Restaurant Industry Insights-2H 2012

Notwithstanding the continued economic malaise and uncertainty surrounding the upcoming presidential election, the restaurant industry has powered ahead in 2012, delivering increased sales and profits.

Strategic and financial buyers, attracted to the industry’s solid fundamentals and long-term growth prospects, have demonstrated continued strong interest, announcing 12 transactions (greater than $25 million in enterprise value) through September 30, 2012. In addition, the public equity markets recently re-opened for certain restaurant concepts – Ignite Restaurant Group, Bloomin’ Brands, Chuy’s Holdings and Del Frisco’s Restaurant Group – matching the total number of restaurant IPOs over the past four years. CKE Restaurants, Cheddar’s Casual Café and Dave & Buster’s Entertainment also filed this past summer, but have chosen to postpone their launches given recent market volatility. Bolstered by a favorable lending environment, interest in franchise growth opportunities has reached pre-housing crisis levels, fostering unit expansion in both existing and new markets. Despite the aforementioned bright spots within the restaurant sector, the environment for restaurant operators continues to be challenging. Continued volatility in commodity prices and food input costs, modest traffic counts and vastly fluctuating consumer confidence have challenged even the very best operators.

Many restaurant operators have committed significant capital to pursue growth in 2012 and beyond, a welcome change to the capital preservation and cost control measures taken over the past three years. Fast casual and quick service concepts have generally fared well as consumers continue to “trade down,” seeking the right quality / value balance. Conversely, casual dining concepts have, on the whole, struggled in their attempts to appeal to an increasingly value-oriented consumer base. In an effort to combat a potentially protracted traffic slump for more mature brands, a handful of casual dining companies are pursuing growth through the acquisition or development of popular, complementary concepts. Darden Restaurants’ acquisition of Yard House demonstrates the willingness of large corporate buyers with more mature concepts to pay robust premiums for differentiated brands with broad appeal and significant growth potential. Many casual operators, such as Pie Five Pizza and Uno Dué Go, have also developed new, complementary concepts in higher growth segments. In this increasingly competitive marketplace, we see creative, new concept launches driving continued growth with no signs of a slowdown in acquisition appetite (particularly for strong and differentiated brands).

With the presidential election days away, an already heavily regulated restaurant industry anxiously awaits the outcome. Irrespective of the election results, it seems likely that healthcare costs will rise sharply for many operators, forcing management to balance controlling costs versus investing in growth. In addition, having already absorbed a large minimum wage increase in 2009, operators face yet another potential increase, with some Democrats calling for a minimum wage of $10 per hour. In the near-term, commodity price volatility is expected to continue to pressure the industry, forcing operators to carefully consider price increases. Despite this overhang, we remain optimistic that a 2013 economic rebound will finally take hold, and that traffic counts can return to the pre-recession levels that fostered healthy top line growth for restaurant operators.

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