State of the Restaurant Industry

In the best of times, the path to success in the restaurant business is uphill, winding, and more than a bit bumpy. Thanks to significant overhead, volatile supply chains, inventory that must be monetized or discarded within days, debt-heavy financing, and (typically) meager cash reserves, existential dread often goes hand-in-hand with “business-as-usual”.

Even the successes are frustratingly fleeting, with shifting consumer tastes, an incredibly competitive market, volatility in the prices of ingredients, and normal economic risks looming, with the potential to torpedo an eatery with little in the way of notice.

What, then, when a health crisis disrupts virtually every aspect of the global economy, completely halting every social aspect of society as we know it, hindering the ability to even open for business while casting a shadow over the very nature of socializing in the near future and demanding immediate adaptation of that already-difficult-in-good-times business model? It’s literally the sum of all fears.

Even before the outbreak of COVID-19 and the resultant shocks to both the economy and daily life across the planet, industry professionals and observers were already calling for contraction in the restaurant industry due to oversaturation. In the eyes of some, COVID has simply accelerated a shakeout in an overinflated industry that was due for some sort of reckoning.

The Restaurant Financial Picture

Like several other industries, restaurants took advantage of more than a decade of ultra-low interest rates, borrowing aggressively to fund expansion, renovation, and, in some cases, dividends for shareholders. By year-end 2019, the ratio of debt to earnings among publicly-traded companies in the Russell 2000 Restaurants Index was the highest on record. This was a stark departure from decades past when restaurant debt was low compared with that of other industries. The extent to which this would have been manageable in a “normal” environment is debatable. As the market became oversaturated, lease and labor costs climbed, leaving a large portion of the industry to simply wager that American diners would happily continue to spend more, more often.

Troublingly, data released in October by Euromonitor forecast restaurant industry sales growth of 1.6% in 2019 and 1.4% in 2020. That’s a far cry from the average growth of 3.4% over the prior five years. Additional data released in late 2019 revealed that, despite the continued, albeit modest growth, the number of customer visits was actually in decline. Slowing growth in sales, in an increasingly competitive market, shackled by a historically high debt load suggested the outlook for significant portions of the industry was less than rosy. That was all before March.

According to the Bureau of Labor Statistics, in light of calls for quarantine and stay-at-home orders in March, more than 20 million U.S. jobs were lost in April 2020. Roughly 5.5 million of these were in food and beverage services, which had reported payroll employment of 11.9 million the month prior, and 12.3 million in February. The pandemic has undone decades of growth in the industry, sending restaurant and bar employment to levels not seen since the late 1980s. Many of the losses are supposed to be temporary, and Paycheck Protection Program loans designed to maintain payroll have facilitated the rehiring of some staff, but the fallout from a forced hibernation is sure to prove too severe for many.

Restaurant Bankruptcies

According to the National Restaurant Association, the industry had already lost $120 billion by May, and that figure could climb to $240 billion by year-end. The government’s multi-trillion-dollar aid package propped up the economy in early 2020, and staved off even greater devastation across the industry. Despite this, however, a number of household names were still forced to seek bankruptcy protection or close their doors altogether: NPC International (a 1,200-unit Pizza Hut and Wendy’s franchisee), Chuck E. Cheese, FoodFirst Global Restaurants, Garden Fresh Restaurants, Le Pain Quotidien (US), TooJay’s Deli, Cosí, CraftWorks Holdings, Sonic franchisee SD Holdings, Houlihan’s, and Bar Louie.

Meanwhile, a handful of publicly-traded names have served to illustrate the state of affairs for brands who’ve thus far averted a worst-case scenario. For starters, in recent weeks a half-dozen sit-down dining brands – Darden, Bloomin’ Brands, Cheesecake Factory, Ruth’s Restaurant Group, BJ’s Restaurants, and Brinker International – issued equity or debt to at a discount to prevailing market prices.

More recently, entertainment restaurant and bar operator Dave & Buster’s reported results for Q1 of fiscal 2020, which ended May 3. The company closed all 137 of its locations on March 20 and kept them shuttered for the remainder of the quarter. The company revealed that, prior to the closures, sales and traffic had declined significantly for three weeks, suggesting that consumers were steering clear of restaurants and entertainment venues before being mandated to do so.

As grim as those details are, events of recent weeks suggest that industry watchers’ forecasts may actually prove conservative. For starters, all of the predictions were made prior to the late-June surge in coronavirus in the U.S., with more than 60,000 cases reported per day. With the first wave ongoing and intensifying, changes in reopening guidelines across the country have begun, with California and New Mexico (along with major cities Miami, Atlanta, and Pittsburgh) re-closing indoor dining, New York delaying the reopening dining rooms (from a planned July 6 to, in the words of Governor Andrew Cuomo “until the facts change and it is prudent to open”; suffice it say, 100% indoor occupancy is a ways off), and Texas and Arizona rolling back capacity limits to 50%.

Independent Restaurants

Turn your attention to the independent restaurant space, and the prognosis is downright harrowing. The crisis has already claimed New Orleans’ legendary K-Paul’s Louisiana Kitchen, which had been open since 1979, and, in the current climate, threatens to destroy the market segment. According to a report by the Independent Restaurant Coalition, in the absence of direct aid, a staggering 85% of independent restaurants could close permanently by year-end. It’s worth noting that the impact of such a nightmare scenario would extend beyond the owners of the restaurants and ripple through the supply chain, to purveyors, farmers, and logistics companies.

Reports and interviews from the spring suggested many of New York’s most successful restaurants – Le Bernardin, David Chang’s Momofuku, along with the iconic eateries of Daniel Boulud and Danny Meyer, were making concerted efforts to secure additional liquidity that would provide some buffer in the event of a prolonged (or recurring) closures.

A more recent survey (from early July), conducted by industry group The Hospitality Alliance, polled 509 restaurants, bars, and clubs in New York, which is home to all manner of independent establishment, with everything from quintessential mom-and-pop spots to the aforementioned prestige eateries. The survey does little to dispel the notion that independent operators across the board are facing a brutal situation.

Nearly one in five (19.8%) respondents reported paying their full June 2020 rent, with 36% having paid none at all, and “almost none” of the 31.5% who expected to pay “some” June rent expecting to pay more than 50%. Of that 31.5%, 90% expected to pay half (55%) or less than half (35%) of their June rent. Meanwhile, just over a quarter (26.5%) of respondents said that their landlords had waived any rent, and just two in five reported any COVID-related deferrals. Just 10.4% said they’d renegotiated their leases, while, alarmingly, only 27.7% claimed that any such negotiations were held “in good faith.”

Restaurant Restructuring

On the (relative) bright side, five of the companies listed above (Krystal, CraftWorks Holdings Inc., Bar Louie, Le Pain Quotidien U.S., and FoodFirst) have since found suitors to acquire them out of bankruptcy – albeit at some deeply discounted prices.

Again, this is all relative. With the valuations of many restaurant companies down 50% or more, a number of financial sponsors (hedge funds and private equity firms) that might otherwise be potential acquirers are dedicating resources to rehabilitating the value of previously acquired assets, rather than adding new brands to their portfolios. It’s worth noting that it is these financial buyers that have, in part, driven the overleveraging of the industry, in the pursuit of growth beyond what the market could reasonably support. Exacerbating the issue is the fact that, even prior to the crisis, debt financing for restaurants had already become considerably more difficult to secure than in years past.

Conversely, large, franchised brands and operating groups – particularly those with little debt, access to capital and the ability to pivot to a takeaway-centric model – have avoided the doom and gloom, and see the current environment as an opportunity for expansion and acquisition. Industry giants like Domino’s, McDonald’s and Taco Bell have aggressively stepped up hiring during the pandemic, while Chipotle, meanwhile, has indicated that its fortress of a balance sheet (zero debt) will support just about any expansion or upgrade strategy as closures lead to more real estate openings. Casual dining brand Chili’s (owned by Brinker International), meanwhile, has utilized government and industry relations teams to remain abreast of the ever-changing market, and adjust its aggressive reopening strategy accordingly. As of July 2020, Chili’s, with $113 million in cash, $429 million available in its credit facility and, most impressively, positive cash flow, is outperforming is casual dining competitors.

The Future

It’s worth reiterating that, against this backdrop, in the absence of direct support – for both restaurants and the individuals expected to frequent them – additional lockdowns and stay-at-home orders, whether stemming from this extended spike, or a dreaded “second wave”, would deliver yet another blow to an already-hobbled industry. For a smaller operator, in many cases, surviving in the short term, while contemplating not only a pricey and time-/labor-intensive bankruptcy process but also the turning around of a business, with a reimagined operating model, is too-tall an order. It’s easier and more cost-effective for owners to simply close the doors and walk away. Sadly, what often goes with them is not simply a restaurant, but a small sliver of the diversity, adventure, and cultural education that accompanies the dining experience.

COVID-19 is a shockwave that has accelerated a reshaping of a restaurant industry that had become bogged down by overexpansion and leverage. As things currently stand, it’s speculated that the fallout will leave the U.S. with little more than fast food and casual dining chains. It does appear, however, that tangible options are on the way, namely the RESTAURANTS Act, which ought to provide more advantageous short- and medium-term financing options for independent restaurant operators and preserve some of the diversity in our dining experience.

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