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John Gordon - September 2022



Restaurants: Always Challenges, But We Persevere…

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

The longer one spends in the restaurant space, veterans should be less shocked when adverse actions happen. After all, the restaurant industry is a versatile industry, surviving, World War II, desegregation, multiple gas shocks limitations and lines, 9-11, overbuilding, 23% interest rates, the Great Recession, and other periodic turns, and the effect of them, the Pandemic, which is still biting us years later. But this last week governmental actions took center stage.

The California AB257 Mess… Will cause confusion and trouble and likely will raise wages. Let's face it,  politics in government regulatory matters a lot in the 50/50 Blue/ Red state America we are set in. While CA Governor Newsom greatly improved an awful original bill written solely by an SEIU lobbyist, he signed a recast bill called the FAST Act. New is a Committee composed of 10 unelected restaurant, union, franchisee, and franchisor reps, to review and recommend wages, wage theft, and needed work conditions improvements. This process subverts the will of franchisor companies and contract/budget requirements. Yes, the legislature can strike the Committee work later, and the Committee needs to be authorized by voter signatures.

And yes, in 2023 wages can be increased to a max of $22/hour. And 2024 higher on the 2023 base. Could happen. Not will happen. The current CA min wage maximum is $16, with surely some employers starting employees higher. The problem of course is restaurant margins have fallen off 300-400 bpts since 2020/2021. The CA politicians didn’t check for that. Several wickets have to fall before the wage increases, namely the committee work.

So, the discussion in CA is there will certainly be wage compression costs but in some urban markets starting wages at $20 anyway. There will be litigation (such as… I’m not a fast food operation). I think in terms of financial impact, a pretty good QSR operation might now be $3M AUV vs. $2.5M. More on this later.

New Federal Joint Employer Regulations Are Out.  The doomsday heralded by the IFA for years. But, did you know that… Practically speaking, the Joint employer regs will change every time the party in power changes. The NLRB regs ARE NOT federal law, federal judges and the states are free and do ignore NLRB language all the time. The US Labor Code and FLSA can only be changed by Congress! State and Federal circuits have already taken pro and con joint employer positions over the years which are binding precedents in court decisions. NLRB rulings affect only a small percentage of total labor issues. So investors and employers, use common sense, but this is not the end of the world.

Restaurant M&A Sightings: I am honored to moderate the M&A Panel: What Will It Take to get a Transaction Done in 2023 at the Restaurant Finance and Development Conference in Las Vegas on November 15, 2022, at 130p. You are invited via the Conference! So I am watching the M&A market very closely as usual. So M&A has really fallen off in 2022 what with general inflation, uncertainty with the FED, and lower restaurant margins. It is not dead, however. Last week, there was an 8-unit restaurant IPO, a ramen operator, Yoshiharu, YOSH, on NASDAQ.  In addition, Darden (DRI) seems to be slowly looking for a great acquisition, and another holding company is soon to announce a two-brand acquisition.   So M&A is not dead, and more to come.

Industry Notables: The announcement that RBI Burger King Corp. is putting $400 million of its own money to upgrade the Burger King brand in the US is a positive sign and testimony to new BK leadership. That BK is historically weak in the US goes back decades and scores of CEOs. It also indicates that nothing good happens in a brand unless store-level sales and cash flow (EBITDA less taxes and capital spending) is positive and growing…Private equity…in discussions with franchisees with brands that have been acquired by private equity funds, the number one complaint is that rolling CEO turnover exists—every 1.5 years or less destroys morale and momentum. On my part, I can see the difference in exit multiples with companies with higher CEO turnover.

Starbucks Investor Day:  Like everyone else, we look forward to seeing the grand plan for the future. From an investment standpoint, I wonder how much all these investments have added to the shop's annual breakeven levels. Howard and Co. are convinced investing in partners equals improved sales and ROI. It should.  

Seen and Heard: While in Phoenix lately for a franchising conference, I toured a Portillo’s (PTLO) unit as well as a deep dive at a Dutch Bros (BROS) unit with an investor friend.  The Portillo’s unit is a big buildout (watch that) but the most amazing variety of food types under one restaurant roof. The realistic average ticket per person was $12-15. It has some beer and wine, and a drive-thru of course.  I had a burger and entrée salad, and both were high quality. The staff was beyond friendly and helpful. The investment question I have is how effective can digital and local store marketing be to drive awareness in those new markets so far from Chicago to drive sales and profits.

The Dutch Bros unit was in the heart of the ASU campus on the main road. It got tremendous walk-up and drive-thru traffic. The DT traffic drifting into the main road is a major problem of course. It is on a lot with parking, fortunately. The staff, about 5 on board at 6p, were friendly. They indicated they loved working there, with casual dress and atmosphere. Its pathway is solid and will compete with Starbucks, indies, and Dunkin to a lesser degree. Especially for sites and employees.  Their guests are young and price sensitive, but the drink profile is targeted.

About the author: John A. Gordon is a long-time restaurant industry veteran, with 46 plus years of experience in restaurant operations, corporate staff (Finance FP&A, 20 years), and 20 years via his restaurant analysis consultancy, Pacific Management Consulting Group. He works complex operational and financial analysis projects for operators, investors, attorneys, and others. Contact him at 619 379-5561 or jgordon@pacificmanagementconsultinggroup.com.

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