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Are restaurants at risk of a ‘bloodbath’?

Weak sales, high costs and a potential recession could be an ugly mix, says RB’s The Bottom Line.
Photograph: Jonathan Maze

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Marcus Jundt, the new-old CEO of Kona Grill, was somewhat-famously honest about the state of his chain in a presentation to investors at the ICR Conference this week.

That honesty extended to the restaurant space as a whole.

“There’s a potential bloodbath and a shakeout and a recession in the restaurant business,” he said. “You can’t just willy-nilly raise wages. You can’t take a third of your costs and raise them by 50%.”

He’s not necessarily wrong.

First, let’s examine what’s been going on in the restaurant business.

At the outset of 2019, chain restaurant same-store sales have been weak for three years. Traffic has been down, even as some evidence suggests improvement. Companies have been aggressively discounting in hopes of pulling in traffic. That hasn’t worked, but has frustrated franchisees at multiple brands.

At the same time, costs are rising. Jundt mentioned labor costs, and that’s a big one. But other costs are going up, too, such as construction costs and rent costs.

Maybe not surprisingly, restaurant chains are filing for bankruptcy protection and closing units, and often both.

It’s not an industry acting like you’d think it would act given the state of the economy, with less than 4% unemployment and strong consumer confidence.

And then there is the state of the economy.

Last month, we wondered about the prospects of a recession. Since then, that risk has only grown—mostly because the federal government is in the midst of the longest shutdown in history, one that is showing no signs of ending.

The longer that shutdown goes, the more the economy risks going into a recession. Don’t ask me, either. Ask the White House.

Add an economic recession to a restaurant industry in a recession of its own and, as Jundt said, a “bloodbath” is a definite risk.

Here’s another factor he mentioned: debt.

A lot of restaurant companies have a lot of debt following years of eager lending. There have been rumbles already that more companies have stressed finances, not counting those that have already filed for bankruptcy.

Weak sales, higher costs and a lot of debt tend to lead to bankruptcy. A weak industry environment made weaker by a recession could push a lot of companies into debt protection.

Indeed, industry watchers should heed the lessons being taught by franchisees of McDonald’s, Jack in the Box and others who revolted last year.

McDonald’s operators, who not long ago had strong cash flow, are overwhelmingly upset with their profits now following a year of heavy discounting and capital expense demands.

Papa John’s franchisees, who themselves are banding together to protect their interests with that brand, have closed down units over the past year after just one year of weak same-store sales.

Remember: Papa John’s had the longest streak of same-store sales growth among publicly traded companies until late 2017.

The brand, much to its credit, has taken steps to protect its operators. But it’s a sign that even franchisees of chains recently considered healthy are at risk in a weak sales environment.

Applebee’s franchise RMH Franchise, which filed for bankruptcy last year, is a classic example of what could happen. Many franchisees have a lot of debt after those years of eager lending. They, as much as the brands themselves, could be in danger of bankruptcy in a deteriorating economy.

The restaurant industry is in a period of oversaturation, with too many restaurants for the demand that is there. So yes. A bloodbath is a definite risk.  

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