While Arby’s is well positioned as a QSR drive-thru player that can serve as a credible alternative to a NY deli, the challenge is to expand its market reach among more affluent consumers sufficient to drive both frequency and checks.
While Denny’s management team is executing well around a very solid strategy, the brand is held captive to currently unfavorable economic conditions which are particularly hard on its core low-income demo and which also challenge Denny’s ability to execute around its key price value objective.
• A 2021 spike in the franchise transfer rate reflects the need for scale in a high-cost environment facilitated by an abundance of underperforming units post-covid and the predilection of some franchisees to exit the business because of post-covid operational challenges.
• The average number of units owned by a franchisee group in the $1B+ Chains increased from 5.5 in 2019 to 5.8 in 2021. Smaller operators (like in the sub-sandwich segment) are ripe for further consolidation.
Del Taco is the 2nd largest Mexican QSR, positioned around a wide variety of better-quality food (use of fresh ingredients represents a competitive distinction) offered for reasonable prices. While Del Taco enjoys strong concept fundamentals, the chain is tested by a harsh California business environment aggravated by the brand’s orientation towards a vulnerable, less affluent demo.
• While 2Q comps for the $1B+ Chains increased +3.5% (+14% 3-yr. stack), RR’s consumer survey (which measures intentions to eat-out over the next month) continues to reveal a challenging 3Q sales outlook.
• Food prices continue to surge, breaking another record in July (+10.9% y/y & +14.8% 2-yr. stack).
• Recent passage of the California Fast Food Accountability & Standards Recovery Act increases QSR wages in the state by +40% to $22/hr. in 2023, aggravating labor inflation.
• Unit-level operating margins for the corporate owned stores of the publicly traded $1B+ Chain companies declined 4.5% to 16.5% during 2Q:22 vs. 2Q:21.
• Macro-economic results continue to represent a major head-wind for restaurant stocks.
• While 2Q financial results for the public QSRs were OK, we suggest a review of current unit-level performance may provide important insight into the challenges that are weakening the franchise systems that are core to many of these public companies.
• 2H:22 EBITDA multiple outlook (-6% y/y decline) represents the biggest contraction since 1H:20.
2Q22 Investor Calls indicate significantly higher prices and labor shortages (impacting both operating hours & delivery service) are impeding traffic (especially for low end consumers) and not able to fully compensate for current commodity and labor cost inflation. Fortunately, several companies indicated that commodity costs are peaking and expected to moderate later this year.
Burger King is challenged to find ways to expand its market reach towards new, more affluent consumers who are willing to pay for the brand’s strong core equities and quality upgrades at a time when its core lower-income demo needs more value than ever.
Taco Bell is extremely well positioned as the only $1B+ national QSR Mexican player and enjoys the added bonus of being able to tap into a material COGs outperformance to go deeper into value should that be warranted.
• Aggregate 1H:22 franchisee unit-level EBITDA valuation multiples contracted slightly (-2.3% y/y) and are -3.9% below their 2H:16 peak.
• 2H:22 EBITDA multiple outlook (-6% y/y decline) would be the biggest contraction since 1H:20 and reflects weaker unit level economics; higher borrowing costs; and a growing disconnect between seller & buyer perception of going forward profitability.
• Full-year 2022 restaurant originations (excluding sale leaseback financing) are now projected to be $10.5B which is -23% lower compared to initial expectations.
While Popeyes enjoys a very strong brand positioning, even as sales moderate from its famous chicken sandwich spike, the current economic challenges for its core lower-income demo combined with huge chicken cost inflation represents a notable sales challenge for an unknown duration.
• Comps must be interpreted through a prism of mid to high single digit menu price increases, suggesting QSR traffic losses while FSR benefits from an ongoing return to normal dine-in habits.
• The average price of food in the United States surged +10.4% in the 12 months ended June 2022 (+13.1% 2-yr. stack), the most since February 1981.
• Unit-level operating margins for the corporate owned stores of the publicly traded companies that have so far reported declined by -3.9% y/y during 2Q22.
While Applebee’s solid turnaround is exemplified by its recent sales outperformance, it remains to be seen how well the brand’s core Middle American demo will fare given the current economic stress that is sure to prompt at least some QSR trade-down.
• 2Q GDP decline of -0.9% represents the second consecutive quarterly contraction and is consistent with a slight +1% increase in personal consumption expenditures which is falling behind a supply shock driven +9% inflation rate.
• July’s restaurant stock performance suggests that investors called a bottom at the end of June.
• Unit-level buyers are increasingly wary of rising borrowing rates and deteriorating unit economics.
While Little Caesars maybe the best at carryout, it remains challenged with the need to translate its fun menu and marketing into sustained traffic around its higher price points sufficient to increase unit level profits.
• While AUV’s continue to benefit from the closure of underperforming stores over the last 2 years, significant 2022 sales headwinds reflect the need to pass along higher prices to consumers with less disposable income.
• The average 2021 unit-level EBITDAR margin for the $1B+ chains rebounded to just under the 2019 level as higher COGS were more than off-set by lower labor and operating costs, both of which benefitted from significant sales leverage.
• RR’s consumer survey (which measures intentions to eat-out over the next month) reveals a deteriorating sales outlook after showing signs of improvement during the previous 2 months.
• Both QSR & FSR operators are losing their grip on value as inflation continues to spiral out-of-control.
• According to government data, total net unit growth for the restaurant industry improved each quarter throughout 2021 (versus 2019).
Domino’s extended record of sales outperformance is now threatened by a necessary move away from its core equities in the form of price certain value and fast delivery while it pivots towards carryout and higher prices.
While Wendy’s has done well to magnify its significant menu prowess sufficient to generate a respectable +14% cumulative U.S. comp growth from 2019 – 2021, the chain must continue to work to translate its QSR+ positioning into increased frequency from a higher income demo sufficient to drive a higher check and in-line comp performance.
• Subway is the largest sub sandwich chain by far with an ad budget larger by multiples than the other sub chains.
• Notably, a +29% comp rebound in 2021 followed a -20% 2020 decline and 2021 digital sales are triple 2019 levels, supported by its FreshBuzz App and loyalty program.
• Subway’s well-conceived upscale Refresh must now pivot to value if the system is to endure an economic downturn that is disproportionately afflicting its lower income core demo.
• 1Q22 same store sales for the $1B+ Chains increased +6.1% (+14.7% 3-yr stack) on slowing momentum (relative to +11.5% during 4Q21) with 7 of 30 chains reporting negative sales (compared to just 1 in 4Q21).
• With food-away-from-home CPI up +6.7% during the quarter, it is easy to see that comp growth is primarily attributable to menu price increases as opposed to traffic.
• Restaurant stocks on average are down -40% from their 52-week high, trading at ~15x EV/EBITDA, as investors continue to struggle to assess the impact of out-of-control inflation on consumers’ ability to maintain their dine-out habits.
• Given current inflation rates, interest rates should be much higher.
• The spread between cap rates and the 10-yr. approached the record low set in April as real estate has become the most attractive asset class to NNN investors.
While McDonald’s is currently well positioned with solid execution around very sound fundamentals, its core value oriented customers are caught in an inflationary spiral which may require a sacrificial pivot towards price value from this iconic brand which has worked so hard to earn America’s trust over the many decades.
• FSR 1Q:22 comp performance for $1B+ chains outperformed the annual average for the 3-year stack comp as the sit-down concepts continue their recovery.
• Conversely, QSR comps are slowing, mirroring recent industry commentary about how the higher income demo (FSR) has been more resilient to current economic conditions relative to the lower income demo (QSR).
• Record highs for many commodities and wages have prompted most of the public restaurant companies to raise their cost outlooks for 2022.
• 2021 gross unit development rate of +2.6% for the $1B+ Chains was in-line with 2019 and is expected to grow +3.1% in 2022 despite headwinds.
• 2021 closure rates for the $1B+ chains improved from 2020’s elevated levels, but net unit growth was below the overall industry.
• Systemwide sales for the $1B+ Chains increased +15.7% during 2021 (+9.9% 2-year stacked basis) compared to +32.8% (+14.9% 2-year stacked basis) for the total restaurant industry and total restaurant industry market share for the $1B+ Chains has steadily declined to the lowest level in 19 years.
Total 2021 net marketing spend for the $1B+ Chain restaurants increased +8.9% y/y (+2.8% 2-yr. stack) to $6.9B, reflecting the benefit of +15.7% systemwide sales growth (+9.9% 2-yr. stack) somewhat off-set by lower net marketing spend as a percent of sales (continuing a longer-term trend in which marketing spend has declined from 3.1% in 2017 to 2.6% in 2021). Notably, total net restaurant marketing spend as a % of total domestic spend across all industries has declined from 3.2% in 2017 to 2.5% in 2021 as the chains appear less impressed with marketing ROI compared to other industries.
While Jimmy John’s has taken important steps to improve its relevancy, a sustained sales rebound for the chain would certainly benefit from a return of office workers and an increase in the availability of affordable delivery drivers sufficient to support the chain’s “freaky fast” core equity that distinguishes in a crowded field.
• April was a difficult month for equities with both the RR $1B+ Index and S&P losing more than -8%. QSR stocks were hit hardest, evening-out some over-size gains during 2021 (relative to FSR).
• A -14.9% y/y decline in disposable income reflects: a tough compare with last year’s government stimulus benefits; exploding inflation (CPI for all items up +8.5%); and higher borrowing costs.
• Concerns about sales, labor, inflation and interest rates are beginning to weigh more heavily on valuations with both the QSR & FSR indexes falling into bear territory.
• Initial 3-year stack comp performance for the $1B+ chains reveal that QSR is still outperforming FSR despite less impressive headline sales numbers for 1Q:22 alone. Going forward prospects are less optimistic as indicated by RR’s recent consumer survey which measures intentions to eat-out over the next month.
• The BLS Foodstuffs Index notched another all-time high in April and is up +109.3% y/y on a 2-year stacked basis.
• While operators are working hard to lower controllable costs, they cannot drive sales sufficiently to maintain their store-level margins in the current inflationary environment.
Chili’s recent sales strength reflects its ability to distinguish itself in a crowded FSR space with an attractive Tex-Mex menu, fun experience, leading value and digital strength which looks like a winning formula in the casual segment which is otherwise challenged by a stressed consumer in pursuit of a discretionary purchase.
• 4Q:21 same store sales for the $1B+ Chains increased +11.5% (+10.4% 2-yr. stack) and increased +16.7% for full year 2021 (+11.0% 2-yr. stack).
• $1B+ Chain market share of the total foodservice industry (food away from home & grocery) increased +0.06% to 17.61% (-0.85% below its 2016 peak).
• April RR Intent to Eat Out Index plunged -13.7% y/y due to difficult comparisons with April 2021 when consumers benefitted from $1,400/person government stimulus payments.
• The Food at Home (grocery stores) CPI expanded at its fastest rate in 40 years (+8.6% y/y during 2/22) – surpassing both the QSR and FSR CPI for the first time since 7/20.
• The price for regular gas increased +$0.70/gallon (+20%) to $4.22 compared to last month (+50% y/y) and represents the highest price ever.
While Jack has done a good job of reviving an iconic West Coast brand in a crowded field, it remains to be seen what impact its premium positioning will have on traffic and sales given the current inflationary environment squeezing consumer income.
Dunkin’s work is to finish executing its move upscale in pursuit of adding the purchasing power from a new, younger clientele to layer onto a stream of loyal sales from the brand’s core base of middle America.
In this issue of our Insights Journal we explore impact of gas hikes on traffic by looking at comp sales correlations and franchisee comments. While the economic data suggests that consumers have some cushion to deal with the gas price shock, franchisees have a different opinion.
• 4Q21 comps for the $1B+ Chains increased +11.5% and +10.5% on a 2-year stacked basis (’21 vs. ’19), but is it sustainable?
• Investors piled into FSR stocks as mandates are lifted across the country while weak QSR performance reflects concerns about the impact of record inflation on lower income consumers.
• 1Q:22 GDP outlook was already flat before the Ukraine and oil price shock (crude up +43% YTD to $110 on 3/2) added further headwinds to an already fragile consumer.
While Panera is well positioned for the long-term with a healthy halo and digital strength, near-term results may be tempered by the need for: more value in a difficult economy; a return to normal dine-in habits; and a solution to relatively high labor costs.
• Record breaking 2021 restaurant financing volume driven by pent-up borrower demand and increased consolidation.
• Lenders indicate a much stronger financial condition for QSR borrowers with FSR showing some improvement since July.
• 2H:21 valuation survey results indicate a further increase in franchisee EBITDA multiples with FSR outperforming QSR.
• 2021 restaurant system sales were record highs for both the $1B+ chains and, shockingly, for the independents and smaller chains according to government data.
• Stocks were particularly hard hit in January as concerns over inflation and rising interest rates were most worrisome for consumers & restaurants.
• While franchisee EBITDA multiples for the $1B+ Chains declined -1.7% according to RR’s preliminary 2H:21 valuation survey, they are expected to rise to 2019 levels during 1H22.
Sonic’s positioning works well in the current operating environment and, hopefully, will translate into new development, a national footprint and sufficient marketing scale to properly communicate the brand’s strong core equities.
While Pizza Hut’s positioning is improving, the brand must still address value in a tough economic environment while it simultaneously completes its asset conversion in order to finish its evolution into a relevant competitor in the very challenging pizza segment.
It’s going on 2 years since our world was turned upside down with government lockdowns, mask mandates, social distancing, remote work & schools and eventually a steady diet of new tech vaxxes. In our opinion, there is an opportunity for our country to grow strong in unity so long as everyone is allowed to work towards their own version of the American Dream (life, liberty and the pursuit of happiness).