Publicly Traded Restaurant Franchisors Live on Same-Store Sales but Franchisees Live on Store Free Cash Flow

The difficult nature of the restaurant franchise business life is about to hit again: Wendy's has rolled out a $4 combo meal of small bacon burger, 4 chicken nuggets, a drink and french fries. The first report of how all-day breakfast is faring in McDonald's from Nomura and Mark Kalinowski is out today.

The fact is franchisors that are publicly traded have a pass or fail bumper sticker placed on them by the investment community. Investors look at how high are same-store sales? What is their ascending or descending nature: higher than last year, higher than a two-year rolling total, higher than a five-year "stacked" prior year accumulation? Same-store sales (SSS) shows up in mergers & acquisitions marketing pitches too. Buyers are willing to pay more for a brand with higher reported same store-sales rates.

On the other hand franchisees live on free cash flow, that is to say store EBITDA, which is to say income less taxes, overhead, debt service (principal and interest) and future remodeling capital expenditures (CAPEX).

Franchisees truly live off the very bottom line.

The problem of course is that same-store sales gain is not necessarily profitable sales. Where there is heavy discounting involved, cash is pushed down the standard, higher priced sales mix. This is especially true in the overloaded QSR space in the United States, where discounting is the easiest way out for marketing efforts of weaker brands, and the only way that some brands know how to stand out.

Many chains (Subway, McDonald's, KFC, Pizza Hut, Burger King, Applebees, IHOP, Denny's, Wendy's, among others) are more than 90 percent franchised in the US. Unfortunately, there is little to no accountability by franchisors to investors or franchisees in reporting. Franchisee profitability results are not reported, except regularly by Popeye's (PLKI) and mentioned sometimes by Domino's (DPZ). This is no way to run a railroad for Wall Street, or for the real direct investors, the franchisees.

The old saying that we learned years ago is true — you cannot manage what you cannot measure.

A lack of reporting is one thing. Another is a lack of looking ahead. This is especially important in the restaurant space, which has ever demanding upward wage pressures both regionally and nationally and demanding customers who expect ever higher quality products.

At some point, the math just does not work. Remember your old marketing professor who said that price sends out an important value signal as to the worth of a product?

What to do about these problems? I suggest that you talk about it with your peers, your friends, your business partner, the press, your franchisee association. Find ways and tools to agitate your brand to change — to NOT do things the same old way.

 

Comments

Franchisee bottom line- where is CFA metric?

One way to change the discounting behavior of frantic management team as of publicly traded CEOs is to tie their stock option amounts and bonuses to franchisee EBITDA increases.

Profitable franchisees grow, and create more royalty revenue streams. Squeezed franchisees eventually run out of juice.

Can CFA propose some sort of measure to promote and ask publicly traded Zors to adopt it in exchange for an endorsement?

Where there's a will there's a way

There is a way.....but it will not come from franchisor because zor will not want it to affect share price...there is no legislation or any complicated required....

Publicly Traded Restaurants

The fact is, publicly traded firms are under constant pressure to increase EPS. This country faces a far greater threat from publicly traded healthcare providers. Some large hospital chains like HCA have cheated the taxpayers and possibly put patients at risk. As Vito Corleon said: " This is the life we chose" Publicly traded companies are an inherent part of our system.

Protection Against Bad Business Decisions will not Happen

This will never come from the franchisor.

Profitability is always the result of the business owner who needs to take control of their business by understanding it and executing sound business practices.

Asking a franchisor to share in the failure of franchisees is unreasonable and unenforcable.

If you have given the right to control your pricing and/or product mix when it does not work through a franchise agreement, that was a bad business decision.  It is by no means illegal (so far as I know).  Looking to legislators and "business partners" to protect against bad business decisions is unreasonable and will result in disappointment.

Who said you need protection against bad business decisions? New

And who said that you needed franchisor management employees to agree to anything? They are slightly more than irrelevant to the discussion, even though they won't like a new valuation metric for the system. They SHOULD like it if they want to stay, because it is an easy measure.

Their board members are only slightly more relevant.

For a publicly traded Zor, Wall St analysts are the most important constituency to convince that a system's value should be based on the profitabllity of its franchisees where the system is "asset light."

If the Zees' profitability is shrinking, the system is doomed and the money should flow out of that stock immediately. It is only a matter of time before investors lose their money. If Zee prfits are growing, they will be paying more royalties, even if they don't expand. They WILL expand if they are making money, because replicating what you are already an expert at doing is easy money.

This is the new paradigm. Watch and see.

Same Store Sales Metric Befuddles Me

John,

Thanks for the review of the Same Store Sales Metric. I agree with your analysis.

I am often confused by Wall Street’s use of Same Store Sales (SSS) metric as it relates to a franchisor's value. SSS makes sense for a chain that is 100% owned and operated such as Chipotle or Starbucks. A 2% rise in same store sales is indicative of a 2% increase in sales and an increase in profitability as well as an indication that the brand value is growing. We all get that.

However, when applying the SSS metric to a franchisor like Dunkin’ Donuts, which is 99% franchised, the metric gets significantly watered down. A 2% increase in SSS for Dunkin’ Donuts relates to a .1% increase in royalties for Dunkin’ Brands (DNKN). It shows an indication of a rise in brand value, but that is not very relevant. If same store sales are static for Dunkin’ but they increased distribution in number of units that is a more appropriate indication of increased brand value.

The SSS metric is not as suitable for a franchisor as it is for wholly owned retail companies.

Wall Street’s focus should be on free cash flow and unit economics. That is the way you evaluate the health of a franchise system. If unit economics are strong, then that brand will continue to grow and prosper. If unit economics are decreasing, then that brand is headed for troubled waters.