John Gordon, Restaurants: Big Bets Underway, July 2024

Restaurants: Big Bets Underway

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

The restaurant universe has always been dynamic, variable, “up and down, back and forth,”[1] exciting, hard to predict, characteristic of individual brand booms and busts. However, it always remains investible year after year; there is always something to do to react to or prepare for the next cycle.  

The summer of 2024 to date has been an amazing time. We have the most consumer,  perspective, investor, restaurant history, data, and systems information that we ever have had. We are still being rocked by the Pandemic. We should be overjoyed that we survived the Pandemic, and many foundational factors have improved. But time waits for no one.

There is always the battle between short-term interest, benefit, and actions, and long-term interest, benefit considerations, and actions. It is up to the best CEOs Boards, and management teams to navigate that line. Right now, we have a lot of big bets underway.

Current Consumer Environment Weak

The current consumer environment is on edge about all kinds of things. The political news of late, President Biden’s withdrawal from the race, and news from the GOP convention is an influencer. So the fact that even QSR restaurants are considered a “luxury” by some is telling. Significant Is the fact that restaurant pricing hasn’t slowed up much and is still exceeding grocery store inflation by 400 basis points[2]. That is not helpful. Part of the price problem is due to the heavily franchised state of many brands; the individual franchisee has to cover OPEX and CAPEX costs and meet remodeling and new unit growth standards set by the franchisors. They do not have the same access to capital that the franchisor has.

Looking at June/July, consumer spending in restaurants is not the best, but not a disaster. Some brands/segments are better off. Sara Senatore at Bank of America has reported the Bank of America credit data and Bloomberg Second Measure, which track debit and credit card activity, among other indices. Median consumer spending was up 2.2% in June, versus 5.0 % in May. IT IS NOT A NEGATIVE VALUE, but momentum went side to side. The index was up in May. Recent restaurant spending spikes occurred in December 2022 and 2023, with generally descending values through each year. Bank of America data showed full-service restaurants as a whole remained positive and grew slightly to plus 1.8%. Fast casual was positive but marginally down in June. (see Chipotle (CMG), Shake Shack (SHAK).

QSR (less pizza) fell from .1 % positive to  -1.4% negative. QSR July spending for a 6-day month shows a 1.1% deterioration.[3]

The overall economic backdrop remains the same. Despite a strong economy and job growth, usually a prime driver of restaurant sales, reported and expected same-store sales (SSS) remain depressed for many brands. Note total sales are up.  The University of Michigan Consumer Confidence number last month fell to 66, versus app. 100 in 2019. Sour moods and perceptions hurt us.

“Houston we still have a problem”: Too Many Restaurants Continue

While there is no central coordination in this vast industry, and capitalism supports growth, the US still produces too many restaurants versus population growth. Still. The Bureau of Labor Statistics produces the unit count growth (both chains and independent), and the US Census Bureau produces the population growth.

US population growth has been very modest over the last decade and 3 years. The Census estimates show population growth of only .98%, not quite one full percentage point from the 2023 year-end versus 2019 year-end projected.[4]  

At the same time, the number of restaurants in the US grew from 654,217 in 2019 to 711,15 at year-end 2023, a simple average growth rate of 8.7% over that period. [5] 

[Yes, independent restaurants are included, no these are not CAGR numbers but those can be run.]

Naturally, it is hard to get US SSS traction with this as an additional limiting condition. That’s why international growth (Memo to Darden $DRI: you’ve got to!). New brands will get consumer attention (see Cava $CAVA). All brands need to have powerful unit economics and differentiators that speak to the desirable core and aspirational guests.  In my opinion, the onus falls to public brands and especially franchisors to manage unit growth numbers; the US unit growth expectations need to be measured. 

The McDonald’s Big Bet in the US

McDonald’s takes the stage prominently always because it is the US’s leading QSR brand, it has built management systems, brand marketing, and identity; along with economic success over time. Many of its franchisees have prospered and grown as well. McDonald’s has raised the issue for the last six months that there would be sales softness in the US, and softness with international franchisees due to global events and political backlash. They were most concerned with low-income consumers, especially those under $50K in household income. Eventually, this softness and McDonald’s initiated an industry price war.

So McDonald’s came up with a US $5 “Meal Deal” priced at $5 nationally, with some high-cost markets and territories at $6, which kicked off in late June.  Unfortunately, compared to the great creative and product work done in 2021 and 2022, in my opinion, it was an offer without pizzaz, not smashing. It did not have much of a creative or social pop. There were no creative products. It was cast as a 30-day LTO, but that may expand. McDonald’s did not design a bar-bell approach with products and pricing. It seems to me it was just communication that McDonald’s has lower prices.  To its credit, McDonald’s later rolled out a new sauce and an MCD Smoky BLT Quarter Pounder (not available after midnight[6]).  

Of course, virtually every QSR brand was discounting too, many before MCD.

So we’ll see. There are varying opinions if this LTO should be kept longer. The franchisees I have talked to speak of heavy negative mix shifts, traffic improvement of some amount, and SSS either slightly up or down overall. The problem with this is even a small sales increase will likely lead to low or no profit flowthrough. Negative mix shifts always should have been considered. On the upcoming call, McDonald’s executives will talk to franchisees “cash flow”, and EBITDA-like numbers, and that they had a traffic uptick. The more significant issue is what does MCD US do to fix this price perception problem in the intermediate term. I hope it involves better, more sophisticated marketing, and hope that MCD product development can get new product new news out into the mix.

Meaningful M&A Breaks Out

Restaurant Companies react in all kinds of ways to the environment.

Darden (DRI) announced a not-unlikely acquisition of Chuy’s (CHUY), the Tex Mex southwestern-based company, in an all-cash deal of $605M in cash. The stock price offered was a 40% premium the the pre 60 day trading value. The EBITDA value is appx. 10.3X. Very quickly, Darden announced $15M in likely synergies. CHUY AUV is $4.5M and restaurant margins of 20%. Total acquisition costs are projected to be a hefty $50 to $55 million. Darden expects that the acquisition will add 12 to 15 cents/EPS share by 2027.

Investors and analysts should not be surprised by Darden’s portfolio management. It is always more efficient to buy a brand with potential, rather than build it from scratch. It is what Darden does. The question always is what kind of growth CHUYs can attain, synergies and how quickly can the acquisition costs be amortized, and get to free cash flow. And how does the new brand square with core and aspirational Darden guests? Is it expandable to the numbers necessary? For the industry, this is more consolidation into powerful casual companies. Think of Darden’s marketing, site selection, and balance sheet. However, like other casual diners, its sales have been soft.  Uplift will be necessary.

Another interesting M&A report broke Friday that JAB/Panera was lining up to sell Caribou/Einstein/Brugger’s Bagels, Noah’s New York Bagels/Manhattan Bagels. JAB made these acquisitions in a coffee lead acquisition phase in XXXX. The deal's EBITDA value was reported to be $150M (based on 2000 total worldwide units, including 800 Caribou units in the US), and a hoped-for $1.5 billion.

We don’t have financials or international unit counts. US franchise disclosure documents are useful. So anything is possible and potential. However, we don’t get the reported logic that JAB wants to sell the coffee/bagel brands BEFORE that of a listing, IPO, or otherwise of Panera. The listings could crowd out demand or influence multiples in an unfavorable way. Panera is the jewel. More to ponder and watch.

More: Starbucks has picked up an activist: Elliott Investment Management.

It was logical that pressure would be on SBUX before long, what with its US and China sales problems. And its store margins are down, due to dramatic labor and benefit investments and OPEX/CAPEX for new equipment to realign store workstations. SBUX has socio-political perception problems in the US (in the wake of the just concluded SEIU battle and internationally in some markets due to the crazy perception that Starbucks was influencing US foreign policy in the Gaza war. Starbucks has been reacting to the waves of business, consumer, and store economic changes from the Pandemic. Then, in the fall of 2023, US guest frequency fell off in some Gen Z cohorts due principally to price and political sensitivities.

See my quotes in The Deal on July 12, 2024, relative to SBUX problems and potential activist investors. I thought someone, but not Paul Singer.  He was busy at Southwest Airlines and never had a retail multiunit campaign other than Barnes and Noble, which it acquired in 2019.  Barnes and Noble are on the mend with a UK bookstore CEO as the joint combination book entity CEO. No restaurant engagements were seen.[7] Its investments are all over the business and a whirlwind of sectors. Elliott has a few hundred employees who are no doubt good spreadsheet people and can envision strategy. Starbucks is talking to them, without Howard Schultz on the Board.

P&L Notes Seen

In watching earnings results at Pinstripes, the company provided commentary that heavy startup costs, particularly labor affected company earnings. Large amounts of new employees are hired at company-owned concepts—and franchise brands—during the early ramp-up period. It’s been my long observation that such overstaffing—even after training--might not be necessary. Yes, employees will quit and others weeded out by hours of control. However, employees working in too easy of an environment might foster unrealistic expectations later. An area to think about.

US Restaurant metrics: Restaurant Research has published a brief note with good news. It noted that the top billion-plus brands had a small EBITDAR unit improvement to 18.6%  in the second half of 2023.  Franchise leverage on the whole was not stretched, although some of the recent wave of restaurant Chapter 11s are not in the data. Write to Restaurant Research for more of their valuable data.    

 About the author:

John A. Gordon MAFF is a long-time restaurant analyst and management consultant. With unit operations, 20 years of corporate staff experience, and 21 years via his consulting firm, Pacific Management Consulting Group, he has the knowledge and gravitas to work complex analytical engagements efficiently for clients.  Call him at (858) 874-6626 or email, jgordon@pacificmanagementconsultinggroup.com. 

[1]   Credit to Sara Senatore, Bank of America, July 2024.

[2]   There is a line of logic, that deserves further review, is that the “price paid” survey is overstated and is influenced by tipping and sales tax. Hat tip: Wally Burkus, Restaurant Research, June 2024 

[3]   From Sara Senatore security analyst reporting July 2024  

[4]   Census Bureau, www.usafacts.org

[5]   Bureau of Labor Statistics, year end 2023 tables.

[6]  MCD website.

[7]   See a summary list of historical Elliott investments in Wikipedia, Elliott Investment Management.