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John Gordon - December 2023




Restaurants: 2023 Lessons and Trends Carry Forward into 2024

 

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


We are about to close out 2023, although a few more surprises may yet come our way. We are expecting Darden's (DRI) earnings to come up on December 15, which will tell us much about the casual dining and fine dining segments. Darden is a powerful operator and has been adjusting value messaging. However, smaller M&As (ex Subway—more on that later) and proxy board battles—(see discussion on  SOC (SEIU proxy organization) battle to gain 3 Starbucks board seats by proxy battle later) issues have popped up lately. We got confirmation of the 2023 lessons and trends from the great Restaurant Finance and Development Conference last month where some key takeaways were presented. We hear more 2024 perspectives at the 2024 ICR Conference next month in Orlando, where many public and private restaurants will present.


We did not get a recession in 2023 but….

Despite forecasts, the US and most of the world dodged a recession. Consumers kept spending, although weakly. At McDonald's Investor Day last week, CEO Chris Kempczinski rather cheerfully admitted “I was wrong” on his projections for US and global mild recessions. However, many restaurant brands, QSR, fast casual, casual dining, and fine dining are reporting: (1) weakness in the under $45K income cohort (2) weakness in the over $125K income cohort.  That dual observation is not typical.  Over time, the upper-income spending holds up in all except situations like the 2009-2010 recession.


What we did get fortunately is…..general food commodity moderation (except beef). QSR brands that had decent SSS had restaurant margin improvement. What we got that was expected but very troublesome was higher interest rates (plus 500bpts) which makes remodels and new unit ROI much more difficult. The cost of new unit builds is up 30-40% since 2019, another Pandemic effect. Restaurant equipment and permitting were also difficult. The most important development is that we have finally hit the wall on too much pricing.   The industry, especially limited services restaurants, has been taking price increases way above food-at-home (grocery store) prices. [1]  See the historical Food Away  From Home (FWFM) price trend via the footnote below. It is stunning.

In my view, it is only logical that the middle of the P&L must receive greater attention. Many initiatives can be done in addition to targeted pricing.  [2]


2024 Projections upcoming.   Projections from various sources are now coming up. However, I’m going to study Q4 projections as well as the direct person-to-person sentiment to be heard at next month’s ICR Conference to provide you that will be a  more studied recap and projection.


2023 Restaurant Finance and Development Conference:  Key Truth Moments for the Industry


RFDC2023 was outstanding with over 3400 attendees. At this conference, there were two moments  of truth for this industry worth mentioning:


First, Patrick Doyle, now the Executive Chair of RBI laid out very clearly what the duty of a franchisor is: to turnover a good franchise economic model to the franchisees that is profitable so that they can improve upon it. Further, the every day, priority one HQ mission is to improve and enhance franchisee profitability.   Patrick linked this to the disclosure of average franchisee EBITDA for the 4 RBI brands earlier, as a benchmark.

All the readers of this column know that some franchisor priorities vary widely around this imperative; while all talk about supporting franchisees.  It is industry wisdom that a strong franchisee economic model has to produce growth and success, and ultimately higher EV and market capitalization if publicly traded.  [3] 


Secondly, a real moment of truth was displayed by Lisa Miller and Neil Culbertson who told the industry that restaurants should focus on promoting brand attributes, and that “value is not price”. Neil noted, “Top performing brands, when you think of value, they don’t promote on price very often…Not there is no place for it, but if used to the extreme, it can undercut brand value and the brand itself.” Lisa noted growing anxiousness in consumer sentiment and introduced the notion of “price shock” due to our cumulative pricing markets actions. [4]


The industry has been confused forever, equating value with low prices. This refutes it. Consider the struggling Burger King and Subway that historically were extremely discount-heavy. Under new US leadership, BK is reengineering its approaches. Subway has not. Its US franchisee profitability is reported to be extremely low. 


McDonald’s Investor Day was a glitzy affair that was unfortunately short on hard numbers. It is targeting 8,800 new units by 2027, with incremental capital spending ramping up each year as a result, $300M to $500M per year.  That is startling. 900 US units are targeted, 1,900 in their company-owned international markets and app. 7,000 by its developmental licensees.  We can expect the bulk of the CAPEX to be in the US and the international company-owned markets.[5]    They did not break out company unit margin guidance.  On sales channel management, they made it very clear that digital sales turning into loyalty platform sales was the absolute pathway to success. “Loyalty drives the business” noted CEO Chris K.  In response to a question, the CFO noted US franchisee's “cash flow” was up in 2023 and that credit to franchisees was always available backstopped by McDonald’s.[6] 


The new coffee concept CosMc’s was briefly discussed, now building to a ten-unit, one-year test. High-priced we think; handcrafted beverages most similar to Dutch Bros. We peeked at the menu[7] and think they had too many beverage options but they would discover that in a field test.  It needs volume to make it, the suburban Chicago site has four drive-thru lanes. This new concept creation is exactly what global leading franchisors need to do. The concept will have to post a ROI.

Through the presentation, I was impressed by the new dedicated Global Business Services (GBS, VP Skye Anderson), to work with corporate field staff on internal reengineering projects; as well as a large number of future themes the CMO presented ( global events) that McDonalds can build upon. 


More Notable News: 


Restaurant activism is afoot in several brands.   We will start with the most troublesome, the SEIU-driven SOC organization starting a proxy campaign to win three board seats on the Starbucks Board in 2024. The SOC is a union think tank and activist organization that owns stock in targeted companies, among other things. Two years ago SOC targeted Starbucks for unionization for a variety of reasons.[8]  Now, in reaction to its efforts, it is accusing Starbucks of “severe human capital mismanagement that has materially damaged the Company’s reputation and exposed it to significant financial, legal and regulatory risk”. It is noting potential future risks to shareholder value.  The three nominees have impressive legal and political credentials but no retail or restaurant experience.[9]


So the note must be made: Starbucks would have no issues had the union targeted another restaurant chain. Starbucks partner level satisfaction was historically higher in the past but has declined with higher AUVs and more drive-thru sales. In response, the company has already re-engineered equipment, and workflows and raised pay and benefits. In my view, there is nothing more productive that a union can do.  At this time, there are only about 370 US unionized units and some union decertification actions are pending.


From a broader perspective, there seems to be no great demand for more unionization. Press reports in 2023 indicated that field-level interest has ebbed. What value can SOC bring to the table, either at the store level or at the board level? Hard to see in my view. 


A proxy campaign would be a waste of time and money on both sides. On Friday, December 8, Starbucks notified the union that they would be willing to resume contract talks. Given this, perhaps this will dampen the proxy campaign, a good thing.


Bloomin Brands and perhaps Wendy’s have activist activity underway:  Veteran restaurant activist Starboard Value has taken a 10% stake in Bloomin Brands which it feels is undervalued to peers Darden and Texas Roadhouse on an EV to EBITDA basis. Chair Jeff Smith is personally interested in restaurants, having lead roles at Darden and Papa John’s. In its initial presentation, Starboard noted operational store-level improvements at Outback were mission one; more “fun” themes in its marketing needed; and more expansion in Brazil where it is doing very well. Starboard mentioned the smaller brands and their promise. Unlike other raiders in the past, Starboard did not mention spinning off Fleming’s, a sign that it believes management plans for growth.[10]   This doesn’t seem like this will turn into a pitched battle like Darden was; I bet CEO Dave Deno and the Board will welcome Jeff Smith. The large issue is how much new OPEX for marketing and CAPEX for brand expansion can be generated. 


The ongoing Roark/Subway acquisition process runs on and on… readers by now probably thought this process had ended, but no. The FTC is reviewing it per their regular competitive process, but this seems to be the first restaurant review on the FTC’s books, as I noted to Jonathan Maze last week. Jonathan was kind enough to invite me into the Deeper Dive podcast on December 6 [11]  to talk about the FTC and Roark. I pointed out that franchise business structures were not specifically noted in the FTC analysis procedure but they had discretion. Employees could be a review factor. Looking at Roark, their restaurant brands are so diverse they populate 6 groupings with only 3 existing QSR /sandwich brands. It is hard to see where a critical anti-competitive cluster would emerge.


What may have gotten the FTC’s attention is the sheet risk of the Roark deal. Every restaurant universe potential buyer but Roark walked away from the Subway/DAI deal, and even then they did not get the $ 9.6 billion price at first, they have a $800M earnout. US franchisee profitability was very low in the base case, now it is even lower as Subway is mandating accepting digital discounting.


More to come//


About the author:

John A. Gordon is a long-time restaurant industry veteran, with 47 years of industry experience in operations, corporate staff  (20 years), and 21 years via his founded management consultancy, Pacific Management Consulting Group. He does operations, financial analysis,  organization reviews, and special investigations for clients who need detailed restaurant perspectives. Please see his website, Linked In profile, and X links at https://www.pacificmanagementconsultinggroup.com. He is always available at 858 874-6626, jgordon@pacificmanagementconsultinggroup.com.

     

 

[1]  Bureau of Labor Statistics, November 14 2023. See trend at https://fred.stlouis.org/series/CUUR000SEFV

[2]  In California, due to the disastrous AB1228 effect coming on wages in 2024, QSR restaurant chains have no choice but to take large price increases.  Recall the chief actors in this mess were SEIU, the Governor, the California Legislature, and the IFA.

[3]   Recommend compare the publicly traded restaurant stock tables with the brand values and franchisee strengths.

[6]   True on “cash flow” or EBITDA as it really is. On credit, while MCD franchisees should get good rates, interest rates have risen 500 bpts year over year.  

[8]   For more discussion in a future column.

[9]   See Businesswire.com November 21 2023, Strategic Organizing Center Nominates Three Candidates to Starbucks Board of Directors 


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