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John Gordon - December 2022



Restaurants: We Should be Looking Ahead, to 2024

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

Merry Christmas and Happy Holidays forthcoming!

So I am back from the Restaurant Finance and Development Conference. 3300 people attended, the most ever. There were two other major restaurant events in the world that week.  I had the high honor to moderate the M&A Panel: What Are Conditions Now and How to Close More Deals in 2023. The Four-panel members were outstanding and laid out that and more. Panel member Susan Miller laid out the highly anticipated current M&A multiple ranges for business types by maturity. <1>

Current View of the Business for 2023

To be clear, the restaurant business is dynamic and optimistic. It does go through cycles. A down cycle at one point in time is not permanent, history shows it will reverse soon!  Do not despair at a down point. There is always something to do, plan, strategize and improve current operations in the restaurant business.

2023 v 2024 business recovery was the question du jour throughout the conference.  My takeaway:  While there is latent deal activity (including IPOs) waiting for better conditions, 2022 M&A activity died off because of poor multiples and higher interest rates. And, QSR consumer activity weakened throughout the second half of 2022, while higher-end casual dining and above-sit-down segment consumer activity was more positive. 2024 will be better than a mixed 2023.

The overall view is that food and labor inflation will continue in 2023, albeit at lower levels. Interest rates and cost of new buildings will be a problem, and most of my consumer research friends feel sales demand won’t fully recover until 2024.

While QSR same-store sales were up around 5% in late 2022, that is nowhere near enough to cover the increasing food and labor costs. As a result, restaurant margins and profits have remained below their 2019 and 2021 thresholds. Managing pricing will be one of the company operator and franchisee’s biggest challenges. 2024 will be better once the mild recession ebbs.

After surveying 300 finance executives – including 60 consumer and retail leaders – accounting giant KPMG released its 2022 inflation report, which shows that retailers and consumer brands are taking a proactive approach to combat inflation.

“After months of passing on rising costs to resilient consumers, consumer and retail companies are looking to strike the right balance between pricing strategies and profit margins,” the report says. “To achieve cost efficiencies and optimize space, companies plan to evaluate their physical, office, and retail locations, seeking to reduce or restructure their real estate footprint. From a technology or digital transformation perspective, respondents expect investments in those initiatives to stay on track as they seek to extract actionable, data-driven insights.”

Company-owned fast casuals, meanwhile, are gobbling up available real estate to build or expand drive-thrus, even with volatility around customer traffic, and food and labor inflation. He notes that 2022 QSR traffic was modestly negative verses 2021 and 2019, and should remain so in 2023. Most of all sales gain, in roughly the 5-6% range, will come from price and mix. Many QSR guests are rather price-sensitive now, so adjustments must be made strategically. Creative marketing, new news, and digital expansion are essential. McDonald’s notably has made headway.

On the QSR margin side, many raw foodstuffs are now falling, with chicken completely lower. Experts say some food and paper items will remain inflationary in 2023, but less so than in 2022.  On the labor front, the average wage rate of a new employee hired increased from 5 to 10%. Depending on sales, check and inflation, the store EBITDA margin could drift 1 to 1.5 full points lower in 2023, he adds, but far less than the dramatic falloff in 2022.

While franchisors will continue to push for more store development, franchisees may feel emboldened to push back based on costs and ROI. Some franchisors have done an excellent job in putting new store prototypes out in circulation which will help. Loan underwriting will be tighter in 2023.

Labor Outlook Improving 

On a more positive note, the labor outlook for restaurants is improving. A late 2022 survey by Bank of America restaurant analyst Sara Senatore found that restaurants are in a better position to find employees, emphasizing “more staff means better service for customers and less of a need to raise wages, which in turn helps the bottom line.”

A December Restaurant Business Online article echoed that optimism. Highlighting data from the Bureau of Labor Statistics, which shows an upward trend in hiring among restaurants and bars, the article reported that 62,000 jobs were added in November versus 36,300 in October, “which itself was an upward revision from previous estimates,” the publication wrote.

Factors Muting 2023

Many attendees at this year’s Restaurant Finance and Development Conference were focused on how the industry will fare in 2023 and 2024, examining key aspects of doing business such as operating profits, sales outlook, cost of construction, cost of equipment, frequency of traffic, and average ticket targets. Virtually all analysts are convinced the average ticket will continue to be higher, and that customer traffic will be negative in 2023. Every tracking report shows some effect of a real or perceived slowdown or mild recession now hitting US consumers.

Positive signs for the future will be clear once food costs, commodity pressures, and labor pressures as we’ve seen in 2022 begin to reverse themselves, With the current inflationary pressures, our best guess is that consumer demand will be muted until later in 2023 and recover more fully in 2024.

Management Notes: How to Take Advantage of the Ex-CEO

Reading in detail lately about the drama of the short-lived CEO tenure of Bob Chapek, the hand-picked CEO successor of Bob Iger at Disney there was one interesting background point: Iger after his retirement as CEO was NOT on the Disney (DIS) Board of Directors. The same circumstance was true in Howard Schultz’s most recent retirement before coming back to work at Starbucks (SBUX) for the third time in 2022. Odd board rotation practices leaving David Brandon still on the Dominos (DPZ) board after so many years were also seen in 2022.

The job of a CEO certainly isn’t easy these days. For any restaurant company, the flame out of a CEO has enormous significance. I discussed how firms might better utilize outgoing CEOs, with our own Bob Gershberg, CEO of Wray Search, who works restaurant board search and consulting engagements. “ No doubt, the skills, and knowledge of the former CEO are valuable”, said Gershberg. “A desirable outcome might be to name the Ex-CEO as Executive Board Chair, for a finite period.”

This could process the ex-CEO’s wisdom and opinions efficiently. Interestingly, one situation where this scenario did not work, perhaps because the ex-CEO was not named Executive Chairman, was McDonald’s. Jim Skinner, then CEO, retired to a regular board seat in 2014, only to have the next two CEOs, Don Thompson, rotated out after a few years and Steve Easterbrook terminated in a spectacular scandal.

Heard and Seen:

Through the end of Q3 earnings, I am seeing little evidence of the long-anticipated “trade down” of fine dining and casual dining guests to fast food in the numbers. We do hear discussion of less frequency and trade down of mix within the $75K income cohort within a brand, which is two different things. In fact, the “the sit-down space” has gradually strengthened the last few months per the data I’ve seen.

Jack in the Box (JACK) posted very difficult earnings in November, for both  Jack in Box and Del Taco, with margin pressures. I traced back through the original documents that JACK actually paid 15X EBITDA for Del Taco versus their “7.6X synergy adjusted EBITDA number”. So they goofed. Worse, the Del Taco synergies won’t arrive mostly until 2024. Now they have to refranchise quickly. Is there franchisee demand? CNBC said it: “Jack in the Box is indeed in a Box”<2>

McDonald's Franchisees in the Know point out continuing equipment acquisition and quality problems, including buying fryers and grills, and failures of compressors. (Hat Tip: McFranchisee (McDTruth). The long effect of supply chain problems continue.

Interesting to see only Starbucks (SBUX), and YUM (YUM) on the WSJ/Drucker Institute Management 2022 Top 250, published on December 12. Drucker has a whole series of weighting factors, including customer satisfaction, employee engagement, innovation, social responsibility, and financial strength. The cutoff value was 55.5 points. There was one restaurant holding company that should have been close in my opinion, Darden (DRI).     

About the author: John A. Gordon is a long-time restaurant industry veteran, with experience in financial planning and analysis corporate staff roles (20 years, QSR and steakhouse chain ) and 20 years via his own niche consulting firm, Pacific Management Consulting Group. He does complex operations, financial assessment and feasibility and strategy engagements for clients. His website is www.pacificmanagementconsultinggroup.com, office 858 874-6626.

<2>   JACK Earnings Day CNBC Video, November 22 2022

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