution, we may come out of this.[iv]
This will require smart brand operator and franchisor attention to cost containment, especially the middle of the P&L and remodeling CAPEX requirements.
About the author: John A. Gordon MAFF is a long-time restaurant analyst and management consultant. He focuses on complex analysis and advisory projects, and routinely works for investors, restaurant operators of all kinds, attorneys and lenders, and others who need a restaurant detailed drill down. He is a Master Analyst of Financial Forensics (MAFF) and can be reached at jgordon@pacificmanagementconsultinggroup.com, mobile and text 619 379 5561, and office 858 874 6626.
[1] See: https://technomic.com/tindex. Last retrieved Nov.17 2024.
[i] Think about Starbucks (SBUX) where the stores are deliberately kept cold temperatures, summer, and winter, even though 76% of the drinks are cold beverages.
[ii] Think about the effect of the creative and customer catching media at Domino’s as an example.
[iii] A OPCO are the restaurants themselves, with a market rent applied; a PROPCO is the owned read estate, with the same market rent as above applied as a revenue item.
[iv] Micke Halen, Senior Restaurant Analyst at Bloomberg, told me exactly that at RFDC2024.