The Outlook For Quick Service Restaurants is Poor

The outlook for quick service dining establishments ain’t good.

Nation’s Restaurant News, the bible of the segment, reports traffic has declined by 1.9% in fiscal 2014, the sixth consecutive year of decline.

Bank of America, Merrill Lynch and Wells Fargo, three of the most active sources of financing, report that in recent months 20 of the strongest chains have borrowed more than $2 billion from the three banks, mainly in senior secured credit facilities. That means, to qualify for the bank loans, the chains hocked what they own outright.

A look at some current and prospective operating conditions explains this. Most importantly, expenses are rising inexorably. A $2.00 per hour increase in the minimum wage would probably put some chains out of business. Let’s take a restaurant doing $1 million per year in business. This restaurant typically will have a non-management payroll of about $240,000. The higher payroll would cost this restaurant about $60,000. Assuming such a restaurant is making a 12% profit, with the non-management payroll rising to $300,000. A good restaurant would be able to absorb the increase. Do the math. A weak chain would have to go out of business.

It’s worth noting, at this point, that forecasting is at best an inexact science. The annual growth rate for the industry in 2013 was 2.1%. In years past, the forecasts have been 1.7% too high, or too low.

The restaurants at the low end of the spectrum, with average checks under $10.00 each, will be hardest hit. Higher end chains, such as Cracker Barrel, can survive a 1.9% decrease in traffic. They first need to have, as Cracker Barrel does, a 1.2% increase in same store sales. This combination reflects a 3.1% increase in the average check.  The low end chains, barring the Cracker Barrel experience, will have to raise prices.

The outlook, at least for the foreseeable future, is rather grim. The full year 2014 will see housing starts hit 1 million. That’s up for an average of 750,000 starts since the recession. However, another way of looking at these numbers is that this year there were about 3 houses built for every 1,000 Americans. This compares with 7.5 houses built per 1,000 Americans in the l960’s and 6.5 houses per 1,000 Americans built in the early years of this century.  

Unless quick service restaurants are able to reverse or otherwise offset this decline in customer traffic, they are going to be vulnerable, and the weaker players are going to have a difficult time surviving.