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John Gordon - March 2021



We Are Finally Lapping Covid 19

by John Gordon

On March 11, the industry began lapping the most extraordinary event ever to hit the industry since World War 2. Looking ahead, it is exciting to be in a country with multiple vaccines developed already and being implemented.

But COVID's long slowdown was painful and will impact us for years to come.

Is Pent Up Demand Real?

In the consumer discretionary sector of the economy of which restaurants are categorized, every industry except airlines is talking about “Pent Up Demand” as the rationale for 2021 and 2022 sales and profit recovery. It is a consistent theme on restaurant earnings calls and commentary by analysts, economists, the business press, and many others. Recently, the UCLA Anderson School 2021 Economic forecast highlighted pent-up demand and forecasted robust growth for the US and California in 2021.<1>  Jonathan Maze noted the restaurant CEOs have been talking up pent-up demand also, in his opinion post on March 9th. <2>

My research shows that there is documented restaurant pent-up demand, but it has been historically been present. Prior NRA surveys point to this historical pent-up demand. It makes sense that more people would dine out if they had the time or money. This condition was present before COVID, however.

FY-20 is a terrible basis of comparison

From a comp sales and earnings calendar basis, all restaurant brands are now entering a period where large positive variances versus prior year are inevitable. That is the result of the improvement in sales from that depressed period. Whether “pent up demand” is involved is another question. A better base of comparison is FY-19 itself. Even a stacked 2-year comps measure is not good.  2020 is just awful in every way. Unfortunately, the publicly traded restaurants are stuck with the prior year as per the SEC formats. We’ll see what do they with the narrative. If they overplay the gains, then they will have to own it next year, too.

Likely 2021 Sales Drivers

For all this pent-up demand, I believe there has to be a catalyst to release it. Vaccine distribution will help but so too will economic stimulus. I’m very optimistic that the just passed $1400 stimulus cash injections<3>. There is a very solid history back to 2012 that shows when cash is released into the economy, restaurant sales, especially, casual dining sales jump. The January-February 2021 sales jump from the $600 stimulus show that FSR got the better end of the bump. <4>  The checks will take time to be released to bank accounts.

The other factor I think about in assessing future restaurant sales in 2021 is business travel and reopening of sporting events and mass entertainment venues. Our business has always been about being where people are. At this point, central business district occupancy seems consigned for much later recovery and domestic tourism is slowly recovering. We need domestic business travel and reopening of sporting events to power casual diner and fine diners. I’m optimistic about the latter but not about the former. The airline, hotel, and other analysts are not forecasting international recovery until 2024 or later. US room demand versus 2019 remains soft. <5>

Restaurant Profit Extraction: Flowthrough 

We financial types have for years have spoken to the concept of restaurant flowthrough, that is, the restaurant variable profit ratio. Years ago, it was called the PV, profit to volume ratio, and it was always documented to be around 50%. If a dollar of incremental revenue hit the top line, the variable profit line (the store EBITDA line) should go up 50 cents. Over the years, the QSR brands PV ratio has largely remained around that 50% value but casual dining has had a tougher time, with labor costs rising. But it largely depended on the alcohol sales mix (less labor-intense) and other product mix issues.

In February, three publicly traded restaurant brands, including Darden (DRI) and Starbucks (SBUX) noted on their earnings calls that their flowthrough ratios had improved to at or above 50%, from pre-COVID.  This is the legacy of higher average tickets and less dining room business and more drive thru and take out. One question will be how will this mix shift going to shake out going forward.

Greg Flynn Takeaways

One interesting interview heard last month was John Hamburger’s interview of Greg Flynn, CEO of Flynn Restaurant Group, now the largest US franchisee. He related that he had no restaurant experience after business school and created a brand called World Wrap in 1994, which was unknown to landlords, guests, employees, and guests, getting to 14 units. It was very difficult, and 100% debt-financed. Then they got the idea to do Applebee’s. Flynn is still a fan of using the franchised brand platform, and would not create a new brand from scratch again. He is not sold on virtual brands yet. They prefer to buy sites with real estate attached but might not keep it forever. He is definitely not a fan of debt financing.  The interview is interesting and can be accessed at https://register.gotowebinar.com/recording/34055447227706

About the author:  John A. Gordon is a long-time restaurant analyst and management consultant, with 45 years in restaurant operations, corporate staff roles, and management consulting positions, including via founding principal of his niche restaurant analysis and advisory firm, Pacific Management Consulting Group. He works complex operations and financial analysis engagements for clients. He can be reached at office (858) 874-6626, and email, jgordon@pacificmanagementconsultinggroup.com.  ­

<4>   See www.facteus.com, First Reports, January-March 2021.

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