“Follow The Money” in the Restaurant Finance Monitor (as of 5-15-23)
Straight Answers are Hard to Come By – One of the most successful macro driven investors in the world is Stanley Druckenmiller, a multi-billionaire who “made his bones” helping George Soros “break the Bank of England” in 1992. They sold short the British pound, after interest rates in the UK had been kept abnormally low and inflation had accelerated (sound familiar?). Anticipating the inability of the Bank to maintain this interest rate suppression, they sold short the pound and made billions. Druckenmiller’s forecasts are therefore closely studied, to the point that he is invariably modulated, intentionally careful not to create panic. An interview last week was telling. He talked about the debt, the deficits, interest rate suppression, and misallocation of resources as investors reach for yield, all the distortions of the last twenty years, with the USA leading the way. He made reference to Paul Volcker, hired as Fed Chairman by Jimmy Carter in 1979, supported by Ronald Reagan in 1981, fought the 13% inflation by raising the Fed Funds rate to 18%. Druckenmiller recalled how this tightening process caused a painful recession until 1983, and he was not sure that politicians and central bankers would have the will to impose similar hardships today. His (modulated) conclusion is that he is hoping for a “soft landing” as the Fed corrects past excesses, but investors should recognize the possibility (not a probability) of a much worse scenario. Now comes the interesting part, well known but unstated by Druckenmiller. The total US debt in 1980 was $1B versus $30B today. The annual US deficit was about $100B versus about $2 Trillion today. The long term unfunded entitlements of Social Security, Medicare, and Medicaid were insignificant compared to the tens of trillions today. Today’s economy is about six times the size of 1980, but the problems, inflation adjusted, are many times as large. Judge for yourself whether Jerome Powell will channel Paul Volcker, likely imposing a recession many times as serious as the hard times of the early 1980s. Our bet is that the Fed folds, rebuilds the money supply while reducing interest rates, essentially kicking, once again, the can down the road. Don’t be surprised if we read, five years from now, about Stanley Druckenmiller making another fortune by shorting the US Dollar.
For the Restaurant Industry, the Glass is More than Half Full. In short, the problems are well documented and largely discounted by the marketplace. Almost all the publicly held companies have protected their balance sheets well during challenging times, and are in a position to freshen existing units as well as expand upon brands with attractive unit level economics. The 20-30 analysts that spend full time analyzing quarterly results and trying to predict short term changes in same store sales may have lost the forest for the trees. The restaurant industry provides an affordable luxury to families that need a break from their workaday routines. Over half of all meals continue to be prepared away from home. At the risk of sounding sexist: women don’t have time to cook, and men don’t much like to clean up. It is more expensive than ever to eat out but it’s the same story at the supermarket. While the industry is far more competitive than a decade or two ago, many independent operators have closed during the three years including Covid, providing greener pastures for survivors. This is not your parent’s restaurant industry, with technology playing a major role, providing convenience and labor savings. Smaller stores are becoming a pattern because permitting and construction are more time consuming and expensive than ever, “capacity” is used mostly on weekends, and a growing percentage of meals prepared away from home are delivered or picked up.
We have come to the above views after listening/reading March results from over thirty publicly held companies. Space here does not allow for details, which we provide on our website, but the consensus is that (1) Commodity inflation is abating. Most companies reporting are showing lower cost of goods (2) Labor inflation is also moderating, with most reporting a modestly lower labor expense. (3) Menu prices, mostly chasing the cost spiral over the last few years, have pretty much caught up. Modest increases from here can pretty well protect current margins. (4)The current macro environment is far from robust but fairly stable. Brands that can provide an “experience” as well as consistent food and service are in a relatively good position. (5) Companies with a strong digital presence continue to outperform the industry. (6) Lots of companies are building units again. (6) Though Q1 sales comparisons are relatively easy against the Omicron Variant in Q1’22, and traffic gains YTY (rather than SSS) are still hard to come by, very few publicly held companies are undershooting previous cash flow and earnings guidance. (7) Some publicly held restaurant franchising stocks are more interesting than others, but very few are grossly overpriced.
If you are either a restaurant operator or an investor, there are lots of worst places to be in an economic environment that reflects either Stanley Druckenmiller’s probabilities or possibilities. Count your blessings and get to work!