Key Points from RR’s 2020 New Build Report

• 2020 new build ROIs continued a declining trend, reflecting: higher construction costs; moderating new build AUV growth; and store-level margin pressure.

• A ramping build vs. buy ratio reflects the above trends in addition to declining acquisition multiples.
• This suggests that growth minded operators are more likely to buy than build for the time being.

• Other notable post-lockdown new build trends: an unfortunate rise in closures (particularly as it relates to independents) provides the big chains with an opportunity to pursue development growth via cost effective conversions; and an acceleration of a move towards smaller footprint new build formats (including off-premise only) as the role of dining rooms remains in flux given varied and largely undefined government restrictions.

Source: RR’s New Build Cost Report

Industry Fundamentals Continue to Improve

• The astounding ability of restaurant industry players to adapt and evolve are evidenced by sharply improving 3Q20 comps.
• Even though the post-lockdown world has brought a tremendous market share shift to drive-thru formats, sit-down concepts have succeeded at meeting the huge pent-up demand of Americans to eat-out by implementing creative off-premise and dine-in solutions.
• McDonald’s recently reassured that it will lead the industry in sharing safety best practices which have allowed the chain to report that the rate of infection at its restaurants is below the U.S. rate generally.
• According to the blog: “After all, McDonald’s success — just like the success of Walmart, Apple, Starbucks, or any other U.S.-based business — depends on all of us getting back to some version of normal as quickly as possible”. (click here for full blog entry)

Source: 3Q20 Investor Call Summaries (outline)

SUBWAY – RR EXECUTIVE SUMMARY

Subway is the largest sub sandwich chain by far with the 2nd largest QSR ad spend behind McDonald’s. Guests move along Subway’s iconic make line, customizing sub sandwiches by choosing bread carriers, meats, cheeses, veggies and condiments/dressings. Core brand equity: customization (made-to-order); interaction between sandwich artists & guests; sub sandwiches which include lots of veggies (Subway prides itself on offering more veggies than anyone); and bread baked in-house. Positioning is reinforced by taglines: “Subway, Eat Fresh” & “Good Food is Good for You” and its current “Buy 2 Footlongs, Get 1 Free” deal (based upon full menu prices) is better for margins than past $5 Footlong deals and helps to support its new NFL campaign featuring Bill Belichick and NFL stars J.J., T.J. & Derek Watt. Innovation has ramped-up significantly in 2019 in an effort to increase the brand’s relevancy, moving Subway more in the direction of QSR sandwich players as opposed to fast casual sub sandwich competitors which are better known for quality than innovation. Notably, post-lockdown comps declined -40% to -50% initially in March 2020 (reflecting typical results for non-drive-thru brands) before steadily improving, helped by increases in delivery, loyalty & app mix such that some stores have reached 100% index y/y as higher checks have offset remaining -15% traffic declines. In any case, historical comps have steadily under-performed the segment average, mostly reflecting traffic declines. Given so many competing options for consumers (both up-stream and down-stream) that didn’t exist 10 years ago, Subway’s challenge is to carve a defensible niche in the sub sandwich category that excites its middle-class core with mid-tier pricing. In essence, Subway has been challenged to find a value equation that works with consumers and which is profitable for franchisees. Notably, while a shift to national advertising is intended to support national value offers, franchisees have been very vocal in their opposition to low price point/low profit deals. In conclusion, while it is difficult to assess how long it will take to reignite sustainable sales, the system benefits from the fresh look of a completely new management team, new digital initiatives and solid brand equity that hopefully can be leveraged to transform Subway into the Dunkin’ of the national sub chains.

HARDEE’S – RR EXECUTIVE SUMMARY

Hardee’s brand attributes as a regional chain with a Southeast & Midwest orientation include: made-from-scratch breakfast biscuits; made-to-order charbroiled burgers (with over-sized patties & Black Angus options); hand-breaded chicken tenders; charbroiled chicken line; hand-scooped ice cream shakes; and table service. Hardee’s is unique in that its high-margin breakfast business generates a material sales mix and efforts to extend breakfast hours to 2PM should increase brand appeal. New “Feed Your Happy” campaigns (featuring an animated version of CKE’s logo-turned-mascot Happy the Star) helps achieve national marketing scale with a format that can be used to promote the products & LTOs of both Hardee’s and sister brand Carl’s Jr. (West Coast orientation). While messaging will mostly promote common menu platforms, there also will be sufficient support for Hardee’s substantial breakfast business. Efforts to compensate for Hardee’s relatively small scale/share of voice include an increased marketing allocation towards cost effective digital-first and social-friendly content which also targets a younger demo. A significant innovation ramp-up in 2020 helps increase trial/brand reach during a post-lockdown period when drive-thru QSR brands are in high demand. Having said this, pre-lockdown comps have been negative for the last 4 calendar years through 2019 with 5-7 years of traffic declines. The chain’s historic under-performance reflects its struggle around a premium lunch/dinner positioning at a time when QSR competitors have been emphasizing the value portion of their barbell strategies in order to drive traffic. Hardee’s is reluctant to compete with the larger, national players around value/discounting as the brand lacks sufficient share of voice to promote both quality & value sufficiently to overcome trade-down. A lack of all-day breakfast also represents a competitive disadvantage. Further, operational complexities associated with its hand-crafted positioning (particularly as it relates to its biscuits) translate into slower service speeds. The system would also benefit from more progress around digital/loyalty although a recent hire should help facilitate this. In conclusion, stakeholders must continue to exercise patience as brand management works hard to find ways to best leverage the chain’s considerable brand equity built upon quality biscuits, burgers & tenders in a difficult competitive operating environment.