John Gordon - October 2020

Restaurant Recovery: A Balancing Act Required

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

In my September 2020 Executive Connection article, I noted 10 strategies and tactics<1> that restaurant operators, investors, and other analysts had mentioned to me and that I had seen since the onset of COVID-19 that would be necessary to build the foundation for a solid restaurant recovery post-COVID-19. Of course, some individual brands have rebounded and are in better shape now but they are in the minority; throughout the US and the world, the reality of the infection continues to cast its dark shadow.

New investments are required, but all spending is not incremental…..

Looking at the 10 factors<2> all of them involve an investment in restaurant operator time or funds. Fortunately, all ten factors have clear cost or revenue efficiencies that can be seen resulting from the action if executed properly. The question is how far out and at what carrying cost until P&L efficiencies can be realized. For example, relative to the site improvement through unit migration factor, restaurant operators in now almost vacant center city locations certainly would like to relocate or thin down their store market penetration. But landlords will resist. So it’s a long slug of asking for rent concessions, paying off the lease, and closing or waiting for traffic vitality to return.

Reprogramming of priorities and funds becomes the order of the day

Fortunately, there is some give and play in the operator’s P&L and capital budgets where there can be offsets.  Money can be moved around, as smart CEO and CFO’s realizing that the business has changed after March 12th.

Two elements, add pickup windows, popup drive-thrus, and other access factors; and add attached patios, and outside dining among other features to promote open-air access, will require new CAPEX but not the same level of CAPEX proportionately that building a new unit might require. That gives clear signals to both company-operated and franchised brands: while demand overall is rebuilding post-2020, take a break from putting up big numbers of new units or requiring your franchisees to do so. Instead, perhaps the smarter play now is to add features that will improve guest access via lower-cost CAPEX investments.

Much larger capital investments will be required in redoing restaurant HVAC systems to arrive at optimal air circulation. McKinsey has recently opined on the options of how HVAC systems might be modified to prevent transmission of COVID-19.<3> I’m no engineer but I can see that system improvement on the roof, electrical and duct modifications will be required. On the brighter side, this may be a circumstance where medicine and technology will evolve so that we have a better understanding of the movement of the virus on the skin, surfaces, and in the air and that HVAC technology can be built to the latest information. New information on the virus lifecycle comes out almost daily.  It would be awful to spend money on a virus solution only to find new information that would make that investment not effective.

The passage of time will be helpful

The passage of time will facilitate progress on two other complex factors, find ways to lower store rent costs and divest debt, reengineer the M&A process to remove leverage and risk. Every restaurant analyst and observer will note that rent, debt, and deal acquired deal multiples were at an all-time high in the 2018-early 2020 period, a supernatural bubble if you will. In my opinion, while the COVID-19 effect is horrible, one of the positive effects is that it will pop those bubbles over time.

The landlords are highly levered with debt too and are of the opinion that their lenders will not allow them to subsidize restaurants. They continue to desire primarily fixed rent terms with a percentage sales override to continue. Once enough retail and restaurants close, they will understand closed storefronts and slowly reduce rents going forward but that will take time. That will be the time for restaurant operators to make their moves.

On the M&A side, lower price multiples paid for acquisitions will eventually lower funded debt. That should result in more attention to paying down debt and making funds available for the post-COVID-19 recovery factors.

Return on Investment timeframe

Being in the people business as we all are, not enhancing human capital is not an option. For a brand only at square one, there would be an incremental cost to get to square three or square four, but that is not a realistic comparison. Moving from square two to square three would yield great improvements in turnover, staff capacity, and deployment that would yield direct and direct organization improvements at low cost.

We’ll discuss other actions and prospects coming up, including the necessity for IT, digital drive-thru, and loyalty program CAPEX spending; maintenance capital spending (which has to happen no matter what), and what to with bars now that they are mostly sidelined.

About the author:

John A. Gordon: is a long-term restaurant analyst and management consultant with 45 years of restaurant operations, corporate staff, and management consulting experience. He founded his niche restaurant analysis consultancy, Pacific Management Consulting Group in 2002. He works complex restaurant operations and financial analysis projects for operators, investors,  stock analysts (both buy-side and sell-side), attorneys on expert witness matters, and other complex engagements regarding restaurants. He can be reached at office (858) 874-6626, email, jgordon@pacificmanagementconsultinggroup.com. Please see my website, www.pacificmanagementconsultinggroup.com for my twitter and LinkedIn profiles, and much else.

<1>   Gordon, September 2020 Executive Connection, Foundational Elements for Restaurant Recovery

<2>    Solving the cost and low customer ratings of the 3rd party delivery model; invest in HQ  Concept Product and Concept Development;  finding a replacement for the bar; adding DTs, pickup windows and other access features; world class HVAC; divest debt, reengineer M&A  to remove leverage and risk; lower rent; get out of central business districts and weak malls; get serious about human capital.

<3>   See: https://www.mckinsey.com/industries/advanced-electronics/our-insights/can-hvac-systems-help-prevent-transmission-of-covid-19