While Denny’s management team is executing well around a very solid strategy, the brand is held captive to currently unfavorable economic conditions which are particularly hard on its core low-income demo and which also challenge Denny’s ability to execute around its key price value objective.
• A 2021 spike in the franchise transfer rate reflects the need for scale in a high-cost environment facilitated by an abundance of underperforming units post-covid and the predilection of some franchisees to exit the business because of post-covid operational challenges.
• The average number of units owned by a franchisee group in the $1B+ Chains increased from 5.5 in 2019 to 5.8 in 2021. Smaller operators (like in the sub-sandwich segment) are ripe for further consolidation.
Del Taco is the 2nd largest Mexican QSR, positioned around a wide variety of better-quality food (use of fresh ingredients represents a competitive distinction) offered for reasonable prices. While Del Taco enjoys strong concept fundamentals, the chain is tested by a harsh California business environment aggravated by the brand’s orientation towards a vulnerable, less affluent demo.
• While 2Q comps for the $1B+ Chains increased +3.5% (+14% 3-yr. stack), RR’s consumer survey (which measures intentions to eat-out over the next month) continues to reveal a challenging 3Q sales outlook.
• Food prices continue to surge, breaking another record in July (+10.9% y/y & +14.8% 2-yr. stack).
• Recent passage of the California Fast Food Accountability & Standards Recovery Act increases QSR wages in the state by +40% to $22/hr. in 2023, aggravating labor inflation.
• Unit-level operating margins for the corporate owned stores of the publicly traded $1B+ Chain companies declined 4.5% to 16.5% during 2Q:22 vs. 2Q:21.
• Macro-economic results continue to represent a major head-wind for restaurant stocks.
• While 2Q financial results for the public QSRs were OK, we suggest a review of current unit-level performance may provide important insight into the challenges that are weakening the franchise systems that are core to many of these public companies.
• 2H:22 EBITDA multiple outlook (-6% y/y decline) represents the biggest contraction since 1H:20.
2Q22 Investor Calls indicate significantly higher prices and labor shortages (impacting both operating hours & delivery service) are impeding traffic (especially for low end consumers) and not able to fully compensate for current commodity and labor cost inflation. Fortunately, several companies indicated that commodity costs are peaking and expected to moderate later this year.
Burger King is challenged to find ways to expand its market reach towards new, more affluent consumers who are willing to pay for the brand’s strong core equities and quality upgrades at a time when its core lower-income demo needs more value than ever.
Taco Bell is extremely well positioned as the only $1B+ national QSR Mexican player and enjoys the added bonus of being able to tap into a material COGs outperformance to go deeper into value should that be warranted.
• Aggregate 1H:22 franchisee unit-level EBITDA valuation multiples contracted slightly (-2.3% y/y) and are -3.9% below their 2H:16 peak.
• 2H:22 EBITDA multiple outlook (-6% y/y decline) would be the biggest contraction since 1H:20 and reflects weaker unit level economics; higher borrowing costs; and a growing disconnect between seller & buyer perception of going forward profitability.
• Full-year 2022 restaurant originations (excluding sale leaseback financing) are now projected to be $10.5B which is -23% lower compared to initial expectations.