Recent Feedback - The (Hard) Business of Eating

"Excellent narrative on the restaurant industry in Sunday’s Petition. Btw, I really love the snarky tone of the writing – it’s awesome!" - Managing Director, Financial Advisor. 

PETITION Response: Thank you! We love receiving feedback like this; we noted that QSRs were generally doing fine while fast casual was looking a bit shaky and casual dining was looking like total dogsh*t. Insert Restaurant Brands International Inc. ($QSR), owner of Burger King (comps up 3.6%), Tim Hortons (up 0.3%), and Popeyes (down 1.8%). It reported an earnings beat on higher revenues (and then stock traded down). Meanwhile, Chipotle Inc.($CMG) - bloodbath. No queso for you. Meanwhile, if you feel like trusting Uber with even MORE of your data, maybe THIS new credit card (which promotes 4% off UberEATS) is for you. With news that Aldi's move into the US is compressing grocery prices even further, the casual dining space looks primed for a lot more hurt. 

10/31/17 Updated: Not to belabor the point, but this story by The New York Times helps drive home the issue currently in the restaurant space. There are currently 620,000 eating establishments in the United States. 620,000. That is bananas. 

Too many restaurants? Too many brands? You think? It's a shame that so many folks are sinking their livelihoods into these businesses. We expect the chart to the right to show continued downward trends given recent reports of the likes of McDonalds ($MCD) and Shake Shack ($SHAK) automating.

The (Hard) Business of Eating

Long VC Subsidies & Facebook's Copying Skills

Generally speaking, there are four categories in the dining space. First, there are the QSRs (quick service restaurants). Your run-of-the-mill fast food spots fall into this space. For the most part, these guys are doing okay: McDonald's ($MCD) and Wendy's ($WEN), for instance, have both seen great stock performance in the TTM. Second, there's the fast casual space. Competition here is fast and furious covering all manner of ethnicities and varieties. Chipotle ($CMG) and Panera Bread are probably the two best known representatives of this category. The former has gotten SMOKED and the latter got taken private. Generally speaking, there'll be some shakeout here, but the category as a whole has been holding its own. Third, there's the fine dining space. This is a tough space to play in but there are clear cut winners and losers (Le Cirque, see below): not a lot of chains fall in to this category. And, finally, there is the casual dining category. Here is where there's been a ton of shakeout. This past week, for instance, Ruby Tuesday Inc. ($RT) - the ubiquitous casual dining restaurant loosely associated with bad New Jersey strip malls - got bailed out...uh, taken private by NRD Capital at a fraction of its once $30/share price. (There was some assumed debt, too, to be fair). Moreover, Romano's Macaroni Grill filed for chapter 11 bankruptcy. In RMG's bankruptcy papers, the company's Chief Restructuring Officer said the following, "The Debtors’ operations and financial performance have been adversely affected by a number of economic factors, but perhaps most notably by an overall downturn for the casual dining industry. The preferences of such customers have shifted to cheaper, faster alternatives. On the other end of the spectrum, there is a trend among younger customers to spend their disposable income at non-chain “experience-driven” restaurants, even if slightly more expensive." No. Bueno. See below for a more in-depth (and slightly repetitive summary) of this particular bankruptcy filing. 

Unfortunately, the restaurant world received some other (slightly under-the-radar) bad news this past week: UberEATSUber's food delivery service, reportedly generated 10% of the company's total global bookings in Q2 - which, extrapolated, equates to $3b in gross sales for the year. That's a lot of food delivery to a lot of people sitting at home doing the "Netflix-and-chill" thing instead of the eat-microwaved-mozzarella-sticks-at-the-local-Ruby-Tuesday-thing. Of course, this is attributable to Softbank and other venture capitalists who are subsidizing this money-losing endeavor: UberEATS is unprofitable in 75% of the cities it services. On the other hand, do you know what IS profitable? Facebook ($FB). Yeah, Facebook is profitable. And Facebook is going after this space too; it released its plans to get into the online food ordering business earlier this week. And many suspect that this may be a precursor to a foray into food delivery as well. Why? Perhaps Mark Zuckerberg saw Cowen's prediction that US food delivery would grow 79% in the next several years. Delivery or not, anything that helps make online food ordering easier and more mainstream is an obvious headwind to the casual dining spots. Given that this area is already troubled and many casual dining spots have already fallen victim to bankruptcy, there don't seem to be many indications of a near-term reversal of fortune. Headwinds for the casual dining space correlate to tailwinds for restructuring professionals. Sick? Yeah. Sad? Sure. But true. 

A Call to Action

Last week we complained about a dearth of bankruptcy filings. This week we got a handful of cases: two retail, one healthcare, one oil-and-gas servicer, and two "tech" companies. Because this week's case summaries (see below) are longer than usual, we'll rest on those laurels in lieu of a substantive feature (you can find the summaries here: Answers Holdings Inc., California Proton Treatment Center, Vanity Shop of Grand Forks Inc., BCBG Max Azaria Global Holdings LLC, EMAS Chiyoda Subsea Limited, Lily Robotics Inc.). Gotta keep things tight, time-wise, you know? Trying to keep the time you're billing clients to read our kicka$$ newsletter down to 0.1 hours. 

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The media is feeding us a confusing narrative.  

On one hand, restaurants should be benefiting from recent low gas prices and food deflation - with meat, chicken, and egg prices, in particular, depressed.  

Depressed food prices are not inuring to the benefit of restaurants...or grocers.

Depressed food prices are not inuring to the benefit of restaurants...or grocers.

One the other hand, we've seen that restaurant chains are suffering from increased rent, healthcare and employment costs and, thus, more than a dozen restaurants have filed for Chapter 11 or 7 this year alone. While there are some outliers, e.g., Olive Garden, traffic at restaurants has fallen in 10 of the last 11 months (this includes the once-hyped fast casual segment, which is experiencing a customer count decline so far in 2016). And a U.S. Labor Department regulation increasing overtime pay for managers may still take effect and potentially make matters worse - despite a recent 11th hour injunction issued by a Texas District Court judge halting, at least temporarily, the December 1 effective date. 

Some argue that grocers are benefitting from the restaurants' pain. Are they? The numbers reflect that grocers' margins and stock prices are also taking a hit from this wave of food deflation. A number of publicly-traded grocers like Sprouts Farmers MarketSmart & Final Stores Inc., and Kroger Co. have lowered full-year '16 guidanceWholeFoods reported its first annual comparable sales decline since 2009. RandallsJewel-OscoH-E-BAlbertsons and even WholeFoods are slashing prices like crazy in a race to the bottom. And others have fallen victim to bankruptcy - A&P (the second time), Fresh & Easy (the second time), HaggenFairwayGarden of Eden - or been bailed out.

Much of this is just natural competition. Discounters like Family Dollar and big box stores like Target and Walmart are sacrificing margin in exchange for foot traffic. Indeed, Dollar General reported lower comp-store sales this week and a 10% decrease in its bottom line (and initiated a wholesale marketing process of various rental properties). WholeFoods and KMart are aiming to offer food to lower scale markets. Amazon FreshMuncheryMapleBlue ApronZakara LifeCaviar (owned by Square and on the market), Hello FreshUberEats, and a seemingly endless array of other app-based food distribution and/or delivery services are also complicating matters. With free introductory experiences, consumers can have at least a week's worth of food subsidized by Silicon Valley: this isn't helping grocers in major markets.

What does this all mean in the end? For starters, we are likely to see continued stress and distress in both the restaurant and grocery space. As we get there, there will likely be job losses  - at the highest levels of management and beyond - and additional technological advancement.  Touchscreens are likely to proliferate and, where possible, broader-based automation deployed. To point, McDonalds this week announced the launch of its touchscreen self-service ordering kiosks in its 14,000 locations. While MCD's CEO Steve Easterbrook indicated that this would not reduce costs/jobs - merely alter them - do we really believe that? So he proposes to pay workers more to effectively do less? Not with Eatsas of the world expanding - now at 5 locations. 

The space has come a long way and there are more drastic changes in store.