John Gordon - September 2023

Restaurants: Caution: Banana Peels Lurking Ahead

by John Gordon, Principal and Founder, Pacific Management Consulting GroupTime for thoughtful planning and execution ahead. The industry has made it successfully into mid-September, seasonally the second slowest point of the year. Cable TV is full of QSR brands running discount-oriented offers (Dominos Pepperoni Bread, for example), and others that are in a much stronger position like Olive Garden have a TV flight featuring “more”, a benefit of Olive Garden. The industry is struggling with guests who haven’t come back from the Pandemic break, inflation, too much unit growth (see below), and more. Several macro-econometric developments are converging this fall that we all need to be aware of for better planning. This is not a call for more discounting, which is the industry’s usual quick-term reaction. The restaurant industry is resilient, and the progress we have made since the Pandemic is amazing. But, for us, it seems like there is “one more banana peel after another” on the road ahead. Gasoline prices rose to $3.87 nationally per the AAA just after Labor Day.  Prices are still rising. This rising pattern is unusual and unwelcome coming after the peak summer driving period has ended. <1> Lower gasoline prices are an important potential positive adjustment to consumer discretionary income that we need. Labor strikes. The UAW has active strikes against all three Detroit major automakers.<2> This takes autoworkers and restaurant consumers' frequency down in those strike cities as one would expect. Of the critical impact on our industry, I feel, is student loan repayment must begin again in October.<3> It is estimated that 27 million borrowers will juggle a new monthly payment of $350. <4> As this group skews younger, restaurants can expect a hit. DC Shutdown? Finally, the House and Senate need to pass spending bills by September 30 to keep the US Government in operation. While stop-gap, temporary measures are the norm, this year there is abnormal tension in the House. <5>  Full government shutdowns disrupt the economy. What to do…. So these issues speak to the need for the new budgeting and planning cycle that has been discussed in this column before. It is a model of Mike Bloomberg’s advice to do a good operations and capital budget, but with identified options and reaction levels to react quickly. No one ever knows exactly what the future brings but we can do a limited number of “what ifs drills” to be mentally agile. I worked 20 years in corporate staff roles and now another 21 years via my consulting firm, and my observation is it is true it takes a long time for some companies and cultures to “turn the battleship”. Don’t let that happen. CEOs, force the various corporate disciplines to work together to evolve solutions that everyone owns. McDonald’s Takes Surprising Action… In a move bound to be copied worldwide, McDonald's announced it would phase out the self-serve beverage stations over the next several years. Its stated objective was to achieve a consistent dining room look and appearance worldwide.<6> This move comes at an interesting time as guest traffic eating in is at a low ebb historically (but still up a bit from the COVID-affected months). During that time, some operators came to appreciate a drive-thru-only operation. McDonald’s no doubt took a look at syrup yields, which I imagine had to have deteriorated over the years.  There are some questions looking at this. No doubt dine-in or take-out guests might consider self-serve a benefit, an ability to customize or mix their drinks.  Also, for families, a core McDonald's group, the self-serve fountain is always an area of activity. The kids love it. That in the future is taken away. McDonald’s will have to find some other personalization benefit to replace that value removed. We’ll see. Analytical Notes    The very long-running Subway/DAI auction was concluded on September 6 with Roark purchasing the franchise at a certain $8.95 billion price, with a potential up to $9.55 billion via an earnout clause. Given the estimated DAI annual EBITDA of $750M, that is a floor multiple of 11.9X. Subway will be its entity in the Roark organization. No doubt, international growth will be the key to making this transaction work. There will be both US and International franchise structure reorganizations coming. To make their proforma, I would bet there would be changes in the supply chain operations and the Area Developer structure. Subway has said in the US it doesn’t need Area Developers anymore, but in international markets, that is a future question. Some discussion has recently emerged about what kind of review the FTC will make of the merger, since similar, sandwich brands are involved in the Roark portfolio.<7> US store growth situation: In doing work for a client recently, I noticed that US restaurant store counts have grown again more than expected. This is one of the big reasons that industry same-store sales growth has been declining, even before the Pandemic. <8> As of Q1 2023, restaurant count was 695,821, versus 654,207 in Q4 2019. <9> The point is that the erosion of restaurant counts during the Pandemic years has been offset even more over time. The issue becomes that new sites and new concepts absorb customers faster than existing base brands can generate or regenerate them. Our industry has always had elements of trial and new guest appeal in it, hence why new concepts get a look once they achieve scale and have a story to tell. What to do?  At the very least, the publicly traded franchise brands have to balance their earnings commentary from focusing so much on unit growth. There are many other metrics of a quality franchise organization that can be highlighted. Some brave CEOs have discussed the benefits of pruning very old franchise systems of older, economically unviable units that are a waste of both franchisee and brand resources. M&A Market Note: It is commonly acknowledged that the IPO and franchise markets have improved finally. The CAVA IPO this summer was the US equity star for several days and has had its first earnings call. Other IPOs, including FAT Brand’s profitable Twin Peaks brand, are planned for 2024. A theme is experiential works which bodes well for FSR. In franchise activity, buyer and seller activity has picked up.  Rates are still high but EBITDA trends are slightly better now with food cost percentage reductions seen. About the author: John A. Gordon is a long-time restaurant industry analyst and expert, with 20 years in restaurant corporate staff roles (Finance FP&A), and 21 years via his founded restaurant consultancy, Pacific Management Consulting Group. He works on complex operations and managerial finance engagements for all kinds of clients who need a deep restaurant perspective. Call him anytime at 858 874 6626, email, jgordon@pacificmanagementconsultinggroup.com <1>   New York Times, Marie Solis, September 15 2023. <2>   New York Times, Ivan Penn, September 17 2023 <3>   Due to Supreme Court Decision in 2023. <4>   New York Times, Holman, Smialek and Karian, September 15, 2023.6 <5>   New York Times, Carl Hulse, September 17 2023. <6>   https://www.restaurantbusinessonline.com/operations/mcdonalds-getting-rid-its-self-serve-drink-stations <7>    NY Post, Josh Kosman, September 17 2023. <8>   Black Box come up with same opinion in 2022. <9>   Bureau