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John Gordon - June 2020



It's Going to Be a Very Long Year

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

We are 94 days in after our world changed immensely on March 12, 2020. To be sure, some good things are now going on. For one, the sequential pattern of same-store sales (SSS) improvement is apparent almost everywhere worldwide, especially in the US. For example, McDonald’s  US SSS improved from minus 19% in April to minus 5% in May.<1>   However,  many but not all fast-casual and casual dining and all fine dining brands are still materially negative SSS and are in negative cash burn territory. Darden is of course in a strong position with take out and delivery.  Pizza and chicken brands are very hot; and drive-thrus and ability to leverage digital flexibility are seen as the keystones.

According to recent research presented by Lisa Miller & Associates, going out to dinner showed up very strongly in terms of aspirational “things I’d like to do” activities. The cautionary point is that the US public can be subdivided into five groups, from a group ready to and venturing out now, to a group very fearful/very cautious.  The point is that it will take time to move the very cautious group to the “willing to go out group” and that in-store operations protocols and marketing messages must reinforce the journey.

The financial analysis perspective shifts

In some ways, financial analysis has gotten more simple.  For the brand as a whole, it is vital first to document or project the cash burn.  The focus should be on what is going to happen going forward. The FY-19 and prior year income statement data are less relevant now.  Sweating a point or two of food cost or labor history is much less important because everything will change post-COVID-19. The proforma store economics model going forward is immensely critical of course.  Some investors don’t appreciate the amount of OPEX and eventually CAPEX necessary to reopen and transform restaurants post COVID-19.  The CAPEX isn’t known yet, but we can see incremental OPEX for supplies and additional staffing will be required. Fortunately, every restaurant segment except fine dining is running healthy increases in the average ticket to partially offset it.

The increase in ticket isn’t from price much as it is from mix, from guests ordering more via pick up and delivery. One of the metrics to watch is what proportion of off-premise sales is retained when dining rooms reopen. For example, BJ’s last week, reported that ratios fell somewhat. This is a profit problem and the natural consequence of reopening dining rooms to 50% occupancy caps. On the QSR side, many operators are taking it very slow to reopen dining rooms, although McDonald's spoke of a traffic bump that occurred when they reopening about 1000 US units thus far. <2>

The struggle on rent continues. Tilmon Fertitta highlights his battle every Tuesday on CNBC when he outlines his sales trends. His restaurants were minus 60 last week and he does not think he will be even until late 2021 or 2022.  The industry is fighting like hell and many notable operators, especially in malls are not paying rent. Landlords for their part are resisting a return to true percentage rent and want to retain “fixed” rent. In my opinion, this will not turn out well for some landlords and they will have dark places in their complexes.

Grubhub violates YUM, a view of things to come? 

In 2018, YUM invested $200 million in Grubhub, in part to get low delivery rates for its customers and franchisees. That came to a halt in early June when Grubhub unilaterally raised prices. YUM promptly sued.<3>  Interestingly, the Grubhub action occurred just before its $7.3 billion acquisition by Just Eat Takeaway. Perhaps, Grubhub simply wanted to blow up the 2018 YUM deal.

The 2018-2020 deal was pretty good for restaurants: essentially franchisees didn’t pay any extra delivery commissions and were charged a lower processing fee than the Grubhub standard.<4> But the implications of this conflict are amazing: Grubhub was willing to contractually diss a worldwide player like YUM. YUM is now out 3 of 5 years of its contract value, for which it paid $200 million. In my opinion, this is another brick in the road to brand run delivery platforms.

History Repeats itself: Franchisee v. Franchisor War at Subway

On June 16, the Subway franchisor (DAI)relaunched the 5 dollar footlong special in the US via heavy television support. Bundled as a 2 footlongs for $10 offer, it is slated to run through the end of August. The franchisor marketing offer did not have majority franchisee support, nor a test or a business case analysis as we understand. It was just a rerun of the 2007 strategy. John Chidsey, the former Burger King CEO is on board now.

Among the problems are that store labor, rent, and other operating expenses are up materially since 2007. 13 years of cost inflation. DAI was able to cobble some short term rebates to stores that advanced from the franchisee's marketing fund, i.e, use of their own money.

The Subway franchisee association has documented 75% of all franchisees would not support the offer in-store. Contractually, they are not required to do so. Franchisees have calculated a gross profit breakeven over 20% traffic increases, which is very high. Subway AUVs are only in the $350k to $400K range and a miss in average check and unabsorbed labor will put these franchisees underwater quickly. As Cheryl Bachelder noted during her time at Popeye’s, a leading franchisor can’t be at war with its franchisees.

<1>   MCD 8k filing, June 16 2020.

<2>   McDonalds Evercore Presentation, June 16 2020.

<3>   YUM-GRUBHUB  Lawsuit Shines Light on Delivery Partnerships, Franchise Times, June 12 2020/

<4>  Id.

About the author:  John Gordon is a long time restaurant industry veteran with 45 years plus of operations, corporate staff, and management consulting experience. He founded his restaurant analysis and advisory firm, Pacific Management Consulting Group, in 2003 to focus on complex operational and financial analysis engagements. He can be reached anytime at (858) 874-6626 or (619) 379-5561, email: jgordon@pacificmanagementconsultinggroup.com.

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