Large and middle market restaurant companies, as well as franchisees of top-tier brands, have ready access to capital, but franchisees of smaller brands are finding it more challenging to secure debt financing, according to Bob Bielinski, Managing Director of CIT Corporate Finance, Retail and Restaurants.
Q: What issues have impacted restaurant industry sales this year?
A: At the start of the year, there were three factors that had an impact on domestic restaurant industry sales. The resumption of the full payroll tax, rising gasoline prices, and, to a lesser extent, the delay of income tax refunds all had a negative impact on sales. In addition, as a result of the mild winter of 2012, sales comparisons were difficult during more normal winter conditions in early 2013.
During the spring, economic data and jobs numbers were generally positive, gasoline prices eased, and comparable restaurant sales returned to the slow and steady improvement we’ve seen over the past few years. However, this summer, the consumer returned to a more cautious approach to restaurant spending. Consumers may have shifted discretionary dollars to bigger ticket items, like cars and home improvements projects. So sales performance in 2013 is turning out to be very similar to performance of the last few years — there’s generally steady improvement but not without bumps in the road.
Q: Is financing readily available?
A: Large and middle market restaurant companies, as well as franchisees of top tier brands, have ready access to capital for acquisitions, remodels, and/or new builds, but it is more diffi cult for franchisees of smaller brands to secure debt fi nancing. Access to capital may be getting a little easier for smaller brands, but it can still be challenging.
The liquidity that’s been injected into the fi nancial system by the Federal Reserve, combined with a lack of large M&A transactions this year, has created a supply/demand imbalance in the debt markets with too much money chasing too few deals. As a result, commercial banks and other lenders are aggressively pursuing new loans.
Q: What are your expectations for M&A activity this year?
A: M&A activity has generally been slow in 2013, but activity may be picking up. This lack of M&A deal volume is part of what’s causing favorable borrowing conditions — the capital that would normally finance acquisitions is available because the deals aren’t happening. As a result, you have a competitive lending environment.
Because private equity fi rms generally hold assets for 4 to 6 years, you would have expected to see the beginning of the divestiture cycle for 2010 deals this year, but that hasn’t happened yet. Many of the 2010 transactions were either turnaround situations, which take longer to prepare for sale, or acquired by strategic buyers (i.e., not private equity fi rms), which tend to hold on to their acquisitions. For 2011 transactions, I would expect to see private equity owners begin to look at divestiture options next year.
For those reasons, I don’t expect to see the beginning of an echo boom of transaction activity in the restaurant sector until 2014.
Q: What’s the outlook for IPOs?
A: In general, the IPO market has been very active in 2013, but for a while, it appeared that the market for restaurant company IPOs had dried up. While several restaurant companies went public in 2012, the last restaurant IPO occurred in August 2012, and two companies subsequently cancelled their proposed offerings.
However, Noodles & Company recently completed a very successful IPO, replicating the success that Chuy’s, another small growth restaurant company had in 2012. It appears that the IPO market is still willing to accept restaurant companies if there is a high quality growth story, and I would expect other growth companies to pursue this path.
Q: Has the Affordable Care Act impacted the restaurant industry?
A: The impact of the Affordable Care Act (ACA) on the restaurant industry is still unclear. The government has decided to postpone until 2015 the employer mandate to provide affordable insurance to full-time employees. Waivers of certain provisions of the law have been granted to some companies, and there are a number of proposals to modify certain elements of the law.
There are concerns that companies may reorient their workforces toward part-time employees, so they can avoid certain provisions of the law. It has also been suggested that employees may not sign up for coverage, but instead opt to pay the smaller penalty to the government for not carrying health insurance.
Many companies have lowered their estimates of the cost of implementing ACA, but with so many issues still to be determined, the true impact of the law remains unknown.
Q: What are the current trends in the restaurant sector?
A: Customization continues to be a hot restaurant industry trend, which you can see in two growing areas of the restaurant business — fast casual pizza and self-service yogurt.
Fast casual pizza burst on the scene a couple of years ago, and you are now seeing a proliferation of brands and increased new unit development. The consumer appeal of designing your own pizza and having it cooked for you in a matter of minutes is very strong. Product quality will be the key to success for this category, but for brands that fi gure it out, there will be significant growth opportunities.
Brands like Pinkberry and Red Mango returned frozen yogurt to the top of consumers’ consciousness. These premium brands offered something different from the traditional offerings of TCBY, the largest fro-yo chain. Lately, the new trend in frozen yogurt is self-service.
Self-service frozen yogurt shops appeal to consumers’ desire for customization. It allows do-it-yourself mixing of different yogurt fl avors and toppings with complete control over quantity. More importantly to the operators of these stores, it provides a better economic model with reduced store labor requirements. Combining consumer appeal with better economics can be a winning formula, but frozen yogurt as a category has been an inconsistent performer over the past decades.
The customization trend is also linked to the increased popularity of fast casual restaurants. From the consumers’ point of view, one of the major appeals of fast casual restaurants is the ability to customize, and it’s a big part of the category’s success today. Think of building your own burrito at Chipotle, choosing from a broad range of toppings for your burger at Five Guys, or selecting from many different preparation options for pasta at Noodles & Company.
Q: Where do you see social media right now playing in the industry?
A: The Internet’s more important than ever for restaurants as people increasingly use it to research dining decisions. People have always looked to friends for dining suggestions, and word of mouth is still very important. However, social media has broadened “reviewer’s” scope of infl uence and expanded their circles of “friends.” For independent (i.e., non-chain) restaurant operators, what’s said about you on Facebook and Yelp can be the difference between success and failure.
Social media is also a great way for restaurants to connect with their loyal customers, so you see both independent chefs and large chains using Facebook, Twitter, and other social media platforms to continue to build relationships with customers in between visits.
Q: Where do you see growth over the next year?
A: The most interesting growth in the restaurant industry will continue to come from fast casual brands, which are taking market share from traditional quick serve and casual dining restaurants.
Fast casual restaurants better understand the way consumers want to approach their dining experience today. The quality of the food is higher, the dining atmosphere is newer and fresher, and the consumer is in control of the time commitment required for the meal. Plus, in today’s economic environment, you cannot underestimate not having to leave a tip as you would in a full service restaurant.