Restaurant Conditions: Challenging Yes; But Still Things To Do

After the restaurant industry sales swoon in late January, the trend improved finally in the middle of March. Since then, the traffic line has settled in around or just above zero, with end of April through early May improving to plus 2, balancing out soft weeks earlier in April.  Black Box noted April was up 1.1%, up from .9% in March. Traffic was still negative overall.  During earnings calls, about 2/3 of the brands pointed to a more hopeful second half[1]  

By brand, in the QSR sector, new product and LTO features seem to be working now. Of the publics, McDonald’s has improved, and Taco Bell  continues to be positive traffic every week, for the last ten weeks straight. [2]  Chili’s is still strong (but will begin lapping its 2024 marketing at the end of April), while Olive Garden, Texas Roadhouse and now BJ’s are positive, with really only the Bloomin Brands (Outback etc.) in clear negative territory. In my view, this is a “turn” of momentum. In the fast casual group, Chipotle has slowed, but CAVA and Dutch BROS still strong in early May.[3]  

So, even though the weather is “stormy” right now, there are plenty of things we can do right now.

Consequences of Low Comps

While getting and maintaining positive SSS comps is an accomplishment—and celebrated-- industry investors and analysts should not overact until the comps are high enough, in the plus 3% range or more.   The reason is that the positive comp is needed to recover store level food and labor inflation.

Food commodities have moved higher. Beef was a problem dating to 2023 with the unfavorable cattle cycle and remains. Coffee is a problem, and others. Labor rates  (average wage) continue to inflate. And there is the tariff effect. More brands are noting 25 to 50 basis points estimates at this time.

Minimum wage increases cause compression in the wage base and increases rases to longer term employees is common.    

Profit flow through is almost always less than the sales increases.

Business bank accounts ultimately are fed by profit and free cash flow. The profit flow through, also called PV or variable profits, is important.   

The profit flow through, the actual amount of profit, reaching the restaurant level contribution to profit line, ranges now from 35% to 50%. It changes weekly. This value is based on security analyst notes, simple modeling, academic reports, and court evidentiary records. Public brands rarely discuss flow through percentages.

The actual percentage will vary based on the brand, pricing, variable costs, presence of alcohol product mix (and soda and French fry add ons), among other things. Company owned units do not pay royalties and should come closer to 50%, while franchisee units will be lower, in the mid to low 40% range.  Unrecouped third party delivery fees will lower the flow through percentage of course.

What’s the point ? The new unit or remodel profit flow through has to be calibrated into restaurant growth plans—the all-consuming net new unit growth that every chain restaurant is seeking.   

New Restaurant Unit Development, Buildout, and Remodeling ROI

Restaurant construction, buildout, equipment, and  remodeling costs continue to rise, and have been on upward trajectory since the Pandemic. In 2023, Darden noted the new unit CAPEX costs were up 30% versus 2019 as a base. An additional pressure will be the new tariff effect, what ever that works to be. Steel, aluminum, and electronic components are forecasted to take a hit.  

I’ve worked and reviewed hundreds of restaurant capital projects in my long history, particularly in terms of planning and ROI analysis. Any restaurant veteran can recount bad concept rollouts, in the wrong locations, way over budget and with poor ROI.   

Before anything else, the restaurant brand must have a concept that it is economical to build and at the right location. As a very rough screen, we analysts and corporate budgeters need a sales to investment ratio of app. 2 to 1, or higher. Embedded in this calculation is the profit flowthrough as discussed above. And the overall market expansion must make sense. I’ll use the Jack in the Box (JACK) East Coast expansions, (early 2000s) the Noodles (NDLS) mid country expansion in the 2016-2020 period, and the Dave and Busters self-noted new unit and remodeling waste (2025).  

While risk is inherent in our business, there are too many site selection analysis firms and other resources to prevent this, now. One is Placer AI, https://www,placerai.com. Another cost expert I have used is RS Means, who tracks construction costs of all types.  The values here are stated on a 2019 baseline, so additional adjustments upward to account for cost inflation are needed. See RS Means, at:

https://www.rsmeans.com/model-pages/restaurants.

Managing the Portfolio: What Can Be Done Now

That we have too many restaurants overall has been documented in many places. Via the US Census, the data collection intelligence firms—Black Box  (https://blackboxintelligence.com) and Signal AI (https://signal-ai.com) and others, we know that the number of restaurants has grown faster than population growth—even before September 11 2001.  (See the Signal AI website for a recent paper on this.) And we can see that ourselves by driving around.

Too many underutilized units often do not receive marketing and maintenance support, and atrophy in place. If a company store, it can be closed down somewhat quickly, while working to relocate employees and settle lease issues. Franchised systems are a bit more challenging because it is the franchisee that typically owns the business [for a time] and has the lease. But in difficult times, some franchisees might be willing to get out.  

The franchisor of course has to absorb and report a unit closing, and work exit terms with the franchisee. The net result should be a franchise market or system with fewer units, to allow for some reverse cannibalization to allow for guest migration. A benefit is that either the company or franchised business can reroute capital spending, maintenance, and personnel elsewhere.

This has been worked from time to time. Jack in the Box (JACK) just announced a “Getting Jack back on track” plan that will involve orderly closing 150 to 200 Jack units as the new CEO announced.

Guess what: after the announcement, JACK stock rallied and is now up 26% over the last month.    

[1]   Hat Tip: Sara Senatore, Bank of America.

[2]   Hat Tip: Jeff Framer, Gordon Haskett Research

[3]   Memo for the group: BROS is really a coffee/beverage concept like Starbucks and Tim Horton’s.