FOLLOW THE MONEY 4-15-25 – Roger publishes monthly in Restaurant Finance Monitor
Rather than rehash the problems that have long been overhanging the capital markets and the business world, let’s consider a useful metaphor: picture a snowfall accumulating on a mountain slope, increasingly threatening an avalanche. You just never know which single snowflake will trigger it. Whether this is “the big one” or not cannot be known, but it’s best to seek safety.
The price momentum driven marketplace has been “adjusted”, with everything down substantially and we want to end up with the strongest possible portfolio to weather all storms. “Adjusted EBITDA” has replaced Generally Accepted Accounting Principles, but Depreciation is a real long-term expense, interest and taxes must be paid before capital can be invested in new stores or paid out in dividends, and Pre-Opening Expenses should be considered in calculating unit level Cash on Cash returns. Company executives know that analysts focus on Unit Level Economics, sometimes to a fault, so G&A, Pre-Opening Expenses and Depreciation are allocated with great care.
We recently “ran the numbers” for thirteen publicly held restaurant companies that are building new company operated locations. Since I’ve done some rounding, let me know if I’m off materially. The objective of this exercise is to find the best long-term investment candidates, allowing for their treatment of G&A, pre-opening expenses and D&A. We also want our eyes open in terms of “red flags” such as (1) unusually high G&A expense, perhaps covering for over-stated store level returns (2) Pre-opening expenses, often EBITDA Adjustments, that are unusually large relative to targeted AUVs (3) D&A that is higher than normal, indicating high future renovation requirements.
Looking broadly, G&A plus Pre-Opening Expenses (as a % of Revenues) run from 4.2% to 23.1%. Confirming the marketplace’s judgement, it turns out that Darden (DRI), Texas Roadhouse (TXRH) and Chipotle (CMG) have done so well for a reason, because all three are at the top of this ranking (4.2%, 4.7%, 6.6% respectively). Further down the list a number of questions get raised.
Going further, G&A expenses are predictably proportionate to the growth rate (against the base) in units. Darden, Texas Roadhouse and Chipotle are growing much slower (2%, 5% and 8%, respectively) than Sweetgreen, Dutch Bros and Kura Sushi (growing 16%, 16% and 22% respectively) with G&A (22.1%, 18.3% and 16.4% of TTM Revenues, respectively). Interesting, but not as important, are Pre-opening expenses. While varying widely as a % of targeted AUV, most are not too far from around 1% of Revenues, except for GEN Restaurants (GENK) (at 3.7% of TTM Revenues).
Far more interesting is the case of Sweetgreen (SG). While Pre-Opening expense is about average at 5.7% of targeted AUV, Depreciation and Amortization is the highest, at 9.9%, and Trailing Twelve Month G&A has been 22.1% of Revenues. In comparison, CAVA Group is also growing units at about 16%, but G&A at 11.9% is about half that of Sweetgreen.
Our analysis also raises questions regarding Shake Shack (SHAK). While meeting and beating recent estimates, which we attribute largely to moderation of their domestic company store growth rate. However, G&A is still above average at 11.9%, Depreciation & Amortization is high at 8.2% of Revenues, and Pre-Opening is also above average. Their store level EBITDA return has firmed to 21-22% but they spend $2.5M or so (including pre-opening) per store, so an average store at target revenues and EBITDA margin generates a less than “best of breed” EBITDA return of about 30%. In contrast: CAVA Group has similar percentages of G&A, Depreciation, Growth Rate and Pre-Opening with much better Unit Level Returns. Subtracting SHAK’s $50M of annual licensing revenues from their total, CAVA generates about the same Adjusted EBITDA ($170M) on about 20% less revenues.
Another question mark raised pertains to GEN Restaurants (GENK), a 46-unit chain of Korean Steakhouses. To their credit, D&A only runs 3.2% of Revenue and Pre-opening as a percentage of Targeted AUV is only modestly high at 8.6%. However, Pre-opening is very high relative to TTM Revenues at 3.7%, no doubt a function of their 30% growth rate. G&A is also within reason, at 10.2% of TTM Revenues, modest in light of the growth that we consider high risk. After opening six units in 2024, they are planning 10-13 new units in 2025 (including two in South Korea) on top of three held over from 2024 against a base of 46. History has shown that this rate of geographically widespread rapid growth will be managed inefficiently at best. Looking a little further at GENK’s financials: in calendar ’24, COGS was 33.0% with Labor at 30.9%, on the high side in combination. Occupancy seemed in line at 8.4%, but D&A at only 3.2% (for new construction) and Operating Expenses abnormally low at 10.3% require some explanation. Too many questions get raised for my comfort, and I would welcome a discussion with management.
In conclusion: this market has “taken all the girls”, so let’s upgrade our portfolios, deploying our capital as intelligently as we can for the long term.
Roger Lipton
