Restaurant Stock Performance in Perspective

• While restaurant stocks have tumbled in what seems like a freefall, it is useful to remember the very long running melt-up that preceded our current situation.
•  As evident by the table below, many of the $1B+ chain restaurant stock prices remain significantly higher than the low (from 2011 – 2020).
•  Further, the valuation models following suggest it may be reasonable to believe that current prices maybe close to a fair value bottom (assuming no EBITDA for 2020).

• Using a net present value calculation for aggregate QSR segment EBITDA, we backed into the current enterprise value (as of 3/16/20) by assuming $0 EBITDA for 2020, a 5% EBITDA growth rate from 2021 – 2030 and a 4% discount rate.
• This contrasts with a 16%+ EBITDA growth rate estimate needed to tie-in with the segment’s enterprise value as of 1/19/20.

• Our NPV calculation for the FSR segment shows similar results, with current valuations baking-in a modest 4% EBITDA growth from 2021 – 2030 on top of zero EBITDA for 2020.

2020 Franchise Finance Overview

• 2019 restaurant financing volume of $9.6 billion represents a -3.3% y/y decrease and the 3rd consecutive year of declining volume. 2019 actual originations were -9% below initial survey projections and reflect lower financing needs for the $1B+ chains.
•  Pre-virus, 42% of participating financiers expected to increase 2020 loan originations over 2019 levels while 13% planned to cut back (mostly national lenders), resulting in an expected $300 million (+3%) increase to $9.9 billion.
•  We plan to update going forward plans when circumstances settle down.

• The aggregate 2019 loan portfolio balance increased by +2.6% to $54.3 billion. Originations from new lenders helped to off-set lower originations at 40% of existing lenders. Also, ~34% of originations were related to the refinancing of existing borrowers. Notably, portfolio composition includes $11.2 billion in other financing sources including sale leaseback ($8.4 billion) and SBA ($2.8 billion) but excludes private equity.

• RR’s estimated annual franchisee financing needs for the $1B+ chains continue to decline through 2019 as franchisor corporate refranchising programs have wrapped-up.

Source: RR 2020 Franchise Finance Report (outline)

Quantifind

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•  See Quantifind’s new Brand Sentiment Rank Index below.
•  Chick-Fil-A recovered this quarter after losing ground to Popeyes’ sandwich viral sensation.
•  Jersey Mike’s rating improved as social media pushback about a customer who brought a gun into a store last quarter diminished.

Panera – RR Executive Summary

Panera is the largest fast casual player with a well-established cafe-bakery positioning around “food that tastes good & is good for you” with a menu featuring fresh/healthful ingredients, “foodie offers” and seasonal options/flavors. The brand seeks to move in front of the curve as it relates to a shift in diet preferences away from a culture of “shame & guilt” to “food positivity” in which consumers add more healthful ingredients (like leafy greens) to their meals, and, to this end, Panera will make plant-based options available in every menu category. The chain’s “food as it should be” marketing highlights its core brand equity which easily contrasts with some competitors that leverage processed ingredients to provide an abundance of lower quality, lower priced food. Panera’s ongoing menu evolution includes the addition of: improved breakfast offerings; “heartier” dinner options; non-carbonated & moderately sweetened beverage choices; and an upgraded coffee/espresso platform consistent with its parent company (JAB holdings) portfolio of specialty coffee chains. The goal is to expand beyond its core lunch daypart with menu items better suited for breakfast & dinner. Notably, while Panera offers a dine-in environment well-suited to hang-out, efforts to better appeal to those time-starved and on-the-go include advancements in its digital order & access platforms that are driving the chain’s e-commerce sales mix towards the level enjoyed by the national pizza chains. The brand also benefits from the development of what has become the industry’s largest loyalty program which drives substantially higher frequency among its members. Delivery has been attributed with driving recent comp growth and Panera recently boosted its positioning by adding DSP origination partnerships to its own in-house delivery platform. Having said all this, Panera’s sales are challenged by a sharp increase in industry discounting and while its business model may appeal to its core customers, it is less appealing to value seeking consumers at the margin. Panera’s positioning is also challenged by strong competition from other fast casual players and QSR+ as well as casual players providing greater value and faster service speeds at lunch. Further, the chain faces increasing competition from VC and private equity funded “better food” restaurant start-ups which target the urban, millennial crowd with cutting-edge culinary trends. Another notable challenge comes from operational complexities driven by a very large menu, a very high level of new product innovation and a plethora of new business initiatives. In conclusion, while Panera has a sound long-term strategy, there are many moving parts that challenge its operations and a value-oriented business environment that challenge its upscale positioning.

Church’s Chicken – RR Executive Summary

Church’s Chicken (a 67+ year old regional brand) specializes in Southern-style, hand-battered, double-breaded fried bone-in chicken (available in Original & Spicy) which is marinated for 12 hours & freshly prepared throughout the day in small batches and complimented by its freshly baked home-style sides and scratch-made Honey Butter Biscuits to form a complete meal for individuals & families. Its recent brand refresh is designed to bring Church’s back “down-home” to its Texas roots (real meals made by real people with the bold spirit of Texas). Primary elements of the refresh include: a menu evolution that stays within its guests’ “consideration set”, based upon its reputation for quality food, big portions, lots of choices, innovative flavor & good value; the first national TV campaign in 10 years; a sharper focus on integrated digital marketing which extends the brand’s reach uniformly across all demos & geographies; customer access improvements; and a facility refresh with bolder colors. Church’s repositioning seeks to move it away from its historic positioning as a deep discounter to a leader in value for the price paid. “Bringin’ That Down Home Flavor” campaign features TV spots shot in a test kitchen environment with close-up camera work highlighting fresh ingredients & prep. The chain also benefits from a simplified operational and data-driven management approach which compliments the 2018 formation of an Excellence Advisory Council consisting of franchisees and corporate leaders tasked with leading the brand. Notably, corporate reports recent increases in overall guest satisfaction, speed of service and likelihood to return. 3rd party delivery (launched in early 2019) is available at 70% of the system and drives 50% incrementality. The current 3% delivery mix is expected to grow to 6% to 8% over time. In the Spring of 2019, Church’s also launched order-ahead/pay-ahead and pickup. Delivery & order-ahead has added $1,000/week for many stores and this added profitability has provided many operators with an incentive to invest in capex. Sales trends have been steadily improving since 2016 and 2018 comps were positive for the first time in 3 years with 2019 comps improving from there as the brand’s repositioning gained traction with positive traffic during the year driven by the tremendous success of its Bourbon Black Pepper Smokehouse Chicken summertime LTO, generating double-digit comp growth even in the brand’s “ultra-competitive” markets (Carolinas, Atlanta, Chicago & New Orleans). While we like what we see in terms of the repositioning, Church’s need for AUV growth is evident by an under-performing EBITDAR margin that is currently at a system low. Also, press reports indicated that Church’s private equity owner (FFL Partners) shopped the brand for sale during the summer of 2019 which detracts from the possibility of providing the chain with sufficient stability over time for its repositioning to become fully established. In conclusion, Church’s is executing around a well-conceived turn-around plan that is beginning to gain traction at the same time consumer demand for all things chicken continues strongly.

Five Guys – RR Executive Summary

Five Guys is best known for quality burgers and even better fries which come loaded in a brown bag. The brand has developed a cult-like following along the Eastern seaboard and into the Midwest including a strong presence in DC where the chain started in 1986. All its ingredients are delivered fresh and there are no freezers in the store. Quality is reflected by use of: 80% lean beef; slow-growing, relatively expensive Idaho potatoes; lettuce “torn-out”, not cut; bread products prepared at company owned bakeries; and buns toasted on a grill (not a toaster) in order to produce a caramelized taste. Five Guys’ open kitchen has the look and feel of a mom-and-pop short order kitchen with cooks relying on experience rather than timers to know when the burger is just right. The chain’s practice of making customized food to order in front of the customer adds to the perception of quality and variety while its flat burger pricing allows customers to add fresh & flavorful toppings for free, including an “All The Way” option. This customization option appeals to Millennials and distinguishes Five Guys from QSR competitors. An innovative mystery shop staff bonus program drives service excellence and compliments word-of-mouth marketing strategy (which includes growing emphasis on social media). Notably, after a long period of comp challenges, sales rebounded in 2018 and through the first 3 quarters of 2019, reflecting the benefit of delivery. Having said all this, it is important to remember that sales pressure from 2012 – 2017 reflected: the brand’s high price points & price hikes during a long period of economic stagnation and increased burger competition from QSR, fast casual & casual; a 7-minute order prep time; capacity constraints at lunch (especially considering the lack of drive-thru capabilities); and excess development leading to the cannibalization of existing stores. Five Guys’ average check is significantly higher than the QSR sandwich segment and, despite the use of more expensive ingredients, its food costs outperform by a very significant margin, thus revealing a material value gap. In conclusion, the key questions for Five Guys remain: Could lower menu prices drive more traffic and incremental sales? If so, can operations handle a higher traffic load? Is the current sales boost from delivery sufficient to compensate for the brand’s value gap? Should Five Guys consider increasing its required marketing contribution to fund traditional advertising?

Think’in It Through

RR Interns taking a break after losing lunch money trading restaurant stocks on Robinhood…