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John Gordon - November 2023



Restaurants: A Twisted Road Ahead?

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

So, I’m just back from one of the two must-never-miss restaurant meetings of the year for analytical types like me, the Restaurant Finance and Development Conference. In Las Vegas, they had about 3500 attendees on the books. Whether a “good” or “bad” restaurant year, professionals realize the industry cycles, and there is always something to do to get ready for the next cycle. The next can't-miss meeting is ICRX, in January, run by ICR.

At this week’s RRFC, the most urgent message came from Patrick Doyle, the newly on Board Executive Chairman. He noted their most urgent mission as a franchisor is to provide a good profitable franchise model that franchisees can improve upon. Doyle said franchisee profitability was their single everyday number one attention matter. BK US has shown overall improvement, but some bankruptcies are still to come. Indeed, one happened this week. Doyle mentioned many franchisees got into balance sheet problems with too high debt risk. Patrick mentioned a debt-to-EBITDA ratio of 5X was too risky for the brand given current operating and macro conditions.

The end of cheap money implications  

This raises the need for corporate operators, security analysts, franchisors, franchisees, investors, analysts, and the business press to pay more attention to leverage ratios in their reporting. With interest rates up 500 bpts in a year that will unfavorably impact many forecasts. Franchisors report THEIR leverage ratios but not their franchisees. The interest rate popup has occurred at the same time that CAPEX for new units is up. Darden has reported their new units are up 40% over 2019 levels. This is a time to focus on the entire sources and uses of cash statements and free cash flow—after debt service, principal, and interest.

At RFDC, I heard from some franchisors that some franchisees had so little cash reserves that the uptick in construction costs caused their buildout to fail. Of course, then the franchisee remained liable for liquidated damages.

In general, I did not hear a lot of positive sentiment about 2024. Bankers were cautious and reminded us that loan underwriting standards had tightened up. On the positive side, franchisee store margins were improving throughout 2023, taking advantage of the price increases to date. While that is somewhat a function of moderating the cost of goods sold commodities values, it is clear to me that the industry has overpriced. We have very few brands getting positive transaction growth right now. This is due to many reasons, which I’ll detail next month.

In 2024, we are going to find our P&L efficiencies not in pricing but in the creative menu mix and the middle of the P&L.

About the author: John A. Gordon is a long-time restaurant industry analyst, with 20 years in corporate staff financial management roles, and 21 years via his founded restaurant consultancy, Pacific Management Consulting Group. He does complex financial, organizational, and operational reviews for clients. He can be reached at 858 874 6626, jgordon@pacificmanagementconsultinggroup.com.

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