by John A. Gordon, Principal and Founder, Pacific Management Consulting Group
So we are back from Restaurant Finance Conference last week where we were delighted to catch up with 2000 or so of our extended family. The same will happen in 60 days at ICR Exchange Conference in Orlando where the public traded CEOs and pre-IPO hopeful companies attend. I’ve attended both conferences for 16 years straight. In every year, there was a set of themes and critical challenges that emerged.
In my view, this year, and forthcoming years, the industry will be challenged by the bitter backbite of the Pandemic, in four key areas: PEOPLE, PRODUCT, PRICING, and PLANNING. Simply, we don’t have enough employees; we will have to struggle with supply chain problems to get product at the backdoor costs we need; the need to cover dual food and labor cost impacts make pricing a prime concern; and lastly, effective short-run and long-run corporate planning are essential for all kinds of brands. Planning will be a challenge because business and social conditions are incredibly confusing right now.
Observations at Restaurant Finance Conference
There is a dichotomy now between current restaurant-level margin deterioration driven by higher food and labor costs versus favorable balance sheet conditions. Balance sheets are strong and EBITDA has been strong for many brands [note EBITDA isn’t cash flow; lots of real cash outlays remain to be paid from EBITDA]. The issue right now we have double food and labor cost inflation impacts: RFDC M&A session moderator Allan Hickok reminded us correctly that no one present has managed double inflation. The P&L turning point was evident in Q1 2021, versus 2019 as a base.
And we have an eroding workforce. No one at Restaurant Finance had any magic solutions to make us preferred employers. Some employees can’t stand working for us. Starting wages have floated up way beyond what one would think. The key numbers to watch is average wage, staff complement, staff hired v. lost, operating hours lost. Our employee counts per store are down. And the cost of new store construction is up. The supply chain difficulties will be with us going forward, it’s a global problem affecting all businesses and nations. We can maximize supply chain operations, with specs, packaging, and routing economies but these are all that we can influence. If there are no drivers, our cost containment plans mean little. Where more creativity is needed is doing something to make our brands more employee-friendly. Talk about culture has to be manifested in action. If we have fewer and fewer employees, spreadsheets and earnings call estimates mean little. What repeatable series of small things can the company do for your employees that are meaningful and say that you care?
On the positive side, investors, lenders, and funds are available for restaurants. Only a year after the Pandemic year that is great. I asked a unit growth question at the M&A session and the panelists confirmed there was a lender/underwriting appetite for US new unit growth. But they watch margins; the lessons seen just in Q3 with compressed store margins are visible to all. The 2022 risk is that restaurant earnings dollars could erode vs. 2021 due to margins.
Where there is waste in restaurant processes, such as TV marketing discounting or coupons, companies need to consider quickly as the food and labor inflation problems are not transitory. In addition, strong new operators like Dutch Bros (BROS) are now public and are on the hunt for smaller, efficient drive-through sites. Legacy QSR operators, get smart on your site standards. Don’t make them too large. Spend time and money on loyalty and digital infrastructure via your CAPEX budget. Insure new market growth proformas are solid. If the growth pattern looks like a hockey stick, you have a problem.
Paul Brown, the Chair of the multi-concept Inspire Brands spoke and showed off their new Alliance Kitchen concept, which is a ghost kitchen-like property that combined product and equipment platforms of five of their seven brands to considerable cost and space savings.  Paul was demonstrating exactly the common support practices sharing that Inspire is charged to do, similar to his experience at Hilton Hotels. Paul was wary and said “we are good” when asked by John Hamburger when he would acquire another brand. Perhaps that should be read as ‘we are good for now and have to work what we have.’ (my wording). Inspire is a rumored eventual IPO.
Dr. Scott Gottlieb, the former FDA Commissioner, presented that with 80% of the US population vaccinated or naturally immunized, that the going forward COVID threat should decline rapidly after January 2022, similar to the UK trend. He noted that preventative COVID pills were almost on the market that would help too.
Sales Momentum, Discussion of Check/Mix/Price
Analysts do field checks, look at Black Box, subscribe to Technomic or watch its published index, look at the NRA indices, talk to specialized analysts like myself, listen to any current quarter discission on calls, and look at the federal BLS survey to detect what is going on. There are some other credit card/digital data shops that report as well. One new data source I’ve found gives us an early peek at retail/foodservice data before the BLS is released in mid-month. From the Chicago Fed, it shows we have an improving retail/foodservice trend in October which is welcome of course. It tracks declining September-October national COVID cases and deaths. We will have to confirm what the foodservice sales growth portion is because our inflation is much higher. See Table One below:
Chicago FED CARTS, Retail/Foodservice Sales Activity v. YAG
|Measure||Oct. 2021||Sept. 2021||Aug. 2021||July 2021|
|Real, X Infl.||+1.8%||+.3%||+1.5%||+1.1%|
Restaurant Pricing/Mix/Traffic: Is Price Too High?
I have had many conversations with restaurant investors who are concerned about the amount of restaurant price and average check growth the industry has taken and recorded in the last two years. Predictably, some publics have removed their average check breakouts in an attempt to avoid questions.
Some investors don’t seem to understand that when COVID hit, drive-thru brands had an increase in drive-thru sales rates to as high as 100% for a time but now slightly lower—that’s called mix—and that the number of food items per bag increased as customers ordered more. Both McDonald’s and Starbucks have talked about this consistently on their calls. Casual dining brands don’t have drive-thrus but they had to pivot to sell more take out which typically has a higher average check than in dine-in guests. So all this is called mix.
Restaurants also have had to take price—with dual food and labor cost inflation hits. Historically it ran around 3%, but now the trend is 6%. Restaurants do not like to take price naturally and many see it as a last resort.
Is the current price too high? Perhaps not! The restaurants with good feedback polling systems will know, as will marketing research and management consulting companies with the market research infrastructure in place. One simple way is to check against US food at home—grocery store inflation. Here finally, we have some good news, at least right now, grocery store inflation is exceeding food away from home inflation in 2021.
US BLS Rolling Year Food at Home v Food Away From Home Inflation, October 2021
|US Food at Home 12 mo. Inflation, October 2021||+6.2%|
|US Food Away from Home, 12 mo. October 2021||+5.3%|
About the author: John A. Gordon is a long-time restaurant industry veteran, with experience in restaurant operations, 20 years in corporate staff roles (Finance, FP&A), and via his own management consulting firm, Pacific Management Consulting Group, since 2002. He works with investors, restaurant operators of all types (large franchisees, franchisors, corporate HOLDCOs), attorneys, a sell-side restaurant team, strategy management consulting firms, and others on complex restaurant issues. He can be reached anytime at firstname.lastname@example.org, office 858 874-6626.