Chain Restaurant Sales and Profitability Update , February 2011

In January and early February, we had a lot of restaurant earnings and investor conference news, from YUM, Darden (DRI) Wendy’s Arby’s Group (WEN), Brinker (EAT) and McDonald’s (MCD). And we’ll count Starbucks (SBUX ) too, even though they are hoping to transition to a CPG company. As always, we look for interesting notes and common denominators.

Retail activity surprise: the January 2011 traditional retailer same store sales monthly values were shockingly favorable, reported at plus 4.9% by the top 30 retailers tracked by RetailSails. As we know, with life threatening US weather throughout December and January, sales should have been softer. This backs up some aspects of the optimism of the National Restaurant Association’s 2011 forecast, but we don’t see their forecasted logic that “quick serve sales gains will outpace full-service”.

Earnings Hit/Miss: MCD was at consensus, DRI, EAT, SBUX, YUM above, and WEN likely below. Every CFO likely has several million dollars of flexibility and buybacks in their back pocket, and as a result, we are really most impressed by earnings blow-outs (plus $.10 or more). No one hit that.

Likewise, no one reported same store sales pops, our definition of a same store sales trend movement of 1000 basis points or more from trend. Of the group, we note that SBUX reported a very healthy plus 7 with 5 coming from traffic, which is healthy.

It was interesting to see the MCD European shortfall in comps (-.5%) and YUM’s (YRI–International, non China) softer performance (the full year was zero SSS, Japan, Canada and Australia all negative in Q4).

Restaurants in market share battle: the fairly consistently cited long term EPS growth goals (10 to 15%) all seem to signal the necessity of weaker operators dropping out, more cost containment (DRI had extremely focus here), and more stores.

But: LT Earnings Assumptions Problems: we see a disconnect between the logic indicating chain restaurants will get market share from independents and new store growth, versus the fact that restaurant counts really haven’t declined. Coming out of the worst economic down period since the 1930s, and with very tight to no credit available, surprisingly only 1% of independent restaurants closed last year (and chains unit counts were flat).  That doesn’t work down the over expanded restaurant supply at all.

In addition, as the population ages, dining out propensity generally falls. Despite putting on a great analytical display as they always do, we saw this disconnect most evident at the Darden (DRI) Investor event.

While they downplayed the need for it, we also feel DRI must find an appropriately priced acquisition that meets their national platform standards and the 15% growth. BJ’s Restaurants (BJRI) or California Pizza Kitchen  (CPKI) could be it. BJRI is still in nosebleed territory PE wise (57.1 X), but a CPKI acquisition seems to be better timed.

Commodity and Pricing Potential questions properly got a lot of attention on the earnings calls. Every single major food item commodity cash price was above year ago (some well above) except 12 ct chicken broilers on February 2, for example.

Brinker has stepped up its franchisee reporting but otherwise in this entire group there was little discussion of franchisee conditions. There must be more proactive metric to discuss other than unit closings and royalty write-offs.

Older brands being shopped: Wendy’s/ Arby’s Group will become just Wendy’s, putting Arby’s on the street, and YUM is doing the same with Long John Silver’s and A&W.  A&W was one of the oldest food franchisors, dating back to 1921 in Lodi California, but has a significant cluster of units in Indonesia.

Arby’s/ LJS/A&W M&A Valuation: Our rough parent franchisor level EBITDA base, multiples and possible selling price guess for these concepts are:

Arby’s: $75M EBITDA times 5 to 7 equals $450M potential price

Long John Silver:  $28M EBITDA times 5 to 7 equals $168M potential price

A&W:  $6.5M EBITDA times 5 to 7 equals $39.5M potential price

Keep in mind that while Arby’s has about 1000 company units, Arby’s, Long John Silver’s and A&W have around 4000 franchisee units in total that are really the ongoing core value of the brand.

This signals the death of the multi branded QSR concept thrust: the late 1990s and early 2000s idea of multi restaurant concepts under one roof has died out, with even Dunkin Brands not working new growth (it will support existing franchisee concept commitment growth).  But interestingly, Darden is studying/researching exactly a combined Olive Garden and Red Lobster format. They are doing elaborate research.

Ever complicated YUM: YUM is a worldwide company with such an international focus that its hard to explain. YUM has proven the company operated model can work, and US brands can have life cycle extension internationally. Think about its twice than US level AUV levels, much higher restaurant margins and less than 3 year cash paybacks in China.  However, the risk of deempahsis and maintenance of the US brands remains a risk. YUM US same store sales for the year were only plus 1 (plus 5 in Q4). YUM didn’t talk its Q4 Pizza Hut or KFC US same store sales numbers but noted Q4 US Taco Bell was plus 4, and Pizza Hut was plus 8 for the year.

The expected 15% China wage growth note was striking because it is precisely there that YUM has a big cost advantage versus US labor cost metrics.

We believe Wendy’s has a wonderful QSR Burger platform to build upon as it gets breakfast in place, and second highest AUV ($1.4M) of the national burger operators. We believe breakfast is critical to building daytime/lunch/dinner synergies.

Our opinion is that the fixes at Chili’s and Red Lobster will take substantial time to work.

Casual dining Happy Hour emphasis is epidemic and growing and will truly be an interesting academic topic to plot out customer perception/sales/traffic/margin trends.

MCD Free Cash Flow Metric: there were some notes (and even a CNBC debate) that MCD free cash flow was failing. That was of course due to the new unit construction and remodels thrust, especially in 2010 and 2011 (with more coming up).  While we really like free cash flow as a metric, that number will be clumpy and should be examined on a compound average growth rate basis.

About John Gordon

John A. Gordon is a restaurant sector expert, who focuses on restaurant management, operations, and related earnings and economics matters. He consults with attorneys and other professionals who need to know about restaurants, via expert research, expert consultant and expert witness roles. Working for both plaintiffs and defendants, he has experience with both state and federal actions. He is an expert on chain restaurant business conditions and publicly traded companies. Gordon has extensive, career-long executive restaurant operations, corporate staff, financial management and management consulting experience, and is familiar with virtually all management issues and business disciplines. He has completed PSLRA securities, financial projections, due diligence reviews, earnings and damages, franchisee/franchisor matters, wage and hour and menu analysis expert work. Expert witness and article contributor for www.ForensisGroup.com

One Response to “Chain Restaurant Sales and Profitability Update , February 2011”

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