From a macro standpoint, our Federal Reserve is close to running out of ammunition, hesitate to encourage higher rates, and has indicated that a first rate cut will come in ’24. The inflation rate (understated as it is) will not approach 2% on a year to year basis, and we are stuck with prices almost 20% higher than two years ago. Actually, about two points of the recent decline from 6% to 4% was from the decline in oil prices, about half of that was retraced in July, and food prices are moving up again. While the PHDs at the Fed seem to rely on lagging indicators, Teamsters have just reached a new agreement calling for a 10% increase PER YEAR over the next five years (with lots of other labor groups to follow), the US Dollar has weakened substantially over the last six months, and our Trade Deficit was $100B last month, all factors that feed inflation. Considering that our deficit is running twice what it was a year ago, not surprisingly the Japanese have cut their US Treasury holdings to the lowest level since 2019 and the Chinese to the lowest level since 2010 ($845B, down 35% from $1.3T). In essence, since foreign buyers are backing away, our Federal Reserve has transitioned from the “buyer of last resort” of US debt to “the only resort”. Though interest on our debt is already approaching $1T per year, the average interest rate is only 2.76%. With half of our public debt maturing within three years, the Fed can be expected, out of practical necessity, to soon encourage lower rates. Unfortunately the likely renewed inflation will create upward pressure on rates and the resultant tug of war can get messy. Buckle your seat belts.
Within the full-service company operated restaurant Industry: With the Covid driven tide having gone out and now largely come back in, it seems like a good time, as Warren Buffet would put it, to see “who was swimming naked”. Store level cash flow (EBITDA) is a good place to start, which, reduced by G&A comprises corporate EBITDA. We’ve compared the first six months of ’23 with pre-Covid fiscal ‘19 and the results were informative. Performance was topped by Chipotle, with store level EBITDA up by 560 bp and G&A down 200 bp. (CMG quadrupled). Darden improved store level EBITDA by 50 bp and G&A was 110 bp better. (DRI was up about 50%). Chuy’s improved store level EBITDA by 430 bp (labor efficiencies), partially offset by G&A up 110 bp. (CHUY was up about 100%) Texas Roadhouse had store level EBITDA down by 190 bp but G&A almost offset it, improving by 120 bp. (TXRH was up by about 100%). Bloomin’ Brands improved store level EBITDA by 90 bp with G&A also improved by 120 bp. (BLMN was up about 20%) Not so good were: Cheesecake Factory, who had store level margin down by 180 bp, slightly offset by G&A down 10 bp. (CAKE was down about 20%). Shake Shack’s store level EBITDA was down 310 bp, G&A also worse by 170 bp. (SHAK, very volatile, is about the same level). Lastly, BJ’s Restaurants had store level EBITDA down 370 bp, with G&A worse by a modest 30 bp. (BJRI was down about 30% from mid ’19). Every one of the 60 restaurant companies we follow has a story to tell, but the sampling above validates the reputations of companies like CMG, DRI, CHUY and TXRH, as well as exposing some of the question marks at CAKE, SHAK and BJRI.
Depreciation is the subject at hand, and BJ’s Restaurants (BJRI), discussed just above, provides a “teaching moment”. Most companies and investors (both debt and equity) now refer to the current cash flow at the store level (before deducting depreciation) as “profit”. However, the Internal Revenue Service allows capital investment to be written off as an expense over time (called depreciation) because leasehold improvements and equipment wear out over time. Every 5 to 10 years the funds that have been theoretically set aside should be reinvested, refreshing the facility and its customer appeal. “Depreciation” is therefore not “Free Cash Flow” over the long term, available to service debt, pay dividends, buy back stock, or build new stores. If it is not reinvested in the stores, the increasingly shabby facilities will not maintain market share. Getting back to BJ’s Restaurants, there are no doubt many reasons that corporate performance has been erratic in recent years, especially apparent coming out of Covid. Just two weeks ago an accelerated remodel program was announced (from 30 to 35-40 restaurants, 20% of the system by year end), including additional seating, an updated bar, new lighting, artwork and larger TVs. CapEx at BJRI in’23 will be $90-95M, higher by $20-$25M than the D&A expensed last year. That reinvestment requirement will continue to be the case as the remaining 80% of the system is refreshed. It’s possible that sales and operating margins would have been better over the last five years if the Company had not allowed the restaurants to deteriorate. Don’t forget to water your plants!
