Product and Service
Companies included in restaurant –fast-casual sector in food service industry primarily operate fast-casual restaurants.
Demand for Product and Service
As our sales data indicates, the demand for fast-casual food service has been declining in the past three years, resulted probably from changes in factors from economy &income and consumers’ spending habit. With less flexibility of improving profitability by franchising their business, the declining demand and thus sales significantly hurt performance of those fast-casual restaurants.
The Sector
Sector’s current, trend, causes behind trend, and future
Current and Trend
- Generally the demand from loyal customers for fast-casual restaurants seems to be declining since 2015 as indicated by the decrease in comparable traffic. While varying in different sun-sectors, the downward trend seems to be worse in 2018.
- While companies have been raising price to try to offset the declining traffic, the decrease in traffic was significant after entering into 2017, which has caused growth in comparable sales of most companies to fall into negative area.
- All sub-sectors of fast casual sector present a consistency in terms of this downward trend probably under the common influencing factors between 2015 and 2017. However, after 2017, they are performing slightly differently in terms of traffic/transactions depending changes in demand.
- Generally, it seems that in the challenging climate in industry of restaurant fast-casual restaurants have received larger impacts than those QSRs as seen by the larger decrease in traffic and sales. This is particularly true for those Mexican food and pizza restaurants. Relatively, chicken/wings and hamburger restaurants had been less impacted than others in this sector.
- Chicken related food/restaurant concept seems to be becoming favorite of consumers in QSR and fast-casual restaurant industry.
- The extent to which business are franchised is much lower than that in QSR sector and therefore, their margins usually have smaller buffer than QSRs to mitigate impact from declining sales. This is actually why we have seen that margins of those companies in this sector have been down largely as their comparable sales went down but those in QSR did not.
- Increasing labor and commodity costs, coupled with pressure in traffic, have been hurting companies’ margin and cash flow. General rising menu price did not lift margin due to simultaneously promotion.
Causes behind the trend
We think the trend happening among restaurants in this sector has reflected changes in slowing down traffic of shopping mall and as well economy that influence consumers’ spending. Generally, benefiting from the recovery of economy, especially quantitative easing monetary policy and low borrowing cost, consumers’ spending has been on the high level, which probably has been the major reason why we have seen the favourable industrial environment in the years before 2015. However, this may have been negatively impacted by the recent change in monetary policies, which caused consumers’ disposable income to decline or caused them to feel that way.
Higher price products usually present higher sensitivity to declining purchasing power from the consumers with lower income. This is probably why QSRs had received smaller impacts than fast-casual restaurants when facing the same consumer pool but charging lower prices/purchasing cost. This also explains why Mexican and pizza restaurants have worse performance than others in fast-casual restaurants sector but a better performance in QSR sector.
Size of consumer pool and margin seem to be the factors determining extent to which business can be franchised in every sector of restaurant industry. Fraternization rate is low because of low margin and small size of segment that fast-casual restaurants usually have.
Industry Future
We think the accelerating recovery of economy will eventually help bring traffic back to restaurants after the temporary impacts from slowing down traffic in mall and cease of quantitative easing policies. However, it may need longer time for restaurants in this sector to deal with narrowed margins.
Numbers
General Financial Performance of Companies In the Sector
It seems that significantly slowing down traffic is the major reason contributing to downturn in comparable sales of fast-casual restaurants between 2015 and 2017. Data indicates the average increase in comparable sales all across this sector went down from around 3% of 2015 to around -2% of 2017and that all sub sectors have experienced decrease in growth in their traffic and comparable sales during this period and the growth turned into negative number in 2017. (Hamburger-sub sector went down from 3.3% to -0.2%; chicken-sub sector down from 4.3% to -0.6%; Mediterranean sub sector down from 6% to -2%; pizza sub sector down from -5 to -13% ;Mexican down from 3% to -4.5%; pasta/noodle sub sector down from 0%-2.5%). Correspondingly, accompanied with declining sales, the traffic has been down for most of companies in this sector since 2015 (average growth in transactions down from 0% of 2015 to -3.5% of 2017). For example, our data indicates that the average decrease in traffic of hamburger sub sector restaurants was 1.2% and 2.1%, chicken wings sub sector restaurants was 1% and 0.9%, in Mediterranean sub sector 1.3% and 3.5%, in Mexican sub sector 3% and 9%, for 2016 and 2017 respectively.
Since 2017, it seems the decrease in comparable sales (down by average 1% in first half of 2018 as compared with 2% of 2017) has been slowing down. Because the traffic/transaction of most companies continued to go down (average -5% in first half of 2018 as compared with -3.5% of 2017) in 2018, the slower decrease in comparable sales has been driven by aggressively rising price. For example, in chicken –wings sector, the average growth in comparable sales rebounded back to about 0% in 2018 from -0.6% of 2017; in Pasta sector, the average growth in comparable sales rebounded back to about 3% in 2018 from -2.5% of 2017; in Mexican food sector, the average growth in comparable sales rebounded back to about 1% in 2018 from -4.5% of 2017; in Pizza sector, the average growth in comparable sales rebounded back to about -13% in 2018 from -16% of 2017 in Mediterranean sub sector, average growth in comparable sales down slightly to -2.5% in 2018 from -2% of 2017; in burger sub sector, average growth in comparable sales down slightly to -0.35% in 2018 from -0.2% of 2017;
Generally, impacts of unfavourable climate of restaurants industry and thus the impact of decreasing traffic seem to be more significant to fast-casual restaurants than to quick service restaurants as indicated by their growth in traffic (not including all sub sectors). Comparable sales followed the same trend as it is in traffic/transaction before 2017. However, due to more aggressively rising price, fast-casual restaurants have been seen a slower decrease in their comparable sales in 2018. The most obvious contrast is from Mexican sector, whose average increase in comparable sales among QSRs and among fast-casual restaurants in 2018, 2017, 2016, and 2015 are about 2%, 4%, 3.3%, and 6% and1%, -4.5%, -1.4%, and 3% respectively.
Growth in Comparable sales Growth in Traffic
2018 2017 2016 2015 2018 2017 2016 2015
- Quick service restaurants 0% 1.3% 2% 4.8% 1% -0.9% -1.3% 0.6%
- Fast-casual restaurants -1% -2% -0.8% 3% -5% -3.5% -1.5% 0.2%
- Casual dining restaurants 1.3% -0.6% -0.9% 1.7% -0.9 -2.4% -2.3 -1.1%
- Fine dining restaurants 1.2% 0% -0.2% 1.7% -1.5% -1% -0.5% -0.5%
- QSR-Coffee, tea, and baked 0.8% 1.2% 3% 4.7% -1% 0%
It seems, unlike in QSR the difference in performance in terms of comparable sales and thus the traffic are larger among different sub sectors of fast casual sector. For example, our data indicates that chicken/wings and hamburger sub sectors have experienced the least impacts and present the least decrease in their comparable sales (average down 0.2-0.6% in 2017 and 0.1-0.3% in 2018). On contrast, pizza and Mexican restaurants present the largest decrease in comparable sales (average down by 8-15% in 2017 and 1-13% in 2018).
It seems that the impacts from decrease in traffic have been partially offset by companies’ general ability to raise menu price/products mix. However, unlike in QSR sector, the raised price/product mix was not able to bring the growth in sales of those companies in this sector back above zero due to generally weak demand (much larger decrease in transactions).
For companies in this industry, franchising seems not to be popularly accepted as compared with
QSRs. Except for some chicken wings chains, which are consistent with chicken QSRs and re-confirm the current main trend of chicken as favourite, most of companies are operating their own restaurants. Their gross margin vary in smaller range than QSR, which depends on the extent of franchising, and have declined due to increasing labor and occupancy costs and deleverage of those costs as a result of decreasing sales. The rising menu price did not help improve margin due to the immediate promotion after rising menu price. Typical gross margins for different sub sectors are: chicken/wings-down to 15% from 17% of 2014, Hamburger – down to 12% from 13% of 2017, Mexican-down to15% from 23% of 2014, pizza – up to 52% due to closure of company owned restaurants, pasta- up to 10.5% from 9%, and Mediterranean-down to 10% from 13% of 2015.Correspondingly, most of operating margins are shrinking: chicken/wings - 6% with a SG&A as percentage of sales of 8%, Hamburger - 1% with a SG&A as percentage of sales of 10%, Mexican - 5% with a SG&A as percentage of sales of 9%, pizza - 1% with a SG&A as percentage of sales of 51%, pasta – 0.5% with a SG&A as percentage of sales of 10%, and Mediterranean - (-0.5%) with a SG&A as percentage of sales of 11%.
Unlike in QSR where companies use franchise as buffer, in fast-casual sector companies’ margins declined as traffic and thus sales slowing down. The typical average gross margin decreased by about 300 basis points since 2015. Relatively, chicken/wings restaurants have been the only sector that generated an improved margin.
According to our analysis, the current companies’ enterprise price/EBI ratios (or /sales) are:
(Fast-casual): average 41 with an interest/EBI ratio of 25%.
(Hamburger-fast casual): average 42 with an interest/EBITDA ratio of 5%
(Chicken/wings-fast casual, company owned only): average 24 with an interest/EBI ratio of 18%.
(Mediterranean –fast casual): average 0.8 (enterprise price/sales) with a debt/assets ratio of 8%.
(Mexican food-fast casual): average 57 with an interest/EBITDA ratio of 3%.
(Pizza-fast casual): average 1.6(enterprise price/sales) with an interest/EBITDA ratio of 20%.
(Pasta-fast casual): average 1.2(enterprise price/sales) with an interest/EBITDA ratio of 17%.
The average cash flow/share of companies in this sector presents increase of 25% in 2015 and continued to decline since then by 13%, 25%, and 50% for 2016, 2017, and 2018.
