Chain Restaurants: Q2 2011 Trends, change in "refranchising" actions
Even though it is clear that there is a global financial problem at hand, chain restaurants are reporting surprisingly strong results through early August, given poor consumer confidence. Here is our critical look:
Revenues and Comp sales: No real US same store sales "pops" were noted, that we define to be movement of 1000 basis points or more, a real sure gain. When the holiday calendar shift is the big news, you know nothing is really happening. But some solid sales trends were apparent.
Certain international market operators had super pops, however: the two highest we saw were Arcos Dorados (ARCO) in South American nations (+ 33%), SBUX in China (+30%).
Biggest revenue miss versus forecast: Papa John’s (PZZA), $8M, but earnings were right on, target, ergo we think someone had bad revenue forecast that skewed the analyst sample.
We are impressed that many of the “July early peek SSS” views were positive with notable exceptions IHOP, Ruby Tuesday company stores (RT) and PF Chang’s (PFCB), despite lackluster to poor consumer confidence and polled less dining out (www.rasmussenreports.com, July 26, 2011, less versus more: plus 37)
The casual dining Knapp track traffic count benchmark moved positive in May (.2%) and June (.5%), for the first time since 2006. Virtually all positive reporting chain restaurants saw higher positive comp sales internationally, except SBUX, that saw higher comps in the US(+8) vs. international (+5). Traffic was the SBUX driver.
Refranchising and AUV link, an optical illusion: Denny’s(DENN) and Jack In the Box (JACK) both noted that as it refranchises lower volume stores, its residual company store AUV would rise. That’s, true from an arithmetic, optical basis and not necessarily from an incremental sales, traffic or check driver standpoint. Have to look closely.
Stability: Several operators noted stability in daypart sales, weekday v. weekend, product mix, ability to yield price increases, etc, which implies of a pretty flat consumer base.
Steak Centric: As we noted in July (http://www.seekingalpha.com/author/john-gordon/articles), we saw steak centric chains with better results in the first quarter, with higher end concepts improved 2500 SSS basis points from their 2009 trough, which was a very low base.
SSS Momentum Captures: Did Denny’s (DENN) same store sales gain (+2.6%) come at the expense of IHOP (-2.9%), and did Domino’s (DPZ’s) gain (+4.8% US) come at the expense of YUM/Pizza Hut (-2%) and Papa John’s (PZZA, .4%)?
Reimaging Sales Bump Reports: McDonald’s (MCD) +6 to +7, Jack in the Box (JACK): app. zero, DIN/APPB: +MSD. Burger King altered its expensive remodel model composed in the 2008-2009 to a less costly option.
Franchising v. Refranchising v. Company Operations: While the franchising/refranchising push over the last 20 years is unmistakable, some operators are contracting franchisees or JV partners, and pushing company store development: Starbucks (in Europeand China), Ruby Tuesday (RT), Texas Roadhouse (TXRH), Panera (PNRA). PNRA reports they can make money even with a 5 to 6 multiple paid. And PNRA and Darden (DRI) say they will never franchise. We are glad that cost of CAPEX is being considered in the store economics tracking, but some companies can make money.
Earnings: Of course food commodity problems were prevalent throughout the space. Many companies were app. flat on labor, with average wage rate inflation only around 1% on average (merit increases and turnover). As an outlier, Sonic (SONC) has mentioned wage inflation its last several earnings calls, despite its tip credit program that should have materially lowered the average wage.
Sonic: problems brewing
Writer is correct about Sonic's doubledealing. The problem there is CEO Cliff Hudson, truly a bureaucrat and politician, not a restaurant operator. What do you expect from the Harvard law set, anyway?
Sonic Is A Fad
What separates Sonic from their competition?
Sonic did have a great marketing strategy in which they targeted markets where they did not have any stores with TV advertising. Stores that were developed thereafter experienced novel grand-openings; however, the initial excitement quickly faded and the revenues were not sustainable.
I suppose the presence of Robert Rosenberg on Sonic's board gives them an edge on franchise marketing strategies.
Recently, a Sonic, in Southampton, NJ, which appeared to be doing well, was actually a cash strapped failing operation. The reality of the closure was that the franchisee could not afford to pay its rent:
Authorities on Monday morning suddenly closed a Sonic restaurant in Lower Southampton after the franchise owner missed rent payments, according to court documents
Sonic management spun the story of the restaurant closure as though it was a collective decision between the franchisee and brand management to close down the site:
“Over the past few months, Sonic and the franchisee who owns and operates this drive-in have been evaluating this location,” the company said. “After careful consideration, the franchisee made the difficult decision to close the location. ... The decision to close a drive-in is never easy.”
So, did the franchisee stop paying the rent when they began evaluating this location for closure? Or, did the court order make the difficult decision to close for Sonic that much easier?
Sonic is a Fad?
Do you know how long Sonic has been around?
1959 Shawnee, OK
Maybe "Fad" was not the correct term. It's a regional southern brand that has a following and has proven to be a sustainable brand in its core markets. However, as they try to penetrate new markets, they are experiencing lack luster performance. Kinda like Dunkin' going out West.
Are you basing your opinion on this one location that closed
coupled with it's current leadership?
tend to agree with Edward Ryan
I've been following Sonic in the tri-state area. Some locations seem to perform consistently where there is limited competition. In highly competitive markets, I've observed the initial "novelty" followed by a significant slow down. There doesn't seem to be anything impressive about the brand as a 2nd tier player in the tri-state.
Sonic closure record
No. Go back over Sonic's FDDs and earnings reports and you'll see the closure trend.
a friend of mine owns 3. He does very well. In the South they
Are very popular. It is my kids favorite fast food. Good onion rings, good cheese sticks, and malts. Not good for the body I am sure.
Lacks a healthy option
Have you been following some of the trends in fast food? Most people prefer healthier menu options as you noted. Perhaps, a Sonic closure trend is on the horizon.
perhaps, but we do not go to sonic for healthy food
We eat home for that. We hardly ever eat fast food, but when we do it is usually Sonic. Ours is also open 24/7 and in a college town.
Sonic Customer Frequency
A successful QSR must have a certain portion of their loyal customer base frequenting the shop at least 2x per week. This factor helps drive volumes. My wife and I will venture out to McDonalds maybe once every 2 to 3 months. She loves their fries. However, our friends with kids will be at McDonalds 2x a week. Something about those Happy Meals keeps the kids wanting more.
The Sonic you frequent is in a college town which makes it an ideal location for repeat customers and to maintain a 24/7 policy. The business must be seasonal with the college's schedule.
In suburban markets, in the tri-state, where the demographics are either scewed above or lower than average incomes, Sonic has their struggles. Their lack of healthy alternatives do not keep the above average income customers coming back for more. Likewise, their higher average tickets discourages those in the lower income demographics from making repeat visits. McD and BK dominate the lower income space.
High traffic areas off of major interstates seem to be working.
Once a week, but spread your trade amongst more than just one
favorite is a more rational approach. Maybe people are just so boring that they focus on one place and that becomes their gastronomic universe. That would explain your rationale. Kids, including college kids, do not count in my lexicon of sentient beings - but I recognize they influence spending - much to our dismay most of the time. No one should have a call on resources for college education who has not served in the military or some other service organization for two years. Without those two years you are still dealing with high school mentalities. Two years of service maek an enormous difference in the maturity level of college first year students and makes the money spent much more impact effective.
Personally, if I don't have a Grimaldi's Pizza and a ten piece box of Popeye's spicy chicken every week I get aggressive.
Emotions Tied To Food
I think once a week is a decent frequency number for a QSR. Anything more says there's something special about the brand. My view is that a brand has to have a product that makes you crave return visits.
The "crave" is emotional. As Richard desrcibes, he becomes "aggressive" if he doesn't get his 10pc Popeyes Chicken and Grimaldi's Pizza once a week. Similar habits are expressed by drug addicts. Once your consumers are addicted, business is good.
Recently, I've been craving falafels and have been on a quest to find the best falafel in the U.S. I think I finally found the place...
1,400 miles, 16 states - emotions
"It's the crust," said pizza lover Shuler. "The way they make the crust, it is so tender and the way the sauce on the pizza, it's different from anything around here."
Note to IFA: Downside of franchsing, $1.3M accelerated rent due
I just about fell off my stool when I read the story: not only could the Sonic in Southhampton NJ (read: upscale suburban NJ) not be able to afford the $9300/month rent, there was a $1.3M accelerated rent payment due !
Wow ! I bet the landlord fronted the franchisee the $1.3M for "buildout" expenses. Where was corporate to do the due diligence and approve the plan.
Note to IFA: history shows over time when people are compensated for "commission sales oriented" activity, excess occurs
Now thats one business plan that couldn't work no matter how much the ''happy hour" sales were.
A Sonic Bankruptcy Boom
"Note to IFA: history shows over time when people are compensated for "commission sales oriented" activity, excess occurs"
Commission oriented sales platforms will always get you in trouble. How could Sonic corporate shaft the franchisee with such a sickening site approval? $1.3M in accelerated rent! Would you mind posting the reference? How do Sonic franchises trade in the secondary markets?
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More QSR Unfranchsing Underway
I'll update my note to add that Jack in the Box (JACK) has bought back Qdoba franchisee stores in three major markets.
Qdoba restaurant level margins aren't revealed, but Qdoba same store sales gains have been positive and improving for some time.
John A. Gordon
chain restaurant analysis and advisory