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John Gordon - January 2023



Restaurants:  The 2023 New Year’s Look

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

Personnel and M&A Moves Now Abound

So, with the New Year upon us, some personnel and M&A moves are now upon us. Both McDonald's and Wendy’s signaled people changes and new corporate reorganization charts, targeted at reducing the number of reporting pillars. It looks like the US  and International pillars will be targeted, at least at headquarters.  The CEOs indicate it will increase efficiency and improve time to market. As always the devil is in the details and we will see.

In M&A news, the earlier reported news about Darden (hat tip: Austin Fuller, Orlando Sentinel) came true: CEO Ric Cardenas noted at their ICR appearance that they were looking for a new brand acquisition. Darden itself is in fine shape, they seem to be looking for a brand to position the portfolio to changes in the consumer marketplace. So they will be looking for the best and this won’t be a rushed process.

Further, Andy Weiderhorn and FAT Brands confirmed the desire for a properly priced casual dining brand: multiples of 10X are too high.

As noted last month, there are several latent IPOs, waiting for the right market conditions.  One of the very first will be Fogo de Chao. They have desired a reentry ever since 2020 and have been waiting for market conditions. They are a strong company.

ICR 2023 Observations

I was delighted to get back to my 17th face-to-face conference attendance a the  ICR Conference, the midmarket investor, and M&A-themed gathering in Orlando. 24 publicly traded restaurants attended, with 19 pre-IPO or smaller restaurant companies presented briefly. Fitch, a ratings agency attended also. They are keen to monitor sales, free cash flow, and debt, but did not seem to have obvious restaurant sector worries.

Ric Cardenas of Darden was the obvious CEO star, who has a masterful command of the facts and the breakout room. And, GJ Hart is back and CEO at Red Robin and presented in dramatic style what went wrong there and his plan to fix it.

Operational themes noted: numerous operators are making equipment upgrades in 2023, all intended to boost BOH efficiency. Many of the smaller growth brands that presented had burger or taco themes. Third-party delivery has finally turned margin neutral, thanks to operator price increases. While dine-in sales generally are improving, fast casual companies like Café Rio and Shake Shack are working in drive-thrus where they can. <1>

What is hanging heavy over 2023 prospects is the impact of the real or supposed recession. That there has been inflation across the US consumer space is unquestioned; it's just that it matters more to certain population groups than others. Restaurant full-service price inflation continued to be plus 9% in December’s report, while QSR was about 7%. Grocery store (food at home) pricing was still higher. <2> Via my research, I expect moderate and varied revenue results by brand and continued but deaccelerating cost pressures in 2023.  But there is more.

Interest cost  and new unit buildout cost increases are a concern to 2023 new unit development:  what to do about it

Beyond the P&L, there are other cash costs associated with new unit development and remodeling that the restaurant community needs to be concerned about. First, the supply chain has not been fixed in terms of providing new restaurant equipment. When senior McDonald's franchisees are routinely speaking of it over time, you know there is a problem. Significantly, as confirmed at ICR and the recent Restaurant Finance and Development Conference, the cost of new unit builds is up some 10 to 15%.  And the absolute kick in the pants is that given general economic uncertainty is that the cost of funds is up nationally by 300 to 400 basis points.   This puts a strain on both company and franchisees trying to develop new units. The margin optics are poor if one compares to 2021 as a base, which had much better store results. Restaurant percentage margins are down app. 300 basis points in 2022 (versus 2021) because of the food and labor inflation that just could not be covered by more pricing or more sales.

What can franchisors do to encourage development?  

Franchisors will be challenged by this one-two punch to maintain development targets. However, there are proactive things that can be done. As Alicia Miller, Partner at Catalyst Insight Group and a true expert in franchise management optimization told me recently,

“Incentives to get a better enterprise valuation in 2024-2025 via IPOs or PE acquisitions require investments now. Franchisees need reasons to believe. Franchisors need to offer incentives to offset this additional development cost.  Otherwise, franchisees will delay, pursue lower-cost concepts, or possibly retire as options. Franchisee thirst for development is not a bottomless well.”

Some proactive moves have been untaken, such as smaller and variable-sized units (Wendy’s example), dedicated loan pools (Burger King example), and vigorous cost reduction task forces working (Jack in Box).  But I sense more will be needed to get through the 2023 squeeze.

All economic conditions change, and if the Fed and macro economy cooperates, I sense 2024 will be better.

About the author: John A Gordon is a long time (45 plus years) restaurant industry veteran. His management consulting firm, Pacific Management Consulting Group was founded in 2003 to work complex restaurant operations, managerial finance and strategy engagements. See more about him on his website, www.pacificmanagementconsultinggroup.com, call him at 619 379-5561 anytime.

<1>   Restaurant Business, 10 Takeaways from ICR, January 11, 2023.

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