More than eight restaurant companies have reported their third quarter results in the last week, and provide a reasonable picture of what is going on out there. The companies whose results we have analyzed below are those of Habit (HABT), Pollo Loco (LOCO), BJ’s (BJRI), Cheesecake Factory (CAKE), Ruth’s Chris (RUTH), Denny’s (DENN), Texas Roadhouse (TXRH), and Shake Shack (SHAK). We will not detail here the many operating initiatives that virtually all are pursuing, such as delivery, curbside pickup, mobile apps and loyalty programs. Presented below is a summary of the key operating metrics, at the unit and corporate levels. Below the store operating line, you should know that the “general administrative” operating initiatives being pursued cost money, such as development of mobile apps and loyalty programs. The operating margins, at both the store and corporate level continued to be affected by much more than the prime costs, namely cost of goods and labor. All the numbers shown below are for the third quarter and nine months ending September.
Sales & Traffic
The first question every analyst asks relates to “the comps”. The follow-up question is about the “traffic”, adjusted for price and menu mix. Looking at the table below, BJ’s and Texas Roadhouse had materially positive comps, Habit and Ruth’s Chris a little less so. BJ’s is bouncing back from a down year and Texas Roadhouse continues to do an excellent job of driving traffic and comps. Habit’s 3.6% comp was driven entirely (and then some) by price, with traffic down 3.4%. RUTH managed a 1.5% traffic increase. In terms of traffic, HABT, LOCO, CAKE, DENN, and SHAK all showed (or implied) negative traffic. Going forward to Q4, based on formal guidance and conference call commentary, TXRH and BJRI are pretty safe bets to have positive traffic and RUTH is probably OK as well. Keep in mind that the traffic challenge is in spite of the progress that everyone is making with their loyalty programs, delivery initiatives, curbside pickup, mobile apps, etc. Most importantly, there was no indication from anyone that trends have firmed up in Q4. General expectations are for “more of the same”.
Prime Costs – Cost of Food & Paper, and Labor
You can see from Chart II below that the change in cost of goods through nine months was most often small, but Habit, Pollo, BJ’s, Ruth’s Chris, and Denny’s had some material benefit. Habit’s “progress” was a result of their 7% price increase, while RUTH benefited from lower beef prices. Overall, CGS did not hurt anyone and a few companies benefited. In terms of guidance for Q4 and calendar ’19, the general expectation was for flat to up commodity costs. Generally, the tailwind of a year or so ago is history, it’s getting a little tougher, and is planned that way for ’19 but hasn’t really shown up yet. Safe to say that CGS cannot be counted on to provide any relief.
The labor picture, on the other hand, is clear, and not pretty. While HABT and BJ’s kept labor costs under control because of higher sales (including the price increase at HABT), most everybody had a higher labor percentage for nine months and are guiding to a continuation in Q4 and calendar ’19. Interestingly, TXRH, in spite of higher sales had higher labor by 194 bp. They have obviously chosen not to stint on service. Guidance for virtually everyone is for wage increases of about 5% in calendar ’19 and beyond, implying 150 bp penalty to the store P&L.
Occupancy and Other Store Expense
Companies report on this category in different ways, some breaking out occupancy and others including it within “other store expenses”. Generally, this category of expense has been increasing, and is expected to continue upward, especially with the expansion of delivery services. Allocation between this category and corporate G&A can be opaque, but we can assume no relief from this area.
The Bottom Line: Q3 Store EBITDA and Adjusted Operating Income, Nine Mos. GAAP Pretax Earnings and Store Level EBITDA
The result of all of the above is shrinking margins, except in “special situations” such as HABT, LOCO and BJRI which are comparing against depressed results and RUTH which has lower beef costs. In Q3: at the store level EBITDA line, margins have shrunk from 30 bp at CAKE to 150 bp at Texas Roadhouse and 170 bp at Denny’s. In terms of guidance for store level EBITDA, virtually nobody is suggesting improvement. It is a similar story in Q3 for “Adjusted Corp. Operating Income”. HABT, LOCO, BJRI and RUTH compared well enough because of easy comparisons, but the others, CAKE, DENN, TXRH and SHAK suffered.
Most interesting to us, in terms of reported results, is the nine month change in pretax GAAP earnings, and GAAP EBITDA, because GAAP was the standard before “adjustments” became commonplace and nine months is a better indication than only one quarter. We are looking at pretax results because the after tax earnings and earnings per share are distorted this year with the much lower tax rates which will not be reduced further. Pretax GAAP earnings and EBITDA can therefore provide the most consistent guidepost to “organic” and sustainable growth trends. The result, for nine months of calendar ’18 is lackluster results. Nine months GAAP pretax earnings (as a % of revenues) were up only at LOCO and BJRI versus depressed results in ’17. The absolute GAAP pretax earnings change was materially up only at LOCO (41%) and BJRI (57.6%). It was down materially at HABT (-81%) and CAKE (-25.7%). It was down 5.2% at DENN and up only 4.5%, 4.2%, and 2.6% at RUTH, TXRH and SHAK, respectively. Lastly, nine months’ store level restaurant EBITDA change was down everywhere but BJRI (up 90bp) and RUTH (up 130bp). Declines ran from -80bp at SHAK to -200 bp at DENN.
Conclusion
The results as detailed above are not encouraging. Behind the generalized optimism by operators, the details show lackluster results for nine months of calendar ’18, by all indications to be continued in the fourth quarter. Moreover, there is little reason to expect better bottom line operating results in calendar 2019. Sales and traffic show no signs of meaningful improvement, cost of goods is not improving, labor expense is guaranteed to grow on an absolute basis and it is difficult to raise prices sufficiently to improve margins. The various operating initiatives all carry an incremental expense of some sort, delivery in particular, so help is not on the way from this front. People have to eat, but they don’t have to increase spending sufficiently to allow higher profits for operators.
Roger Lipton