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A big franchisee’s financial challenges puts more pressure on Pizza Hut

NPC International, which also owns Wendy’s units, make the pizza chain’s turnaround more difficult, says RB’s The Bottom Line.
Photograph: Shutterstock

the bottom line

In April, Moody’s Investors Service and S&P both downgraded the credit rating of NPC International, the big Kansas-based franchisee of Pizza Hut and Wendy’s. The ratings services noted the company’s margin pressures and debt levels.

More recently, reports have shed some light on the company’s challenges.

Last week, Debtwire said that a promised cash infusion from the company’s owners, Delaware Holdings and Eldridge Investment Holdings, was smaller than expected. On Wednesday, Bloomberg noted that NPC’s debt is trading near “distressed levels” as loan investors grow nervous about the company’s future.

Bloomberg reported that Eldridge provided $9.5 million of a promised $60 million cash injection to help the company and that the remainder would be paid as needed.

As we’ve previously noted, NPC’s financial challenges are indicative of the stress franchisees can feel these days amid weak traffic and rising labor costs. Many large franchisees built their businesses with debt, and when the brands begin to struggle, the higher costs can create liquidity challenges that create further problems.

Many franchisees are dealing with higher labor costs, as well as higher costs for things like rent and construction. If their brands begin to struggle, so do they. If a big operator like NPC, one of the largest restaurant operators

These financial challenges could put stress on the brand itself, however, delaying companies’ turnaround plans and making it more difficult to get things done.

NPC’s problems are troublesome for Wendy’s. The franchisee has been buying up the burger chain’s locations in recent years and now operates nearly 400 of them.

But it’s a bigger issue for Pizza Hut.

NPC is the pizza chain’s largest franchisee anywhere, operating nearly 1,200 locations. That’s about 20% of Pizza Hut’s domestic footprint. Few franchisees in major restaurants are that dominant.

According to Debtwire, for instance, NPC management said the Pizza Hut system is under pressure, and that the company is negotiating with the brand to reduce its remodel requirements to improve its liquidity.

That means the company will be less able to make improvements the brand believes could help revitalize sales. Pizza Hut needs to make improvements because its top rival, Domino’s, has remodeled its locations and is now adding a bunch of new ones.

As we wrote last month, Pizza Hut has an asset problem. It has too many old, “Red Roof” locations that are focused on dine-in customers. And many of these locations are “not in the right trade area.”

This takes financing to get that done. But, if the franchisee that operates one out of every five of your locations has financial problems that is requiring it to request a delay in its remodel request, then converting that asset base becomes that much harder.

That will put pressure on the brand to generate stronger sales. The company’s same-store sales have been flat or positive for each of the past seven quarters, though operators could clearly use some stronger momentum to improve their profitability.

Pizza Hut’s average unit volumes are more than a third lower than top rival Domino’s, which gives the larger chain strong advantages in a business where price is the primary competitive strategy.

The situation with NPC should probably force franchise systems to rethink strategies that lead to single, dominant operators. While there are examples of brands with dominant operators that do well, the downside risk can be troublesome if these franchisees run into trouble.

And franchisors should also start questioning franchisees’ debt levels. While lending is a necessary evil in the restaurant business, companies that take on too much debt give themselves little wiggle room if things go wrong.

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