Franchise Finance Midyear Update: Restaurants Look to Maintain Their Momentum
- midyear update
The pandemic created a lot of uncertainty among franchise restaurant operators. Because of the various stay-at-home orders, no one was able to predict how consumers’ out-of-home eating habits would change. In fact, many financial institutions stopped servicing the industry, believing it to be too risky.
Nonetheless, 2020 was a fantastic year for our franchise clients who own quick-service restaurants, and the first half of 2021 has been a continuation of that performance. QSRs with drive-thrus thrived during the pandemic as dining rooms were shut down. The ones who ramped up their delivery options—or had an established delivery system—were also in a great position as more customers relied on delivery for their dining out options.
While the smaller full-service restaurant concepts were hit the hardest during the pandemic, the QSR segment has proven over the years to be the most resilient segment in restaurants. And that was borne out during the pandemic. With a few exceptions, many franchise operators had never experienced such high margins, and they've been able to keep all the top-line sales.
It turns out that having minimal employees operating the drive-thrus and curbside pickup is simpler to execute than a full dining room. Even now as the economy reopens across the country, when you visit a QSR, it's unusual to see a full dining room, but it's very common to have a long line of cars waiting in the drive-thru.
More full-service restaurants are starting to reopen at full capacity, and some of the dollars that were going to the drive-thrus will revert back to full-service offerings. But our view is that a lot of those drive-thru dollars will stick around the QSR space simply because consumers have grown accustomed to it. It’s worth noting that some brands that don't typically have drive-thrus, like Chipotle, are exploring the option.
Labor, of course, has been a challenge, but it’s been fairly manageable on the fast-food side, largely because dine-in traffic is still lagging pre-pandemic levels. Inflation, which has caused higher input costs, is another headwind. The big question is whether franchises will be able to pass those costs along to consumers quickly enough.
Another potential headwind is the proposed change in the tax laws, both on the corporate and personal level. BMO has been having a lot of conversations with clients about how they can prepare for these changes before they take effect. The impact could be significant, so we encourage clients to learn about the changes and talk to their advisers about if they can make any changes to soften the blow. Franchises are typically privately held, family-owned businesses, and any dollars they have to spend on taxes could be dollars that they don't invest in their business. Nonetheless, the franchisees I’ve spoken with are confident that the good times they’re experiencing now will help them weather any future storms.
The Biden administration’s proposed tax changes are also a demand driver for mergers and acquisitions in the franchise sector. Having lived through a pandemic, some older operators are taking the opportunity to sell their stores today to make sure they don’t get hit with higher taxes that the proposed plan will likely bring in 2022. We're seeing a lot of M&A activity as a result. And with recent high valuation multiples, we expect even more of the older operators sell to larger franchises.
That’s significant because this space is set to be dominated even more by the major brands. Last December, the National Restaurant Association sent a letter to congressional leaders stating that the pandemic caused 17%, or 110,000 restaurants, to close permanently.1 That means the major brand franchises are taking more market share.
The larger players are also active in the M&A market. In March, Flynn Restaurant Group completed its acquisition of NPC International’s Pizza Hut portfolio and most of its Wendy’s restaurants.2
Focus on the Fundamentals
As the vaccination program continues and people are clamoring to get out more, QSRs should continue to perform well. On the flip side, as some of the unemployment benefits come to an end, some consumers may be left with less discretionary income, and that’s a cause for concern in the second half of the year.
The successful franchises will continue the strategies that helped them thrive throughout the pandemic. In my 35 years of covering the QSR space, it’s become clear that the most successful franchises are the ones that execute on a high level every day. It comes down to being the best operator with the best products.
Those are the keys to success, and the franchises that execute will continue to enjoy higher same-store sales and higher margins while managing their input costs.
Managing Director, Franchise Finance
Rick Thompson is responsible for the oversight of a team dedicated to identifying the finance needs of a diverse group of franchise clients – and helping th...(..)View Full Profile >
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