MOST RECENT CONFERENCE CALL TRANSCRIPT
MOST RECENT CONFERENCE CALL TRANSCRIPT
UPDATED CORPORATE DESCRIPTIONS: WENDY’S, DUTCH BROS, DINE BRANDS, POTBELLY, SWEETGREEN AND RED ROBIN with conference call transcripts
Dutch Bros (BROS)
Dine Brands (DIN)
Red Robin (RRGB)
THE WEEK THAT WAS, ENDING 1/28 – A FEW RATINGS CHANGES, EARNINGS REPORTS ABOUT TO BEGIN
ERIC GONZALEZ maintains DIN, CMG and MCD at Overweight – OTR Global downgrades YUMC – Brian Vaccaro maintains DIN, CMG, CAKE, EAT at Outperform, BLMN at Strong Buy -G0RDON HASKETT upgrades CMG to Buy -ANDREW CHARLES maintains DPZ at Outperform – Jeff Bernstein maintains MCD at Overweight.
No new transcripts on above companies.
EARNINGS SEASON ABOUT TO BEGIN
2022-02-01 After Market Close Starbucks
2022-02-02 Before Market Open Brinker International
2022-02-08 Before Market Open Portillos – unconfirmed
2022-02-08 Before Market Open Nathan’s Famous – estimated
2022-02-08 After Market Close Luby’s – estimated
2022-02-08 After Market Close Yum China Holdings
2022-02-08 After Market Close Chipotle Mexican Grill –
2022-02-09 After Market Close RCI Hospitality Holdings – estimated
2022-02-09 Before Market Open Yum Brands – estimated
2022-02-10 Wendy’s – Estimated
2022-02-11 Krispy Kreme – Estimated
ASSET LIGHT FRANCHISING – COMPLAINTS FROM FRANCHISEES – LET’S CLEAR THE AIR!!
The long term investment appeal of well established franchising companies is accepted by the investment community. Most of the prominent franchisors’ equities sell at price to trailing twelve month EBITDA multiples in the mid to high teens (Denny’s (DENN), Dine Brands (DIN), Dunkin’ Brands (DNKN), Pollo Loco (LOCO), McDonald’s (MCD), Restaurant Brands (QSR), Wendy’s (WEN), even higher in a couple of instances Domino’s (DPZ), Shake Shack (SHAK), Wingstop (WING), lower in a number of “challenged” situations like Jack in the Box (JACK), Red Robin (RRGB), Brinker (EAT), Fiesta Rest. (FRGI).
The attraction of asset light franchisors revolves around the presumably free cash flow for franchisors, a steady stream of royalty income unburdened by capital expenditures to build stores. The operating leverage is at the store level. Franchisees are responsible for building the stores, then controlling food costs, labor, rent and all the other operating line items. Franchisors receive the royalty stream and have the obligation of supporting the system with brand development, site selection advice, marketing support, and operating supervision. These supporting functions, it should be noted, are optional to a degree, and we have written extensively about system support sometimes being short changed by corporate priorities such as major stock buybacks.
THE CURRENT WORD, IN THE FIELD, AS WE HEAR IT
We acknowledge that in every franchise system there will be some operators less satisfied than others. In the same way, customer reviews on Yelp or Facebook are more frequently written by critics. Bad news is more noteworthy and more customers are inclined to criticize than applaud, so we have to listen to the complaints but dig further for the reality. With that in mind, we hear the following from franchisees of various restaurant systems:
“I’ve been in this business for thirty years, and I’ve never seen it this bad. Everyone is making money but me; the landlords, the franchisor, the banks. My margins have been killed, and I’m up against my lending convenants”.
“All the franchisors want to do is build sales to build their royalties. The dollar deals are trading people down. My franchisor doesn’t care about my margins. I can’t maintain my margins, especially with the increasing cost of labor, let alone build it”.
“The franchisor is putting pressure on me to sell, even though I’ve always been considered a good operator, with high performance scores. I’m up to date on my development agreement, but they want somebody else to take me out, and the new buyer will agree to what I consider to be a ridiculously aggressive development contract”.
“The franchisor has replaced experienced long term field support with lower priced (and inexperienced) younger people. They’re cutting corporate overhead, but these kids, who never ran a store, are telling me to how to control costs.””
“I’m doing my best with the development objectives, but it is almost impossible to build stores with today’s economics. Rents are too high, labor costs are killing me, and I can’t raise prices in this promotional environment”.
“As if things aren’t tough enough, I’m being nickeled and dimed with demand for higher advertising contributions and fees on services (including software) that I thought would be provided”.
The valuations provided to the publicly held companies do not reflect the situation as described by the admittedly anonymous franchisees. The commentators quoted above don’t want to aggravate their franchisor, and we don’t want to be unfair or misleading to particular companies by relying on just a few conversations, though they do support one another. For the most part, franchisees are strongly discouraged from talking to the press or investment community. The companies will say that “competitive” issues require some secrecy, but there are few secrets in this industry.
The optimistic view, as represented by the valuations in the marketplace, is that the comments above are not typical or representative of the health of the subject franchise systems. Allow me to provide a short story which leads to a suggestion.
A SHORT STORY
Twenty six years ago, in 1992, IHOP had just come public. I was a sell side analyst, thought the numbers were interesting and the stock was reasonably priced. The company, led by the now deceased CEO Kim Herzer, invited me to attend their franchisee convention, which I did. I obviously had the opportunity to interface with many franchisees and it was clear that, while all was not perfect, the franchisor was providing a great deal of support that was embraced by an enthusiastic franchise community. IHOP stock tripled over several years for me and my clients who owned millions of shares. I attended several more of their annual conventions and maintain some of those relationships to this day. Obviously, the conviction I gained from their open attitude was critical to the success of the investment. I should add, that many of those buyers in 1992 owned the stock for many years, not living and dying on quarterly reports.
As you are no doubt by now anticipating, my suggestion to publicly held franchising companies: open up your franchisee conventions to the investment community. The companies may quickly respond that lenders are already invited to franchise conventions, but franchisees are unlikely to express their system oriented concerns when they are making a pitch to a potential lender. Companies may also respond that their lawyers think it would be a bad idea, not consistent with full disclosure and analysts would be getting “inside information”. Let’s not allow the lawyers to provide “cover”. A good lawyer will provide a solution to the problem, not just provide the pitfalls. Analysts attending a franchise convention are not being told what sales or profits are going to be. Attending a franchise convention is a “channel check”, no more than talking to a supplier or customer of a manufacturing company, which any decent analyst will do.
The anecdotal critical comments, as described above, have likely been heard by others, but may be atypical of most restaurant franchising companies. There are no secrets in this business. One of the investment appeals of this industry is its transparency. Notable news is going to leak out anyway. The objective of any publicly held company is to build stock ownership by well informed investors. Investment analysts pride themselves on their ability to “build a mosaic”, enhance the information provided in quarterly reports, SEC filings, and conference calls, with “channel checks”. What channel check would be more pertinent than meeting the franchisees of a company that is dependent on franchisee success? Putting it another way, and taking the highest valuation relative to EBITDA as an example: Wingstop (WING) is a company I have the highest regard for. However, you could call it irresponsible to pay almost fifty times trailing EBITDA for Wingstop stock (and I haven’t) if I couldn’t talk to franchisees of my own choosing?
There’s no particular need to invite this writer if I’m not considered influential enough. I have not spoken to these analysts on this subject, but qualified industry followers such as David Palmer, Nicole Reagan, Matt DiFrisco, David Tarantino, Jeff Bernstein, Andy Barish, Bob Derrington, Mark Kalinowski, Michal Halen, Gary Occhiogrosso, Howard Penney, Jonathan Maze, Nicholas Upton, John Hamburger and John Gordon provide the beginning of an invitation list. I rest my case.
DINE BRANDS, GLOBAL (DIN) – IHOP and APPLEBEE’S – INITIATIVES GALORE – CHANCE OF SUCCESS?
Dine Brands Global, previously Dinequity, operator and franchisor (franchisor mostly) of the IHOP and Applebee’s brands, has had its share of challenges in recent years. Applebee’s has been in a “dogfight” within the competitive “bar and grill” or “neighborhood pub” segment, competing against the likes of Red Robin, Chili’s, now bankrupt Ruby Tuesday’s and the up and coming fast casual burger concepts such as Shake Shack and Five Guys. IHOP has been battling the resurgent Denny’s as well as other family dining operators.
From a long term strategic standpoint, it is an interesting question as to whether hundreds of millions of dollars should have been spent in stock buybacks and a high dividend, when the needs to invest in systems to support two franchised brands are so obvious, especially in retrospect. This situation has essentially provided a “teaching moment” to private as well as public investors relative to the need to invest part of the presumed “free cash flow” of these “asset light” franchising companies to support and protect the long term value of the brand. Franchise systems do not prosper and grow without ongoing investment to keep the brand current.
Applebee’s suffered most, as franchisees were left to their own devices to protect market share. The system got behind the curve in terms of product development, service initiatives including mobile app technology, delivery capabilities, new production systems, labor saving approaches, and more. While not “shooting the lights out”, IHOP has been the more consistent performer in recent years, mostly sustaining traffic trends while competing with the resurgent Denny’s chain and other breakfast oriented operators.
There have been many moving parts at both brands. Most of them have been typical within the industry: product development, service improvement without excessive labor, mobile app and online ordering, delivery, curbside pickup, replacement of broadcast by social media and others. Two particular unusual initiatives caught our eye in the last week or so, namely: Remote ordering at Applebee’s, to be immediately consumed at a restaurant table reserved at a particular time, and : IHOP becoming IHOB (“B” for “Burgers”), first announced as permanent, apparently now adjusted to be a temporary attention getter.
The Applebee’s innovation, ordering a meal at a particular time, to be consumed in the restaurant, on the surface seems appealing, to certain “on the go” customers as well as the restaurant operator who can make better use of the real estate by turning tables faster. However, the devil is in the details (as usual) and there seem to be a lot of elements that can go wrong, and cost more customers than the strategy will attract. (1) If the customers don’t arrive on time the food will be waiting and deteriorating, even under warming lights (2) The food must be ready on time, and the table also, or the customer will very quickly become disenchanted with this newly offered service (3) The meal’s “staging” may vary by customer, some wanting everything on the table at once, others wanting the meal in segments, and the non-standard time between courses could confuse operations (4) Table service is still a requirement, but the customers may reduce the tip which will not encourage the wait staff for these tables (5) The whole dining “experience” will differ from normal, almost becoming a different business within the restaurant, potentially upsetting operations that are trying to serve the standard guests. Overall, there seems to us to be lots of room for error here, and this approach will not be tolerant of mishaps. Under normal circumstances, a few minutes one way or another, or some portion of the experience that is not just right, will not upset guests. This approach, however, is supposed to be time saving and reduce stress, which too often may not be the case. Our opinion: Give it a shot, if you must, but be prepared to move on. Too many of the new ideas at Applebee’s are working well. It ain’t broke right now, so let’s not snatch defeat from the jaws of victory.
IHOB?? – It better be a darn good burger, at a darn good price. We hear that more than a few loyal IHOP customers are reacting negatively to their favorite pancake house becoming a burger joint. As we understand the developments, DIN backed off from changing the name of the chain to just using IHOB as a promotional device when customers started expressing themselves. While it seems like an obviously desirable strategy to build on the dinner daypart which it seriously underutilized, hardly any chains have ever been successful in building new dayparts that are not natural attractions. McDonald’s did it with breakfast but it took them over ten years and hundreds of millions of dollars. IHOP has more than a fifty year old identity as a breakfast destination, with pancakes as the signature item. If they happen to serve a really great burger, the customers will figure it out over time and tell their friends. To point out the obvious, flour and water provides a lower food cost than beef, so the last thing IHOP wants to do is have an existing customer order a burger rather than pancakes. Another thing that must be avoided is confusion of the customer, and the name change, if only temporary, may turn off more existing customers than attract guests to this newly self proclaimed “burger authority”. (Red Robin has already assumed that nomenclature.)
In summary: We admire the creative thought process, and there has been a lot of it lately at DIN, especially productive at Applebee’s which is apparently moving in the right direction. However, we think the new ordering (and dining) option at Applebee’s is far from a game changer and could be disruptive. IHOP’s burger gambit runs the risk of confusing (and losing) some customers, so we have our doubts here as well. That’s the problem these days in the restaurant industry. There is no easy way to differentiate your commodity. We’re fond of saying that the only hope is to create, and then build upon, a hospitality “culture’ that is strong enough to get the consumer off the couch, away from their computer or TV set, for a literal and figurative “taste” of the real world.
LIFE IN THE WALL STREET (SHORT TERM) FISHBOWL – BEWARE THE “CONFLICTS” OF INTEREST
There are all kinds of pressures on growing companies, some obvious and some not so obvious. In this piece I would like to discuss some of the conflicting “agendas” of operating principals (owners) versus outside investors.
There are lots of good reasons to expand a successful multi-unit food service concept, if you are so fortunate as to be generating an attractive return on invested capital. Aside from the natural desire to be “bigger and better”, “beat out the competition”, “attain critical mass”, “play on a bigger stage”, and “change the world”, the need to attract the best possible employee/partners to serve your customer base is always urgent. The interaction between your serving crew and your customer base will make or break you, and it is a special challenge to attract and keep the best available talent if you don’t provide the natural career path afforded when growing units. I’ve often counseled that “you’re not in the food business, you’re in the “adolescent training” business. So it helps a lot if you are expanding. You get the picture.
I’ve noticed, over many years, that most troubled restaurant companies bring on their problems by themselves, and virtually every restaurant chain that has seriously suffered, and/or died, has done so by way of self inflicted problems. I can’t think of one successful restaurant company that ran into serious problems as a result of competitors or general economic factors. It is actually amazing that in the face of tremendous long term competitive pressure from companies such as McDonald’s or Starbucks, there are still regional hamburger chains (e.g.-In and Out, Whataburger, Jack’S) and coffee chains (e.g. -Peets, Caribou, Seattle) that are successful. The problems have often been the result of headlong expansion, too many units too quickly, spread too thin geographically, poorly selected franchisees for sometimes immature concepts, new products introduced without proper testing. The names of the departed are legion, from D’Lites to G.D.Ritzy’s to Flakey Jakes, to Po’Folks, and dozens of others.
Conflicts of Interest : Publicly Held
Public investors clamor for growth: unit growth, same store sales growth, traffic growth, and the presumably accompanying growth in earning per share. If you are growing units at 10% per year, they want 15%. If you give them 15%, they ask why you can’t grow faster. If you are growing company operated units at 20% (which has been proven to be the top end of controlled unit growth for company operated stores) public investors eager to see the stock go up “tomorrow” are not sympathetic (or sometimes knowledgeable) to the risks of faster expansion. Public shareholders (and stock valuations) are also sensitive to what is called “the second derivative”. The public investor loves it when all parameters are in gear including accelerating: unit growth, same store sales and traffic increases, with operating margins and earnings growth accelerating. If any of those measures are contracting, the stock valuation will contract. When the growth in units has been 20% (the “first derivative”), the “slowdown in the (growth) rate, the “second derivative” to “only” 15% is considered a negative, and the stock price will consolidate or decline. We’ve seen this lately in the stock valuations of Shake Shack, Zoe’s, and others, who admittedly were very highly valued, “priced for perfection” with all units of measure in gear.
Capital has to be raised to finance expansion, not to mention the allure of huuuge compensation by way of stock options, so the pressure to live up to investor expectations can lead to lots of imprudent decisions. Management may not admit to themselves why they are rolling out a “Wood Fired” menu upgrade, at Applebee’s, or the upscale menu that Ruby Tuesday’s tried several years ago, both seemingly without adequate testing (IMO). Got to keep the SSS and traffic moving upward. Can’t tell the dozen analysts that are taking their P&L apart line by line on a quarterly basis, that six months of testing will be necessary. Buffalo Wild Wings, with the need to improve their entire menu,(IMO) has installed a 15 Minute Lunch Guarantee. It could help traffic (at lunch), but I am providing a guarantee to management that it will not build profits. How much can the customer spend in 15 minutes? How many table turns could you get? And how does that translate to attracting those customers back for a completely different experience in the evening? But analysts don’t want to hear that you are in need of a general “re-invention” of the concept, and it will take time. So money and time is squandered in an unproductive effort. Store level employees are pressured, franchisees question the leadership, and sometimes “activist” investors, (as is the case with BWLD) get involved. As a more positive example, Panera management has done an admirable job describing long term initiatives (mobile pay, catering, 2.0 technology platform) which are costly in the short term but strategically desirable. Analysts have generally responded well to the detailed updates as Panera has led by example with installation into company operated locations. Panera also seems to be adjusting the initiatives with feedback from franchisees as well as from company store experience.
My conclusion: If you are publicly held, doing well and fortunate enough to have a reasonably valued stock: maintain a debt free balance sheet if possible, raise enough equity capital, if necessary to sustain a prudent rate of unit growth, and then go back to running your business as systematically and prudently as possible for the long run. Good examples in the current crop of restaurant companies would include Shake Shack, Habit, Zoe’s and Chuy’s. The stock will fluctuate, but will grow over the long term on a parallel path with your corporate growth. As described above, in terms of the current effort, Panera has done a great job over 20 years to grow from 50 units to over 2000 units, and the stock has risen proportionately to the corporate results.
The Conflicts of Interest – Privately Held
It should be no mystery that there is “a price” when a private equity investor opens their wallet on your behalf. They will want substantial equity, Board of Director representation, and the ability to “influence” operations in a variety of ways. They will have a lot to say about management compensation, key executive selection and expansion strategy, among others. They will have all of the concerns that public shareholders will have, but will take a somewhat longer term view, and will be in a position to strongly influence the decision making process. On the positive side, professional private equity investors can be a huge asset, in terms of their financial and operational knowledge, so the result can be a great partnership.
However, never lose sight of the fact that private equity investors are in the business of buying and selling, sometimes with a shorter timeframe than founders or operating management. Everyone wants growth but the outside investors may be more motivated to grow fast enough to meet their own hurdle rates. Some private equity investors are more experienced than other, but sometimes a growth rate is encouraged that can be costly to all. Let’s say, for instance, that a casual dining chain with 20 units is planning to open 4-6 units in the next twelve months, which is at the top end of the 20% growth rate of units that has often been dangerous to exceed. (I’m speaking of company operated stores alone, and franchised growth, a separate subject, can add to this rough guideline.) Management then finds three really excellent sites, but it’s tough to find two or three more that are quite as predictable in terms of demographics, and /or ideally situated geographically. So management doesn’t want to disappoint their highly regarded P/E partners, in fact would like to meet and beat expectations. I suggest, however, that the guaranteed way to really disappoint the P/E partners would be to open one or two mediocre, let alone poor, locations. One bad location can offset two or three good ones. Open three units instead of 4 or 5 or 6 and investors will be less than thrilled, but no long term damage has been done. You might have actually strengthened the operational team for the long run, with less stress from the extra openings. Open a couple of underperformers and the whole team is, at the least, set back by several years.
So….once again….just as with publicly held companies, maintain financial flexibility, and run your business for the long term, resisting the siren song of short term strategies that can seriously undermine long term prosperity. Compound 15% growth (considered “modest”) and you get a quadruple in 10 years, 16 times your starting level in 20 years. Not too bad.