Pizza Hut

Pizza Hut benefits from substantial scale and strong brand equity as the 2nd largest national player in the $1B+ chain pizza segment by domestic system sales. The brand (historically distinguished by its Pan Pizzas, Stuffed Crust products & fun innovation) has suffered a 15.4% decline in domestic market share among $1B+ pizza chains over the last 10 years through 2017 with comp underperformance attributed to: bi-furcated dine-in/delivery system (with no marketing support for 40% of units that are dine-in); the brand's historical lack of everyday value in a very competitive price environment; delayed digital ordering initiatives; need for faster delivery speeds; increased competition from non-pizza delivery; and increased competition in the pan pizza category. The brand's current goal is to reposition towards a modern delivery concept with the help of its 2017 Transformation Agreement which included: (1) $130MM franchisor investment to: upgrade restaurant equipment; accelerate improvements in restaurant tech; enhance digital & eCommerce capabilities; and boost ad dollars; (2) franchisee agreement to: implement national price points through 2019; increase their contribution to national ad spend; and contribute towards tech investments (digital ready POS). Brand upgrade also includes the addition of extra cheese on its pizzas and plans to either close or convert 80% of existing dine-in units to its Delco or new fast casual dine-in formats. The brand’s marketing pivot towards a new NFL sponsorship (picking-up where Papa John's left-off) goes along with a new ad agency (the 5th in 10 years) and its notable that NFL ratings have been declining even though it remains one of the biggest marketing games in town. Value remains one of the most important aspects of the pizza business and while Pizza Hut has made progress with its $7.99 large 2-top online only deal (introduced March 2017) and a new $5 pick 2 platform (2 medium pizzas for $10), the chain may do well to establish a permanent pizza value offer that is accessible online and off-line alike. Also, the chain may have more work to do to create a better financial model for delivery in high wage states (this represents a concern for the entire industry). In conclusion, while Pizza Hut's sensible turnaround is built upon a return to basics (hot, affordable & convenient pizza) it is possible that sales would further benefit from a strong everyday value equation to go with a renewed emphasis on core competencies including pan, stuffed crust & innovation.

3Q:18 Same Store Sales

 

New Unit Investment

• RR’s New Unit Investment Report provides average building cost estimate details (excluding land) and franchise fee summaries for 47 national restaurant chains.
• Report Highlights: (1) the sales-to-investment ratio for $1B+ chains continues to trend down after peaking in 2013, driven by construction cost increases and a slight decline in new build AUV’s; (2) RR's New Build vs. Buy Ratio rose for the 2nd consecutive year as construction cost inflation increases appeal of acquiring existing stores while store-level acquisition multiples have been relatively flat; (3) franchisors stepped-up development incentives which include franchise fee reductions to improve new build economics; (4) increasing use of non-traditional building formats should help to improve future new build returns; and (5) 9 chains introduced new or tweaks to existing building designs. 

Carl's Jr.

Carl's Jr. is a West Coast regional chain which should benefit from its ongoing brand separation from Hardee's (allowing Carl's to be Carl's) with a resultant return to its positioning around West Coast cool, bold, passionate, disruptive and edgy. Burgers account for 75% of lunch/dinner mix, mostly represented by the chain’s almost ¼ lbs. non-Angus beef patty platform which provides a compelling mid-tier pricing option. Other brand attributes include: over-sized burgers & unique Angus platform; charbroiled chicken line with no artificial ingredients, preservatives or antibiotics ever; hand-breaded chicken tenders; made-from-scratch biscuits; and milkshakes made with hand-scooped ice cream. Its higher-end Thickburgers are competitive with “better burger” brands, but offered at more affordable prices, and value is supported by its All Star Meal box platform & Charbroiled Sliders LTO. Annual comps through 2017 were modestly positive since bottoming in 2009 - 2010 (although slightly negative YTD 2018), helped by steady menu price increases and the 2012 intro of Hardee's high margin breakfast options. An outperforming EBITDAR margin reflects a material COGs benefit (lack of discounting to go with menu price increases) which more than offsets a relatively low AUV, high ad expenditure (necessary to compensate for CKE's relatively small scale) and labor cost pressures. In any case, high rent & labor costs on the West Coast discourage discounting and make it difficult for the brand to compete around price in a very price sensitive market and Carl's premium burger positioning continues to be pressured by marketplace realities. Sales are also challenged by the lack of all-day breakfast (reflecting operational complexities) and digital access (late to the game in terms of customer facing tech & delivery). In conclusion, while the brand is finally rediscovering its true roots, the competitive reality of the marketplace likely requires a new approach to price/value, preferably one that will not dilute Carl's Jr.'s West Coast cool. 

Hardee's

Hardee's is distinguished in QSR by a Southern classic, comfort culture brand positioning which includes table service and a strong breakfast orientation (44% mix). Specialty hand crafted food includes: made-from-scratch breakfast biscuits; made-to-order charbroiled burgers (with over-sized patties & Black Angus options); hand-breaded chicken tenders; charbroiled chicken line with no artificial ingredients, preservatives or antibiotics ever; and hand-scooped ice cream shakes. Value comes in the form of its $5-$7 All Star Meal box every day value platform, various national LTO deals and local offers advertised in-store/on the windows. While the chain's AUV underperforms, its COGs far outperforms the segment average which reflects a profitable breakfast mix and a historical aversion to discounting and low price-points. We also appreciate CKE's plans to separate Hardee's & Carl's (in terms of marketing & menu), benefitting both brands given sharply different geographies and demos. This means Hardee's can now pursue menu, marketing and facilities which best suit its regional orientation in the South & Midwest. Having said all this, the brand remains challenged to compete with the larger, national players around value/discounting because it lacks sufficient share of voice to promote both quality and value sufficiently to overcome trade-down. The challenge is to run Hardee's as a regional brand which requires a very different skill set compared to the past practice of seeking to combine the disparate brands in pursuit of national scale. Some operators believe the brand would be better off emphasizing ample mid-tier choices of higher quality menu options and this reflects the belief that Hardee's is used more as an occasion visit as opposed to a QSR heavy user stop. In any case, a high level of turnover for the brand's ad agencies reflects the difficulty of defining a suitable brand positioning amidst all of these issues. Weak comps over the last couple of years also reflect a lack of an all-day breakfast, operational complexities associated with Hardee's business model that pressures service speed and a lack of a digital ordering platform (which is forthcoming). In conclusion, stakeholders must exercise patience as CKE's new management team continues to find ways to leverage the chain's considerable brand equity built upon quality biscuits, burgers & tenders in a difficult, competitive operating environment sufficient to reinvigorate Hardee's comp performance.