2011 North American Restaurant & Foodservice Outlook
The North American restaurant industry is on the rebound. Americans are dining out more, and they say they plan to continue doing so. Revenue improved across all segments, as did same-store traffic and EBITDA (earnings before interest, taxes, depreciation and amortization) performance. Industry-wide effor ts in 2009-2010 to improve balance-sheet health and refinance debt show signs of success, but challenges remain. High debt-to-equity ratio persists: the industry saw twice the debt ratio it experienced five years ago. And restaurants face the dual headwinds of commodityprice inflation and a still-cautious, value-driven consumer. Innovation will be vital in terms of both cost and growth, as digital media gain increasing prominence.
DISHING UP GROWTH
Mergers and acquisitions activity was the number one growth driver in the restaurant industry. So far in the U.S. in 2011, deal value has kept pace with 2010, even if transaction values (at $600 millionso far) have declined (figure1).
Globally, 125 M&A transactions have been completed or announced so far in 2011, putting the year on track to match the 340+ total for 2010. This includes the largest Chinese-restaurant acquisition in history: the YUM! Brands acquisition of Little Sheep. Still, while companies are attracting higher multiples, only two deals were wor th more than $100 million.
The second-highest industry growth driver : international exposure. Global expansion for several chains is expected to continue in 2011-2012. In the QSR & Specialty category, Papa John’s saw 17% growth globally and 4% growth nationally. YUM! Brands enjoyed 12% international growth, and 2% growth in the U.S.
In the U.S., dining trends are positive. Dining and Foodservice year-over-year sales grew dramatically, up from low spikes in December 2008 and August 2009. In April 2011, year-over-year growth was 5.2%, compared to 0.8% in April 2010 (figure 2). This is due to consumer personal income growth and net job gains, which saw six consecutive month-to-month increases. Disposable income went from a 0.1% decrease in October 2010, to
a .3% increase in May 2011—with various climbs
in between.
FRONT-BURNER CHALLENGES
Still, the overall outlook remains uncer tain, with 75% of Americans feeling the same or worse about their personal economic situation than they did one year ago. Unemployment remains stubbornly high and consumer confidence is uneven.
In addition, the industry faces several challenges. Because commodity prices have returned to 2008 levels, companies will need to exercise active risk management to avoid finding themselves in a rising-costs squeeze with little room to increase prices (figure 3). At the same time, consumerpricing expectations have continued trending downward, with -5% in per-meal spending expected over the next 12 months. In many concepts, menu pricing must remain flat to continue traffic rebound and companies may need to use promotions and heavy couponing to entice new and existing consumers.
And while there is some improvement in balance sheets, the industry remains highly leveraged— especially the Casual and Fine Dining concepts the aggregate debt/equity ratio is approximately 1.5.
CONSUMERS DIG IN
American consumer s are dining out more frequently. In the last year, 70% of respondents dined out at least weekly, up from 49% in our Q1/2010 survey. Convenience and Casual saw the highest recent gains, with a 63% increase and a 25% increase, respectively, from Q4/2010. The highest increase in frequency was among respondents who dine out 2 to 6 times per week, up to 40% from 23%. People who dined out less than once per month dropped to 5% this year—down from 14% in 2010.
While diners are returning, they are doing so with an enhanced consciousness of price and value. Consumers expect a 5% decline in average spending per meal in the next year, down to $13.40 from $14.10, over the next 12 months. And many consumers say they will continue the shift to meals that cost under $10 (figure 4). While they understand that some restaurants will need to raise prices on select items, they are relying on promotions and online deals to get more bang for their dining-out buck—to the tune of a 15% increase since December.
Fuel costs figure prominently. When asked about their personal economic situations, respondents identified fuel costs as the primary concern (28%), followed by the desire to eliminate debt (13%). Thirty-eight percent of consumers said they will cut back slightly on frequency of dining out if fuel costs continue to rise; another 30% said they will cut back significantly. In fact, every $0.50 change in gasoline prices can be expected to impact restaurant same-store-sales by approximately 70 bps.
Quality is also very impor tant. Sixty-four percent of consumers cited food quality/taste as the most impor tant area of innovation for restaurants, followed by customer service and menu variety. Healthy menu options are also in demand, as 81% of respondents rated this important.
BY THE NUMBERS
Amid improvement in dining and foodservice sales overall, Quick-Service Restaurant (QSR) sales topped $53 billion over the last 12 months—a 1.8% year-over-year uptick. The average five-year compound annual growth rate (CAGR) for sales in this segment is about 3%, driven by the success of brands such as Tim Hor tons, which posted a 15.7% five-year CAGR and 2010 revenue of $2.5 million (figure 5).
In 2011, QSR sales improved along with monthly employment gains in the broader economy, although inroads by convenience stores have dampened some QSR positives. International sales growth was significant in QSR, topping domestic sales growth by anywhere from 41% (Domino’s) to 83% (YUM! Brands) in 2010.
Fast Casual sales growth declined to 11.9% in 2010 from 27.3% in 2006. However, revenue during that period climbed 98%, to $15.3 billion, and the category saw continued growth in same-store sales, more than 10% in Q1/2011 (figure 5). This increased traffic in Fast Casual, which grew from 4% in 2009 to 6% in 2010, was driven by several factors including declining unemployment among 18- to 34-year-olds; the perception that Fast Casual food choices are healthier than those of QSRs; increased beer and wine offerings (in select markets); price and convenience when compared to Casual Dining; and a closing gap between Fast Casual and Casual average check size.
Casual Dining sales growth also has declined since 2006, but saw a significant turnaround in the last 12 months, to 2.7% from –2.4% (figure 5).
In 2011, this category’s most significant challenges lie in excess supply and increasing competition from Fast Casual chains. Overcapacity in the segment has star ted to correct but likely will continue for the next one to two years. An increase in gas prices could hur t traffic growth, and competition from Fast Casual is intensifying. Menu innovation, consolidation, and social media marketing are seen as key growth drivers.
Finally, the Fine Dining segment saw dramatic sales growth in 2010 but has been flat, at about 2.2%, over the past 12 months (figure 5). Fine Dining benefited from increased business travel expenses, which have been climbing since 2009 and are expected to grow 3.2% in 2011. While China is expected to outpace the U.S. in business-travel spending, we expect business travelers in general to be more cautious with their expenses.
Across segments, many companies have successfully refinanced debt and increased stock-purchase activity, with available cash and stock investments up across all segments. Much cash has been generated by reductions in debt-servicing costs. Casual Dining, however, is still the most leveraged and lowest-growth segment.
In all segments combined, 50% of companies are still in “fiscal danger,” although the total is down 4% from the previous year. This is compared to the 25% of companies that are in financial distress in an average year. Distress levels remain highest in the Casual and Fine Dining segments (figure 6).
ORIGINAL RECIPES
We expect high performers to focus on strategic imperatives by redeploying funds and improving spend management rather than slashing budgets. Pricing, technology, and brand strategies should all be brought to bear in both growing revenue and containing costs.
On the growth side, innovation imperatives ranged from selective price increases to multi-year planning for updates to concepts, and par tnering effectively for international expansion (figure 7). In addition, companies have exploited several menu innovation oppor tunities to attract customers and grow business, ranging from upgrading ingredients and focusing on health-conscious choices to offering smaller por tions of popular items and customizable menu options.
Alternative revenue is another potential growth avenue. Companies can increase alternative revenue by exploring licensing and other potential growth areas. For example, Starbucks entered into a single-serve par tnership with Green Mountain Coffee Roasters, and Jamba Juice commercialized nine of its licensed product lines.
Finally, social media continue to play a role, especially the mobile platform, and top innovators are using these media for effective marketing. The mobile platform’s response rate is 20 times higher than direct mail or print adver tising, and 38% of consumers use mobile devices for restaurant related activities. The oppor tunity here is to build a unique relationship with the individual consumer and, in the process, create a brand spokesman.
On the cost side, procurement will continue to be a central concern, amid ongoing volatility in the markets. Those companies with more sophisticated practices will be at an advantage. Companies should explore the value in employing risk management strategies including product management, hedging strategies, and extended supply chain leverage to manage through this inflationary period.
SUSTAINING THE SIZZLE
Despite a rebound that is gaining momentum, restaurant and foodservice companies can expect to face ongoing challenges amid continued commodity volatility and an uncer tain economic outlook in the U.S. Promotions and heavy couponing remain potent tools for retaining customers and attracting new ones. Look for simplified menus and refined pricing, advanced social media marketing tactics, and expanded brand-licensing agreements. Expect more streamlined operations and, in short, more innovative approaches to a resurgent industry.
THE CHINA PERSPECTIVE
China’s Restaurant and Foodservice industry is trending positive growth in terms of three factors: market growth, continued company growth, and stable EBIT margins. The Foodservice category grew 17%—the fastest growth rate in recent years. Revenues of China’s leading restaurants grew 20% in 2010, and EBIT is up about 17%. The average 2010 EBIT margin of Chinese companies (12.4%) continues to top that of its U.S. peers (9.2%).
China’s Foodservice industry has been expanding at 15% CAGR from 2003 to 2010, yet remains at nearly half the size of the U.S. market. By contrast, the U.S. restaurant industry has lost revenue for the past two years.
China’s industr y has enjoyed strong stock gains: Hong Kong listed restaurants significantly outperformed the Heng Seng Index in 2010. Valuations/PE ratios are much higher than the market average (23x vs. 12x) and well above Hong Kong and U.S. listed chains, with leading restaurants boasting PE multiples of up to 60x (twice those of U.S. chains). Leading listed Chinese restaurants increased revenues by 20% in 2010. Despite rising labor costs and rent costs, EBIT margins at major listed Chinese chains remained stable last year.
There was continued market expansion by Western chains such as Pizza Hut, which upgraded its menu and services to cater to higher market demand. California Pizza Kitchen opened a Shanghai office in 2010 to supporT Chinese growth. Along with the YUM! Brands acquisition of Little Sheep, Texas Roadhouse invested a minority share into a locally developed Western-style chain, for example.