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THE WEEK THAT WAS, ENDING 1/28 – A FEW RATINGS CHANGES, EARNINGS REPORTS ABOUT TO BEGIN

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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

 

 

 

 

 

 

BRINKER, INTERNATIONAL, INC. – UPDATED WRITEUP – HERE COME THE WINGS!

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BRINKER, INTERNATIONAL, INC. – UPDATED WRITEUP – HERE COME THE WINGS!

As of December 23, 2020 Brinker owned, operated and franchised a total of 1,655 restaurants, of which 1601 were Chili’s and 54 were Maggiano’s Little Italy. Company operated: there were 1,061 domestic and 5 int’l Chili’s, plus 52 domestic Maggiano’s. Franchised: there were 171 domestic and 364 int’l Chili’s plus 2 domestic Maggiano’s.

CONCLUSION

Brinker’s most important Chili’s brand has been managed well in recent years, including the last twelve months,  and results should improve further,  but the longer term expectations at Maggiano’s remain uncertain. The introduction of It’s Just Wings as a virtual concept is promising. However, Brinker’s ability to defend its competitive position over time in this niche is not assured. Other large full service, or even QSR, chains with excess kitchen capacity could presumably compete just as well and Wingstop is not going away. Activists could be attracted by the cash flow and the re-franchising potential but the balance sheet, even with debt coming down, is already leveraged to a large degree. Net Lease Adjusted Debt, currently,  at about 4x the run rate of Adjusted EBITDA is not excessive  for a pure franchisor but is adequately high for a company operated chain.

FIscal ’21, ending June 30th, has become a “transition” year, and FY 6/30/22 is increasingly uncertain. The estimates of EPS for the FY ending 6/22 range from $3.60/share to almost $5.00, with the top end of the EBITDA guess at about $450M. The current stock price, at about 13x the high end of EPS with an Enterprise Value of about 9x EBITDA allows for some modest upside if the high end of performance expectations actually happen, but we have our doubts.  On balance we feel that Brinker (EAT) is fairly valued, with a great deal of the post pandemic recovery potential adequately discounted.

 OPERATIONS AT CHILI’S ARE STRONG, MAGGIANO’S NOT SO MUCH

 According to a National Restaurant Association survey, more than 17% of all US restaurants are now permanently or temporarily closed. That is more than 110,000 businesses and Chili’s seems to have been one of the  beneficiaries. On the recent second quarter conference call, management stated that Chili’s had increased its two-year trend of taking market share with a category leading 18% beat in sales and a 25% beat in traffic according to KNAPP-TRACK. The company’s broad menu and specials such as 3 for $10 and $25 Dinner for Two resonated with diners looking to dine out without spending a great deal of money.

 In the second quarter, ending 12/23/20, Chili’s reported that same store sales only declined 6.3%. This compares favorably to other national chains that have announced results so far such as Olive Garden (-19.9%) and Longhorn Steakhouse (-11.1%). We expect that these results will also compare favorably to results at companies such as Bloomin’ Brands, Cheesecake Factory, Dine Brands and BJ’s when they report in the coming weeks.

OPERATING RESULTS

While sales have held up fairly well, cost control at Chili’s has been even more impressive. Food and beverage and labor costs as a percentage of revenue were flat year over year. Occupancy and other expenses are up about 90bps due mostly to the costs associated with delivery fees. As a result of this cost control, operating income declined only $1.6M to $50M on a $45M decline in sales.

Because of the occupancy restrictions due to the pandemic, there has been a dramatic shift in the percentage of sales that are coming from to-go and delivery orders. The off-premise business at Chili’s has grown over 225% since 2018 and the pandemic has accelerated this trend. Historically, Chili’s, to-go and delivery sales were 14-17% of sales with 74% coming from to-go and 26% from delivery. However, in the first two quarters of FY21 off-premise sales were approximately 46% of sales, with 60% coming from to-go and 40% coming from delivery. Some of the shift has come from the addition of the virtual brand It’s Just Wings, to be discussed later.  For comparison, Olive Garden to-go sales as a percent of revenue is 37%. This ratio will decline for all full service casual dining chains as dining room capacity increases, but demonstrates that Chili’s food is apparently holding up relatively well when delivered.

DEMAND PROBLEM AT MAGGIANO’S

Not well positioned to deal with social distancing, Maggiano’s emphasis is on family style dining and has a large banquet and group meeting business. For example, 17% of sales come from banquets and group meetings. The second quarter is the busiest time of year for this part of their business and sales were essentially zero this past quarter. The restaurants are much larger than a Chili’s restaurant, with 3X the square footage of a Chili’s and average unit volumes before the pandemic were $7.9M compared to $2.8M for a Chili’s. A sales decline such as almost 50% in Q2 predictably creates a huge deleveraging of occupancy costs. Restaurant expenses other than labor and CGS rose 1000bps to 35% of sales. Chili’s comparable expenses were only 28% of sales.

Another disturbing trend is that the average check declined significantly. Before the pandemic, the average check at Maggiano’s was about $28 (compared to $15 at Chili’s). The average check is now running around $22. This decline caused deleveraging on food and labor costs as well. All these factors are manifested in the huge decline in both sales and operating income. In spite of having sales that are $600M per quarter less than Chili’s, Maggiano’s saw a loss of $56M in sales compared to a $45M loss in sales at Chili’s. Operating income dropped $22M to a loss of $1M. As we discussed earlier, Chili’s operating income only dropped $1.6M.

HERE COME THE WINGS, AND MORE

In June 2020, Brinker International announced that it was rolling out a new virtual brand called It’s Just Wings (IJW). IJW offers wings featuring 11 sauces and comes with curly fries and a dessert option of fried Oreos. At this time, customers can only order through DoorDash or the website https://itsjustwings.com/. When the announcement was made, Brinker stated that there were three reasons for deciding to move forward with the concept:

  • It allows the company to leverage the company’s scale and over 1,000 kitchens with no extra equipment needed (It’s Just Wings will operate out of current Chili’s and Maggiano’s, customers can’t walk in and order in-store).
  • It supposedly does not create operational complexity within the Chili’s system.
  • Brinker management is convinced that It’s Just Wings can deliver the best product at the best value for guests.

On the second quarter conference call, management stated that IJW is generating $3M in weekly sales or $150M a year. While the profit contribution is not yet clear, these results seem to be a good start when you consider Wingstop took over eighteen years to achieve $150M in systemwide sales. Also consider that these results are being achieved without any major marketing support. Management revealed that the brand is seeing high satisfaction scores and strong repeat usage. However, at this point DoorDash is not sharing individual guest contact information so Brinker is not able to register these customers in their loyalty program. If the company is not able to convert these users to the Chili’s loyalty program that would be a disappointment.

Brinker wants to expand its virtual brands to further leverage restaurant operating costs. One possible concept that has been mentioned is called Plattered and Pies, apparently an Italian concept, which makes sense considering Maggiano’s Italian heritage. Another concept that CEO Wyman Roberts has mentioned in the past is a fast-casual Mexican brand, since the Chili’s menu has a significant number of Mexican food options on it. While the ultimate profit contribution from this effort is unclear, it seems that Brinker does not have to pay a commission to DoorDash, which would help profitability long-term.

CORPORATE LIQUIDITY IS GOOD

To bolster liquidity during the worst of the pandemic, in May 2020 Brinker issued 8.1M shares at $18.25 per share, raising over $146M. In retrospect, of course, considering that in FY19 and FY20 the company spent $200M buying back 4.4M shares at an average price of $45.50, it wasn’t such a good trade. On the other hand, a pandemic was not on anyone’s radar.

The company ended Q2 2020 (12/23/20) with $64M in cash and over $594M available on its revolving credit facilities. Year-to-date Brinker has paid down $66M on the revolver and is well on its way to achieving its 3.5X Lease Adjusted Debt to EBITDA goal next fiscal year (from 4.5X last year). The two outstanding notes totaling $650M do not mature until 2023 and 2025. The company continues to produce significant free cash flow. Brinker has always been able to generate significant amounts of free cash flow. Cash from operations for six months  was a strong $130M, down only $12M from last year. Capital expenditures were only $37M, which means the company produced nearly $97M in free cash flow YTD. We would expect the company to resume its dividend payments sometime this year, though the resumption of the $0.38 per share dividend would not be huge at a 2.3% dividend yield.

FRANCHISING IS BECOMING VERY IMPORTANT TO OVERALL PROFITABILITY

As operating income from the owned stores has stagnated over the years, income from franchisees has become a significant source of corporate income and profitability. Franchise revenue generates a reported 90%+ profit margin and requires minimal absolutely required capital to grow. We interject here our often stated concern that too many franchisors short change their systems by not investing sufficiently to refresh the brand, as the same time increasing the franchisee burden with required advertising and operational fees. That said, the table below shows how this extremely high margin income stream has become a significant percentage of operating income for the company. Franchise revenue as a percentage of operating income has risen steadily over the last five years, from under 30% to approximately 50%. In fact, in FY20 it represented over 100% of operating income! While there is significant operating leverage ahead for the company stores as the impact from Covid 19 subsides, the growth in franchises, especially internationally, is going to be a significant source of income growth in the future. While the growth rate has recently slowed significantly, there remains a potential to franchise some of the current company store base.

In recent years, Brinker has been adding about 20-30 new franchise stores a year. Most of these stores are being opened internationally. As mentioned, the global pandemic has caused a significant slowdown in this development. In FY19, Brinker opened 23 franchise restaurants and originally projected opening 31-36 in FY20 (It only opened 25). Through the first two quarters of FY21, the company has only opened six (compared to 18 last year). The company is only projecting opening 9-12 franchise restaurants in FY21. This slowdown will negatively impact the growth in operating income for the next two years.

IMPACT OF $15 FEDERAL MINIMUM WAGE APPEARS MANAGEABLE

Now that the Democrats have reclaimed the Presidency and the two houses of Congress, the push for a federal $15 minimum wage has begun. We believe that Brinker has done a good job helping out its employees during this pandemic and has earned some goodwill with its front-line workers. For example, last year the company spent $17M on employee support by continuing to pay hourly employees and managers even though they were not working or reaching their profitability goals. However, that doesn’t mean that Brinker will be able to avoid any increase in the federal minimum wage. Brinker does pay above this rate in many of the states it operates in. This topic remains a political football, and was discussed at length on the recent conference call. As we see it, $15 federal minimum wage or not, labor costs move inexorably higher, but Brinker should be able to cope as well as anyone else.

SIX MONTH CASH FLOW A BIT ENHANCED

One final material detail within the six month 10Q filing (ending 12/23/20) was the relatively large increase in the deferred gift card balance. Over the last six months it has risen by 20% or $20M, not affecting reported revenues or costs, but inflating cash flow over the period. Success in this area indicates that customers are continuing to find value in Brinker’s offerings and should  contribute to a rebound in sales, but the cash receipt has already been reflected.

CONCLUSION: At beginning of this article

Roger Lipton

 

BRINKER INTERNATIONAL (EAT) UPDATED WRITE-UP

Uncategorized,

Key Economic Metrics Summary (from 10K dated August 13, 2019)

CONCLUSION: Selling at less than 10x earnings estimates for the fiscal year ending 6/20 and under 10x trailing twelve month EBITDA, EAT is reasonably priced statistically. The problem is that they are operating in a very competitive segment and continuously challenged to differentiate their commodity. They’ve done a credible job of controlling expenses, at the same time improving customer satisfaction, as evidenced by steadily improving comp sales. On the other side of the coin, typical of most publicly held restaurant companies, the growth of off-premise activity makes “dine-in” traffic comparisons even more negative than reported. Considering that off-premise is the primary source of sales growth, there are still too many restaurants out there and far too much square footage. It’s no accident that the best sales performance is coming from the small box (delivering)operators such as Wingstop and Domino’s. The 3.7% yield here is secure, the earnings improvement this year from their recent acquisition can likely be extended in fiscal ’21, but it is hard to see above average growth from there. They’ve already bought back a lot of stock, and the balance sheet leverage is fairly high (though it could be pushed further). Absent a catalyst that we cannot foresee, we don’t know why EAT would outperform the industry or the market on the upside.

THE COMPANY: Brinker International, Inc. (EAT), corporate headquarters are located in Dallas, Texas. They own, operate and franchise the Chili’s Grill and Bar (Chili’s) and Maggiano’s Little Italy (Maggiano’s) restaurant concepts.

The Brands: As of August 13, 2019 there are 1,613 Chili’s locations worldwide with 664 being franchised.. Chili’s has been operating restaurants for over 40 years with the first being opened in Dallas, TX. Chili’s original core menu was gourmet burgers, skin-on-fries and frozen margaritas. Today it is known for its gourmet burgers, fajitas and baby back ribs. As of August 13, 2019 there are 52 Maggiano’s locations. Maggiano’s is a full service polished Casual Dining concept offering Italian American cuisine. Average check in fiscal 2019 was $28.66.

UNIT LEVEL ECONOMICS COMMENTARY: The AUV increase at Chili’s was 2.0% as shown, including a menu price increase of 3.9%. Maggiano’s AUV was up 4.4%, including a 1.6% menu price increase. The increase in COGS, up 30 bp to 26.5%, was caused from unfavorable menu mix and 20 bp increase in produce costs. Labor and Related costs increase of 10 bp to 34.1% was a result of higher wages which were partially offset by lower Manager Expense. Occupancy & Other Related Expenses rose by 130 bp to 26.2%. This was a result of higher Rent Expense associated with new operating leases, as well as higher Advertising & Marketing Related Expense. Store level EBITDA was 13.2% of total restaurant revenue for fiscal 2019. This was a 170 bp decrease from 2018 fiscal year results. This decrease was primarily a result of the increase in Occupancy and Other expense.

DEVELOPMENT COMMENTARY: For fiscal year 2019 the company opened 4 new company-owned Chili’s restaurants and closed 25 Chili’s franchised restaurants. During fiscal 2020 the company has acquired 116 Chili’s locations from franchisee ERJ Dining. Additionally, Chili’s is expecting to open 9-11 new company units and 30-35 franchise Chili’s. EAT is also planning on opening 1 new franchised Maggiano’s.

SAME STORE SALES COMMENTARY: Comparable restaurant sales represent locations that have been opened at least 18 months prior to the start of the accounting period. The increases in the table above are inclusive of the menu price increases, which provides negative traffic in each case.

RECENT DEVELOPMENTS: Per Q1’20 Earnings Release and Conference Call – Adjusted EPS, as shown in the statistical template at the top of this article, shows a 12% decline to $0.41 per share., primarily due to the acceleration of stock based compensation expenses for newly retired executives. Operating Income, aside from Other Gains, was $30.3M vs. $35.8M, down 15.4%, though $3.5M of the $5.5M decline was the just mentioned non-cash stock based compensation. Chili’s company operated comp sales were up 2.9%, US franchise sales were up 0.4%, and Int’l franchise sales were down 1.3%. Maggiano’s company owned comp sales were down 1.8%. Restaurant operating margin (EBITDA) was 11.0% of sales, down 10bp from 11.1%, well controlled with CGS up 40bp to 26.7%, Labor down 10bp to 35.1%, Other Expenses down 20bp to 27.1%. This was the 6th consecutive quarter of positive comps and the 7th consecutive quarter of outperforming the peer group in terms of traffic. In terms of openings: One company owned Chili’s opened, One domestic franchised Chili’s opened, Eleven int’l franchised Chili’s, , for a total of Thirteen Chili’s systemwide. Most importantly, 116 Chili’s Midwest US franchised restaurants were acquired, representing about $300M of annualized sales, three weeks of which ($15.3M of revenues) were included in Q1 results. The purchase price was $99M, funded from the existing credit facility. Cash flow from operations was $86.6 million, which resulted in $66.1M of free cash flow after $20.5M of capex. Relative to the balance sheet, adjusted leverage totaled 4.1x EBITDA, expected to be the high point of the year, coming down to 4.0x by 6/30/20.

From a product and marketing standpoint, there continues to be an emphasis on the “3 for 10” platform. A new and improved chicken product was rolled out. New products will continue to be developed, at the same time maintaining the narrowed focus that has served EAT well over the last two years. New table top devices are being rolled out and development of hand held units continues. Food to go, both takeout and delivery, is an important growth area, with two thirds of off-premise sales by way of digital channels. Off-premise sales was up over 25% in the quarter, now representing about 15% of total sales. Takeout is apparently growing roughly at a high single digit rate, reduced lately by the faster growth of Delivery. Improved packaging is a current emphasis, to reduce cost and increase customer satisfaction.

In terms of expectations, comp sales and margins are expected to be little changed from recent trends during the balance of the current year. Reference was made to “a little bit of headwind” affecting the somewhat higher end consumer at Maggiano’s, but bookings for the holiday season “look good”. While details were not discussed, earnings accretion, after interest charges, from the 116 store acquisition are likely expected to help during the balance of ’20 and then the fiscal year ending 6/30/21.

 CONCLUSION: Provided at the beginning of this article

RESTAURANT BRANDS (QSR), TEXAS ROADHOUSE (TXRH), BRINKER, INT’L (EAT) REPORT RESULTS — ALL THREE STOCKS ARE DOWN — WHAT’S GOING ON?

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RESTAURANT BRANDS (QSR), TEXAS ROADHOUSE (TXRH), BRINKER INT’L (EAT) REPORT RESULTS — ALL THREE STOCKS ARE DOWN — WHAT’S GOING ON?

Well regarded pure franchising Restaurant Brands, QSR, Best of Breed company operator, Texas Roadhouse, TXRH, mature professionally managed multi-chain company operator/franchisor, Brinker, Int’l.,(EAT) all reported their March quarters within the last 36 hours. What can we learn?

Before we start, because the news is not great and I recently seem to be consistently pessimistic (I would say “realistic”), you should know that I am not “talking my book”. I am neither long nor short two of the three companies discussed, and have a very modest short position in only one of them (which shall go nameless). All three stocks are down since they reported, QSR and EAT more modestly than TXRH, which is down about 10% this morning.

We are not going to provide extensive details, which you can read about elsewhere and which we will discuss in our full writeups to be posted within the next couple of weeks. We will provide just the pertinent highlights as we see them, and our conclusion.

Restaurant Brands (QSR), franchisor of Tim Horton’s, Burger King and Popeye’s, reported EPS down YTY, because of a higher tax rate. Actual Income Before Taxes was up, $302M versus $281M, but it should be noted that Other “Income” this year of $17M was $30M better than Other “Loss” a year ago of $13M. Let’s call it “flat” pretax income, by our simple adjustments. Everybody looks at comps and EBITDA by division here. Tim Horton’s delivered a negative comp of 0.6% in Q1, on top of a negative 0.3% in 2018. Price changes are not discussed relative to any of QSR’s three brands, so we can’t comment on traffic. Adjusted EBITDA at Tim Horton’s was $237M, down from $245M. Burger King had systemwide comps of 2.2% on top of 3.8% in ’18. BK’s Adjusted EBITDA was $222M vs. $214M in ’18. Popeye’s had a comp of 0.6% versus 3.2% in ’18. Adjusted EBITDA was $41M vs. $39M in ’18. The three brands, therefore, had total Adjusted EBITDA of $500M vs $498M a year earlier. Let’s call the results flat, and the bottom line is that, as we have predicted for some time, it will be very difficult to grow the EBITDA and EPS comparisons by more than mid single digits. Combining the “hard” results with the conference call commentary, there is very little happening that will accelerate the cash flow and earnings progress. Readers can refer to our previous commentary regarding QSR, , but, suffice to say: Tim Horton EBITDA growth, which grew from 2015 through 2017 largely by price increases imposed on the distribution chain, is not going to recur, especially in light of the lawsuits by franchisees. Burger King is a steady grower, especially overseas, but the G&A magic has already been imposed on this system so the easy money has been made. Popeye’s is the most rapid growth division, but is too small to move the total needle by much. The dividend of almost 4% supports the stock price, but it has seemed to us for a while that this “mid-single digit” grower is fully priced at 20x trailing EBITDA and 25x forward EPS. It should also be noted that much of the “free cash flow” has been used to buy back partnership interests from their parent, 3G, so this “return to shareholders” has primarily benefited 3G. From 12/31/16 to 12/31/18 the average weighted fully diluted shares outstanding has gone from 470M to 477M to 473M. There is substantial cash flow here, but a great deal of it has been used to buy back exchangeable Partnership interests from 3G. The long term debt was constant at $11.8B in ’18 over ’17 (after $3B was borrowed to buy back Berkshire’s Preferred), and “free cash flow” is not so “free” when debt is over five times trailing EBITDA. The Board of Directors preferred in ’18 to buy back stock from 3G (at 25x expected earnings and 20x trailing EBITDA) rather than reduce the debt. We agree that it seems sensible, from 3G’s standpoint, to lighten up. To be sure, there is a substantial dividend for common shareholders.

Texas Roadhouse (TXRH) is a simpler story. They are truly one of the premier operators in the full service casual dining space, consistently delivering same store sales growth as well as traffic gains. The most recent quarter was no exception, with an admirable comp of 5.2%, including 2.6% traffic. The monthly comps, though decelerating through the quarter were fine, up 7.2%, 4.7%, and 4% in January, Feb., and March. April to date is up 2.9% on top of 8.5% a year earlier. However: Income from Operations was down 6.8%, and diluted EPS was $.70 vs $.76. Restaurant margin (EBITDA) was down 128 bp to 17.9%, and the problem was labor, which cost 118 bp. The discouraging part for investors and analysts is that the Company has predicted ongoing wage pressure, and these guys are not about to disappoint customers by cutting labor.  An additional concern, though a lot smaller, is expected commodity inflation of 1-2% for all of ’19. There’s a lot more that could be detailed here, but the results at TXRH demonstrates what we’ve been saying for a while, that it takes more than even 3-4% comps (and now 5.2%) to leverage the higher costs of operations, labor in particular. We don’t know to what extent the Street will lower expectations for ’19 but at $54.37 at the moment (24.7x ’18 EPS) doesn’t seem like a bargain when it is hard to know when EPS growth will resume. FWIW, $54.37 is 14.5x Bloomberg’s estimate of TTM EBITDA.

Brinker International (EAT) reported Q3 (ending March) with somewhat of a “mixed bag”. The headline indicated that EPS, excluding special items, was up 16.7% to $1.26 vs $1.08. Comp sales for Chili’s was up 2.9% (company) and 2.0% (franchised). Maggiano’s was up 0.4%. Operating Income was 8.4% of Revenues, down 50 bp from 8.9%. Restaurant margin (EBITDA) was 14.3%, down from 16.1% but, excluding the effect of a sale-leaseback transaction, would have been flat YTY. (However, the higher rent is a cash charge vs. depreciation which is non-cash, so the true cash EBITDA margin was truly 180 bp lower). Chili’s results are the main driver of results, and, aside from the sale-leaseback penalty, it was pointed out that: “cost of sales increased due to unfavorable  menu mix, and commodity pricing, partially offset by menu pricing, also partially offset by a decrease in restaurant labor from lower incentive compensation, which in turn was partially offset by higher wages.” So: CGS was up, wages were up, restaurant labor (hours?) was down, and there was less incentive compensation. That doesn’t sound like the industry wide wage increase is abating, and commodity costs are up, which we also heard at Texas Roadhouse. While it is admirable that comps were up again at Chili’s, with traffic up as well, it should be noted that the gain in after tax EPS was entirely due to a lower tax rate and far fewer shares outstanding. Income Before Taxes was $55.5M, down from $58.9M. Adjusted for an Other Gain of $3.5M this year versus a $2.7M loss, the comparison would be $52.0M of Adjusted Pretax Operating Income vs. $61.6M. The number of fully diluted shares was 38.1M vs. 46.0M. From a financial engineering standpoint, EAT chose to do a sale-leaseback transaction, paying higher “rent” vs. non-cash depreciation of the stores in return for retiring a large number of shares. From an operating standpoint, even with flat EBITDA at the store level, we see that same store sales (and traffic) gains of 2 or 3% are not sufficient to overcome higher labor (and other) expenses.

The Bottom Line:

The above capsulized reports show that the operating challenges have not abated, and will not likely relent in the foreseeable future. Restaurant Brands’ results show how ten years of low interest rates have allowed financially astute executives to assemble a portfolio of franchised brands, but mature (Tim Horton’s and Burger King) chains can only be financially engineered to a certain point, especially in a difficult environment. Texas Roadhouse and Brinker results show how operators ranging from a Best of Breed growth company  to relatively mature brands are similarly challenged.

Broader than the Restaurant Industry: There are something like 20M individuals employed in the hospitality industries, including restaurants, retail and lodging and this is a material portion of the entire US workforce. The wage increases that are so evident to us will inevitably start to affect the national averages, and the next step will be price increases. Operators of restaurants and retail stores and lodging will not allow their margins to deteriorate indefinitely. All those surcharges such as baggage fees at airlines, “facility” charges at hotels, and miscellaneous add-ons with car rentals (that add 25-30% to the quote), will increasingly be joined by higher menu prices. It’s not a question of “if”, rather “when”.

Roger Lipton

 

ASSET LIGHT FRANCHISING – COMPLAINTS FROM FRANCHISEES – LET’S CLEAR THE AIR!!

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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.

THE SUGGESTION

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.

Roger Lipton

THE BAR & GRILL BATTLE – EAT, DIN, RRGB, BWLD, RT – “ROLLUP” OPPORTUNITY?

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PENDING THE RELEVANT COMPANY’S REGISTRATION WITH US, THIS PARTICULAR CONTENT IS LIMITED TO SUBSCRIBERS. For $100/year, SUBSCRIBE HERE. Other content is available by way of Home Page.

INCLUDED IN YOUR ANNUAL SUBSCRIPTION:

  • Access to Corporate Descriptions of all publicly held restaurant companies and selected non-restaurant franchisors.
  • Broad economic insight. As described in “Restaurants/Retail – Why Bother?” the restaurant and retail industries provide a leading indicator of far broader economic trends. You no longer have to be the last to know.
  • Two to three analytical pieces per week (“Roger’s Rap”) personally written by Roger Lipton describing corporate developments within his industry specialization, including their relevance to the broader economy.
  • Periodic “macro” discussions personally written by Roger Lipton, analyzing fiscal and monetary matters that will likely affect your investments and your business.
  • A free copy of the legendary best selling book, How you can Profit from the coming devaluation, as shown at right, written in 1970 by Harry Browne, which predicted the 2000% rise in the price of gold. This profound piece is more relevant today than ever, so Roger re-published it in 2012. This book will help you preserve the fortune you are in the process of accumulating.

BRINKER (EAT) REPORTS – THE DIALOGUE TELLS MORE THAN THE NUMBERS

articles,
PENDING THE RELEVANT COMPANY’S REGISTRATION WITH US, THIS PARTICULAR CONTENT IS LIMITED TO SUBSCRIBERS. For $100/year, SUBSCRIBE HERE. Other content is available by way of Home Page.

INCLUDED IN YOUR ANNUAL SUBSCRIPTION:

  • Access to Corporate Descriptions of all publicly held restaurant companies and selected non-restaurant franchisors.
  • Broad economic insight. As described in “Restaurants/Retail – Why Bother?” the restaurant and retail industries provide a leading indicator of far broader economic trends. You no longer have to be the last to know.
  • Two to three analytical pieces per week (“Roger’s Rap”) personally written by Roger Lipton describing corporate developments within his industry specialization, including their relevance to the broader economy.
  • Periodic “macro” discussions personally written by Roger Lipton, analyzing fiscal and monetary matters that will likely affect your investments and your business.
  • A free copy of the legendary best selling book, How you can Profit from the coming devaluation, as shown at right, written in 1970 by Harry Browne, which predicted the 2000% rise in the price of gold. This profound piece is more relevant today than ever, so Roger re-published it in 2012. This book will help you preserve the fortune you are in the process of accumulating.

BRINKER INT’L REPORTS THEIR Q2 (DECEMBER) – FIRST INDUSTRY VIEW

articles,
PENDING THE RELEVANT COMPANY’S REGISTRATION WITH US, THIS PARTICULAR CONTENT IS LIMITED TO SUBSCRIBERS. For $100/year, SUBSCRIBE HERE. Other content is available by way of Home Page.

INCLUDED IN YOUR ANNUAL SUBSCRIPTION:

  • Access to Corporate Descriptions of all publicly held restaurant companies and selected non-restaurant franchisors.
  • Broad economic insight. As described in “Restaurants/Retail – Why Bother?” the restaurant and retail industries provide a leading indicator of far broader economic trends. You no longer have to be the last to know.
  • Two to three analytical pieces per week (“Roger’s Rap”) personally written by Roger Lipton describing corporate developments within his industry specialization, including their relevance to the broader economy.
  • Periodic “macro” discussions personally written by Roger Lipton, analyzing fiscal and monetary matters that will likely affect your investments and your business.
  • A free copy of the legendary best selling book, How you can Profit from the coming devaluation, as shown at right, written in 1970 by Harry Browne, which predicted the 2000% rise in the price of gold. This profound piece is more relevant today than ever, so Roger re-published it in 2012. This book will help you preserve the fortune you are in the process of accumulating.