1H:18 Valuation & Finance Update

Report Highlights
  • (1) EBITDA multiple estimates (post G&A) for 45 chains based on survey data from 8 leading appraisal firms; (2) a comparison of public restaurant company and private franchisee valuation multiples; (3) a summary of real estate cap rate trends based on data provided by Marcus & Millichap; and (4) an update on borrower financial condition, changes to underwriting standards, restaurant loan origination volume, and interest rate outlook derived from a survey of leading lenders.
  1. While 1H:18 unit level franchisee valuation multiples increased because of a scarcity of deals and an abundance of capital, the absolute level remains slightly below 2016 levels and the 6-month outlook is pressured by prospects of higher labor, food & borrowing costs.
  2. The franchisee lending environment for large operators in national brands remains mostly favorable although operators are facing increasing headwinds as previously outlined to go with slightly tighter underwriting standards.
  3. 21% of lenders indicate a decline in borrower financial condition compared to 17% that are improving although survey trends are pointing in the right direction.
  4. Multiple premiums for large deals rebounded and are now at or close to relative highs. 
  5. While there was some recent stock investor 2nd guessing in terms of the validity of an asset-light franchisor model in an operating environment marked by rising costs, it seems like Wall Street has satisfied itself that franchisee health is OK for now, consistent with #2 above. 
  6. Aggregate cap rates for single-tenant net-leased restaurant properties increased slightly as rising interest rates are starting to dictate a more conservative underwriting and exit strategy.



T.G.I Friday's

Friday's new management has developed a sensible positioning strategy which seeks to create a new category of a bar focused brand, bringing Friday's back to its roots as an energetic, social atmosphere (In here, it's always Friday) where guests gather together with friends for fun and celebrations. The brand's social/bar heritage works well with Millennials who represent 40% to 45% of guests and its bar theme helps provide an exciting experience which prompts consumers to counter their cocooning home dining instincts. Further, a very large 25% mix for alcohol sales helps to increase check and margin with drink specials helping to drive incremental sales. Plans to pulse-in 3-5 new product intros every month should help drive traffic and 50%+ of the menu has been upgraded with a complete menu overhaul expected by FYE18 (which includes continued menu simplification to offset the added complexity from an increased LTO cadence). The new "Fire-Grilled Meats" platform upgrades include: new Big Ribs (featuring a +30% bolder, meatier, juicier rib); and an updated Burger Bar menu featuring a new patty blend of chuck & brisket. Operations should benefit from a focus on: world class hospitality; frictionless operations & service; personalized guest experience inside & outside of restaurants; and award winning facilities. Incremental off-premise sales have been ramping-up quickly helping the brand to better reach new, younger customers and new occasions. Having said all this, the new management team has its work cut out for itself given that this smaller scale player (11th largest national $1B+ casual chain) has suffered mostly negative comps since the 2008 Great Recession which reflects the system's fundamental challenges, particularly as it relates to value in our opinion. The brand's nearly $18 average check before tip and lack of an everyday value platform may impede frequency given consumer price sensitivity and a high level of competitive discounting. Sales challenges have translated into a system low AUV and EBITDAR dollar amount and gross closures have exceeded gross openings over the last 9 years. In conclusion, while Friday's has a lot going for it because of its unique bar positioning in the crowded casual chain dining space and because of its new management team which is well capable of executing its well-conceived turnaround plan, there is still more work to do around value (which we believe is forthcoming) necessary for Friday's to join in the progress that its competitors have made in better meeting today's consumers where their wallets are at. 



Applebee's (directed by a new, well seasoned & collaborative management team) is implementing a well conceived turnaround plan that includes: culinary innovation (with investments in food quality and back-of-the-house simplifications); a renewed value orientation with a return to its middle-market DNA; efforts to leverage high brand awareness as an affordable destination during happy hour & late night, re-igniting alcohol beverage innovation as a driver of high margin incremental sales; accelerated rollout of off-premise channels; and improved guest insights to ensure a strong correlation between test results and end-market performance. The goal is to move Applebee’s away from the perception that casual dining food is processed, microwaved or comes from a package in order to tap into growing demand for real bars and upscale burger restaurants. To this end, its menu strategy seeks to: re-establish culinary culture around broadly appealing, mainstream America flavor profiles that: embrace variety (something for everyone); restore abundant & indulgent value; include guest-driven, ops-validated innovation; and address quality & value gaps. This includes a return to crowd favorites like riblets and low cost bar drinks (which had been removed as part of its failed upscale positioning). Fortunately, new brand leadership recognizes that value for the money is critical given that the brand's core middle-income customer base remains financially strained (value seekers drive 50% of transactions) and the brand's value positioning benefits from its signature 2 for $20/$25 platform and a return to low price drink deals. While long-term system comps have badly underperformed, recent sale trends are outperforming. All-the-same, the system must still deal with the affects of its cumulative sales decline which includes a system low unit level EBITDAR margin and, correspondingly high closure rates. In conclusion, while Applebee's has embarked on a sensible reboot to re-establish its roots as a relevant value player in traditional American fare, stakeholders will require patience as the system works hard to recover from a rather substantial fall.


Unit & Sales Growth

Report Highlights
  • 10-year history for 56 $1B+ chains including: (1) total units; (2) company vs. franchisee ownership; (3) new units; (4) closures; (5) franchise transfers; (6) average units per franchisee by concept; (7) systemwide sales; and (8) system sales market share.
  • 2017 aggregate systemwide sales growth slowed and was below the 10-year historical average due to weak net unit growth and only a modest same store sales increase.
  • Consistently low aggregate annual gross unit development rate (+3.7% average from 2008 – 2017) for the $1B+ chains remains well below pre-recession levels (+5.6% average from 2003 – 2007).
  • Actual 2017 new unit development fell short of initial year projections for the first time since 2007.
  • Coffee/bakery and fast casual unit development continue to lead the industry.
  • Closure rates spiked to the highest level since 2009 which reflects that the 2017 store-level EBITDAR average for the $1B+ chains was at the lowest level since 2008.
  • 2017 closures were notably pressured by sub-sandwich (4.4%) and casual segment (3.1%) weakness.
  • The 2017 franchise transfer rate exceeded the development rate for the 6th year in a row, which reflects: a continued move towards franchisee consolidation (in search of scale based cost efficiencies); high construction costs; and the difficulty in securing acceptable sights. 


Unit Economics

  • RR’s Industry Data Report on Unit Economics provides: (1) FYE 2017 unit level AUV along with COGS, labor, royalty, advertising, other operating and EBITDAR margin estimates for 46 chains; (2) a 5-year history of unit economic performance; (3) an analysis of food and labor cost drivers; and (4) aggregate G&A margins, rent margins and leverage ratios based on RR’s annual lender survey.
  • Report highlights: (1) Average 2017 EBITDAR margin for the $1B+ chains declined -60 bps due to higher labor costs; (2) higher rent expense based on our lender survey suggests 2017 EBITDA (post G&A) also contracted; (3) franchisee leverage levels increased, but coverage ratios remain solid with lenders reporting minimal delinquencies; and (4) 2018 EBITDAR margin pressure reflects expectations that moderate sales growth will be insufficient to keep pace with higher labor & commodity costs.