Publications

What Restaurant Franchising Tells Us About the Future

November 20, 2017Articles The Legal Intelligencer

Restaurant operators and their financiers often need to predict the future. The operators, mostly from franchised brands, need to adapt to changing tastes and fashion. The financiers need to assess risk before making commitments or investments. Experts in these fields met together in November 2017 to test their assumptions.

Kevin Burke, managing director of Trinity Capital, delivered a report which he summarized the economy for restaurants “As Good as it Gets.” The formal title was a very analytical “A Reversion to the Mean: What Happens When Industry Tailwinds End?” The report is basically a data-based analysis regarding restaurant economics. The basic conclusion is that things are great now, but the analytics show eventually the metrics will return to baseline, and this reversion to the mean predicts a slowdown of business and a tightening of credit.

You should in no way conclude that the credit punch bowl will be removed soon. Bankers are still enthusiastic about restaurants and the chains are doing well. Current valuations multiples of cash flow for merger and acquisitions average are near historical highs 10.6, and growing franchisors have multiples of double that. Leverage is at near historical highs of 5.3. These are multiples not seen sustained since 2007. Private equity investment has slowed this year, and so have exits from their investments. Everyone looks fat and happy.

While there is still room for growth, longer term views show that current market conditions like this cannot last forever. The Dow Jones Restaurant Index is at a historical high. Commodity prices are within a narrow trading range and trending lower. Unemployment has not been this low since 2007 and gas prices remain low. But consumer credit card debt is almost at its 2008 peak but median household income is at all-time highs. As restaurants are based on consumer discretionary spending, the credit card level is something to examine but we also need to drill down on the demographics of the discretionary spenders.

The discretionary spenders driving the restaurant renaissance is now the millennials. Millennials constitute the majority of the U.S. population. Their student loan debt is at all-time highs. Less than half of the millennials make as much or more than their parents at the same age. The maturity cycle of millennials will have profound effects on the economy.

Millennials dine in, according to Andrew Charles, senior analyst, Cowen & Co. Millennials are driving 30 percent of restaurant industry sales growth based on their delivery predilections. The largest demographic with the most demand for delivery is the 18- to 34-year-old, living in a major metropolitan area earning in excess of $100,000. Demand for delivery is less frequent in the suburbs and mid-size metro areas among 35- to 44-year-olds earning over $50,000 a year. Demand for delivery is lowest among those in small metro areas or small cities over the age of 45 years old earning less than $50,000 per year. Delivery users clearly prioritize convenience and time over the specific restaurant’s food. Based on the data, Charles predicts that the better a restaurant can meet the delivery demands of its customers, the more delivery will drive sales.

Looking at the data alone, this would suggest that restaurants have a great opportunity to expand their business by catering to millennials and providing delivery. However, the world is not that simple. When looking at the buying habits of millennials, they are now saving for houses and having children. For the past two years their restaurant spending as a group has trended down, and is predicted to fall as they invest in housing and their families. This will put a cap on growth and an emphasis on catering more to the millennial lifestyle of automation, convenience, delivery, healthful choices, as well as “foodie” choices.

Expect new entries in the artisan breads, foods and pizza categories. The “better pizza” will follow the “better burger” trend, with state of the art menu, delivery and payment systems. Expect menu changes in the casual dining sector to accommodate the millennial tastes and the tastes of their children. Look for brands to tout their autonomous car, drone and other novel promises of delivery. Look for slumps in steak houses and casual dining as these brands need to adjust to the changing demographic. Because of these trends, we are seeing a lot of activity in the mergers and acquisitions by strategic buyers ready to upgrade the brands to millennial friendly.

The millennials are the future, and the rest of us are merely tenants.

Reprinted with permission from the November 20 issue of The Legal Intelligencer. (c) 2017 ALM Media Properties, LLC. Further duplication without permission is prohibited. All rights reserved.