This has been one of the craziest weeks in restaurant industry news that I can recall.
It started on Monday morning, following news of dozens of closures of the Italian chain Papa Gino’s and its sister concept D’Angelo Grilled Sandwiches, resulting in the parent company’s bankruptcy filing.
Taco Bueno filed for bankruptcy protection. Cliff Hudson announced plans to retire from Sonic Corp. Marcus Jundt returned to the struggling Kona Grill and brought Rainforest Cafe creator Steve Schussler with him.
The struggling, shrinking Papa Murphy’s put itself up for sale. Investor darling Honeygrow is pulling back on most of its Chicago units. And amid all of this there was an election, one in which voters in two red states, Missouri and Arkansas, approved increases in the minimum wage.
Anybody who follows news with regularity knows that these things ebb and flow, and some weeks nothing is happening while other weeks are crazy.
But we can draw a line of commonality through many of these stories, notably the companies being sold or those that filed for bankruptcy or the problems at Kona Grill: They’re the result of the market share game the industry is playing at the moment. Many of these companies are losing it.
The U.S. has too many restaurants. Loaded with choices, consumers are rewarding strong chains and punishing weak ones.
“What we’re seeing over the last three years with comp sales is a widening between the top quartile and the bottom,” Victor Fernandez, vice president of insights and knowledge for TDn2K, publisher of the Black Box Intelligence index, told me yesterday.
“Those doing well are increasingly doing well. Some that are struggling are maybe doing a little better, but they’re not keeping up with the growth on the top end of the equation.”
A lot of restaurant companies have eagerly borrowed money from overly willing lenders in recent years. They’ve also largely abandoned site ownership in favor of leasing. That’s important, because when a restaurant company leases its location, it has less control over the unit and has to make profits while paying rent.
The weakening sales and traffic of the past couple of years, along with rising labor costs, have exposed companies with bad finances. And thus, we have the stories of Papa Gino’s and Taco Bueno.
Gino’s had $60 million in secured debt and more than $100 million in total debt. The company is shuttering a third of its locations—insisting that modern industry trends necessitate fewer, smaller units. That might be true. But it’s an awful lot easier for companies to operate in this modern environment when their finances haven’t been loaded with so much debt that the company can’t effectively invest in the business.
Then there’s Taco Bueno, which has more than $130 million in debt. It was already looking to restructure that debt when heavy rains in the Dallas area contributed to a 20% sales decline. That drained what little cash Bueno had left, forcing it to sell its debt and file a prepackaged bankruptcy so it could get a buyer quickly enough to avoid evictions and, probably, a shutdown.
As Warren Buffett said, “Only when the tide goes out do you discover who’s been swimming naked.”
But it’s not just companies filing for bankruptcy protection. Restaurant chains such as Tilted Kilt don’t get sold for low prices when they’re healthy.
And then there’s Papa Murphy’s.
I won’t delve too deeply into the challenges at the Vancouver, Wash.-based pizza chain, which has seen sales struggles for the past three years, consistent losses and now a store base that has shrunk by nearly 100 locations since the beginning of 2017.
Murphy’s had a lot of debt when it went public in 2014, along with franchisees already screaming that they couldn’t make money. With consumer demands shifting to more convenience, the weak finances of operators and the company’s debt levels, the system was less able to evolve to meet those demands.
The company is finally making some headway: Murphy’s 2.1% same-store sales decline in the third quarter was its best in three years, and the company said it has turned positive so far in the fourth quarter. Hopefully a new owner will build on that while learning some key lessons from the past three years.
I believe that more of these stories are inevitable in the coming several months. A lot of smaller and midsized chains are deep in debt after years of aggressive lending.
The restaurant business is not getting any easier. Lease costs aren’t getting cheaper. Labor costs are rising.
And then consider that the past three years of sales and traffic challenges have come despite a booming economy, low unemployment, low gas prices, a rising stock market and, until recently, surging home values.
Imagine what will happen if the economy hits a recession.