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John Gordon - July 2023

Restaurants: Ever Changing Dynamicsby John A. Gordon, Principal and Founder, Pacific Management Consulting Group The good news in June sales…. The Bank of America credit/debit report shows improved restaurant sales trends in June vs. May in all but one restaurant segment and in all consumer income cohorts. Versus a year ago, chains were up 5.1% in June vs. 3.1% in May. QSR less pizza was down slightly 7.3 %v 7.4%. Interestingly all of the other segments were positive, with a large positive movement to casual dining (-1.3% to 5.3%). Typically, North American restaurant seasonality peaks in June so we will check to see what happens in July. The results by the brand continue to back up the “restaurants as splurge option”. In their June 2023 Consumer Update, McKinsey survey data from December 2022 noted restaurants as the top planned “splurge” event. Tipping everywhere….The  US Census Department July food at home/food away from home numbers will be released soon. US restaurants are still taking price increases, now at a greater rate than grocery stores. That continues to be an item of great price/value concern for restaurants. This matter has become more complex because of the addition of tipping software. See Square. <1>Most common in some QSR and fast casual concepts, guests have the option to add on tips. The tips are starting to add up according to conversations I’ve had, to $3 to $4/hour. The tips are of course the property of the employees and are paid out. The issues are (1) guests have even more price messaging when we have taken so much and (2) for the US Census reporting, there may well be pollution in the so-called “restaurant pricing number” reported. CAVA-momentum startles the IPO markets…. So we all knew it would happen and it did. The CAVA IPO was the international financial markets talk for about 2 weeks straight. As noted earlier, it is a good brand with great demographics already, strong AUVs, and company restaurant margins tracking north of 20% in 2023 to date. It does need more units of course, with only app. 260 now, to improve its current too-high G&A cost ratio. Analysts are just now offering up opinions, the first CAVA analysts call is still some time off.<2> Throughout the roadshow period and IPO, the informal chit-chat comparisons were endless: this is the next Chipotle. The fact is, only the Chipotle of 2006 was the IPO version and the Chipotle of 2023 isn't the IPO candidate. CAVA was built differently. In its S-1 it forecasted a US unit potential of 1000. That was very reasonable. Since its stock price zoomed up to close at $54 in its high close to date, some security analysts will push the company to commit to even more units to make their price/earnings models work. However, US restaurant brands committing to thousands of new units in the post-pandemic era, either company owned or franchised, face tremendously difficult odds to do so. For one, many of the good sites are occupied by tier-one players now. Secondly, the industry, especially the largest, strongest brands is expanding now. It is still hard to find good staff, although CAVA will produce staff promotions from a great operations system. In this going forward, this is exactly where Chair Ron Shaich, who has been through the Wall Street pressure cooker for a decade earlier, can be very helpful and provide guidance to CAVA. Subway Auction Update: “Continuing Drawnout”. Josh Kosman the M&A reporter from the NY Post confirmed<3> last Friday that the current auction cycle closing dates were…pushed back as Subway now thought they had one or two new prospects that may result in a more favorable bid amount than what all of the earlier months of rounds had resulted in. Time will tell if true. This cycle of saying no to a final offer and going back to the drawing board is somewhat remarkable. Restaurant M&A theory is “time kills all deals” as often stated at the Restaurant Finance Monitor’s annual conference.  This process has been underway for 6 months to date. It is difficult for bookrunner JPM to keep market momentum for so long. At least half of the net proceeds after expenses seem to be going to Dr. Buck’s designated will directive, a nature foundation in Maine. That won’t benefit the corporation. We can reasonably assume that servicing the debt on a 15% or so interest rate will be a terrible burden for the brand itself going forward, much like many other LBOs over the years. That raises the question: why fight so much for the highest possible sell price? More Restaurant Developments, Both Surprises and Not: McDonald’s and Grimace’s Birthday:  targeting one of their core markets, the Grimace LTO seems to have driven traffic nicely in June. According to Placier AI, a surge of traffic hit. The only question now is what happened to the ticket. There were 2 associated meals. Another IPO following CAVA…  Gen Restaurant Group, symbol GENK, opened in June at $18. It raised $43M, more than expected. The second Korean BBQ concept is now public that really can be called action-oriented and “experiential." Checkers Drive-In Restaurants reached a deal with its lenders to give up majority ownership from its PE owner, Oak Hill Capital Partners. Checker's debt will be cut by $225M and will receive $25M in new debt financing. IMO, Oak Hill’s prior investment level was mistimed and proves once again that owning franchised restaurant brands IS NOT NECESSARILY a goldmine. Restaurant Staffing Stats: Per WSJ, QSR employees now operating with 10% fewer employees per unit versus 2019, while full-service locations are down 7% over the same period.<4> In my opinion, I am not surprised by the QSR number but the full service number shows the industry still has work to do in recruiting and retention.  The Wall Street Journal piece was filled with a discussion of difficult restaurant service. Future M&A Noted:  Listening to both Darden and YUM earnings calls recently, both mentioned that they would keep their eye out for future potential acquisitions that may enhance their portfolios. This is what good holding companies should do. Darden is just now integrating its Ruth acquisition, so its interest no doubt will be much further in the future. About the author:  John A. Gordon MAFF is a long-time restaurant analyst and management consultant. He works on complex restaurant operations, organizational/brand assessment, and earnings topics for clients.   He has 20 years of corporate staff experience and 20 years via his founded consultancy, Pacific Management Consulting Group. He can be reached anytime at 858 874-6626, <1>   See: Squareup, <2> <3> <4>   Wall Street Journal, June 27 2023, data by Market Intelligence by GuestXM.

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