The restaurant industry is a study in contradictions right now. On one hand, sales have taken off, businesses are more efficient than ever, cash flow is at record levels and the value of their businesses is soaring.
On the other, the environment is as challenging as it’s ever been. Operators can’t find workers. They’re paying soaring wage rates. The supply chain is a nightmare. Few have operated in an environment in which both labor and food costs are taking off at the same time.
These contradictions were on display this week at the Restaurant Finance and Development Conference. “I can’t recall a time I’ve seen operators overall have more cash on the balance sheet than what’s going on now,” said Thomas Hung, head of restaurant finance with First Horizon. It’s a sentiment we heard over and over.
Then again, we also heard things like this: “I thought 2020 would have been the toughest year,” Paul Brown, CEO of Inspire Brands, said at the conference. “But 2021 is giving it a run for the money.”
Restaurants’ earnings reports this week echoed a number of those concerns. Burger King franchisee Carrols Restaurant Group said it paid 13.3% more for wages last quarter and 15.5% more for beef. Fiesta Restaurant Group said staffing challenges cut its same-store sales by 300 basis points.
The question on the minds of many was whether these problems were “transitory” or more permanent fixtures. Lenders, at least, appear to be confident they are temporary.
There is some hope for it already. Some operators and executives have noted an increase in “applicant flow” lately while Carrols suggested that commodity costs have “plateaued.” And there is a general sense that things will clear up, eventually.
“I don’t think any of us believe that millions of people in their 20s are ready to retire,” Nick Cole, managing director with the lender MUFG, said in an interview.
One clue lies in the sector’s valuations. The price required to buy a group of restaurants, especially if they have drive thrus, is as high as it’s ever been. Buyers of such restaurants apparently aren’t too afraid of the labor and supply chain issues.
There were widespread reports of strong mergers and acquisitions activity, to the point that some wondered whether there was a “bubble” for fast-food restaurants. “Anybody who has been out in the M&A market knows we’re clearly seeing multiples increase a lot, especially in QSR,” Hung said. “A lot gets made on the type of multiples getting paid.”
All that said, it’s particularly difficult right now to put a true valuation on restaurants. Some private equity investors have told us they find it difficult to value the industry, given the roller-coaster nature of sales over the past two years, the dramatic shift in cost structure and consumer changes.
“It’s tricky now,” Cole said. “We’re working off a set of projections we haven’t seen before. It’s not normal you get an up-and-down cycle like this.”
Investors paying high valuations for restaurants do run into a potential risk that the issues are not as transitory as they think, and that profitability will at some point take a hit.
It’s worth noting, also, that much of the sales growth has come not from consumers eating out more often but from them paying higher prices. Menu prices hit a record last month. Consumers are paying 7.1% more for their fast-food meal now than they did a year ago. One does wonder when they figure that out.
The higher cost and potential for moderating sales could be a problem for some buyers.
“The next few quarters are going to be very telling,” said Cristin O’Hara, managing director with Bank of America. “We’re advising our clients not just what to do with labor but how to structure the transactions they will survive some of the challenges these businesses are facing.”
For now, however, operators have strong cash flow and their businesses are worth more than ever, even if labor and food costs present some challenges.