DC Advisory
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There has been quite a bit of commentary lately from industry observers, pointing out the unusually large number of restaurant companies that have recently declared bankruptcy.

In just the last 60 days, Garden Fresh Restaurants (Souplantation and Sweet Tomatoes), Restaurant Acquisitions (Black-eyed Pea and Dixie House), Cosi, and Logan’s Roadhouse have moved into Chapter 11 or Chapter 7 liquidation. Earlier in 2016, they were preceded by Fox & Hound, Champps, Bailey’s, Old Country Buffets, Hometown Buffet, Ryan’s, Johnny Carino’s, Quaker Steak & Lube, and Zio’s Italian Kitchen.

There are two reasons for this: the first is long term, the second is “seasonal”. In the four decades I have followed the chain restaurant industry, many chains have come and gone, a minority surviving and prospering over the long term. The article I wrote a year ago, “Visit the Graveyard” can be reached from our “Home Page” and recalls many great old names that include G.D.Ritzy’s, Flakey Jake’s, and Delite’s, to name just a few.

The long term cycle continues, but this trip is exacerbated by the easy money and abnormally low interest rates that our Federal Reserve has put in place, almost non-stop for fifteen years now following 9/11/2001. A Zero Interest Rate Policy (ZIRP) allows for “misallocation of resources”, as investors reach for yield by taking inordinate risks. Stores get built that should never have existed, and locations are maintained long after they have demonstrated lackluster sales. One popular device: treat depreciation like “free cash flow”, call it “profit” at the store level, allow it to barely cover corporate G&A, and justify another debt financing (at far lower rates than normal). Over time, however, sometimes ten years or longer, the stores become delapidated and market share suffers. Same store sales drift down, perhaps “only” by 2 or 3 or 4 percent, but modest declines compound over 7 or 8 years (while depreciation is not re-invested in the facility) to 30-40%, creating a critical situation. Even lenders that are reaching for yield have to acknowledge the questionable prospects and back away. Summarizing this point: we are seeing some of the unintended consequences of 15 years of financial promiscuity in the form of ZIRP.

The short term acceleration in the number of companies “restructuring” is a question of cash flow seasonality, to which every CFO is sensitive, especially those financial executives carrying high levels of debt and lackluster sales trends.  The restaurant industry is a seasonal business, with the summer months generating perhaps 15-20% higher sales than the winter months. The food suppliers are paid with a 30-60 day lag, sometimes 90 days or more if the troubled company can stretch the payables.  It therefore helps a lot if you are paying  (in the northeast) February and March bills with April and May and June receipts. Conversely, it becomes a huge problem to pay July and August bills with September (with the back to school “lull”), October and November receipts. Keep in mind, these companies have been troubled for years, are struggling to pay the rents, utility bills, garbage collections, etc.etc. The CFOs have probably been paying only those bills necessary to keep the lights on, keep the doors open, food coming in the back door, etc. With another winter coming up, it becomes crystal clear that there is no way out. As a result of this seasonal influence, I wouldn’t be surprised to see a few more filings. While the industry is still “overstored”, not too many chains really have “differentiated” offerings, and the economy will likely remain challenged. Further down  the road: spring will come, life will get a little easier in terms of managing day to day cash flow, until “the days grow short” in 2017.