Two more chains go bankrupt, and Starbucks and McDonald's get results

Last week, I dove into the rise of bankruptcies in the restaurant industry and why that trend isn’t likely to subside (too many locations, too few customers, not enough money to go around). Along with M&A activity and public brands going private via private equity takeovers, these are two developments I think you can bank on in 2020.

And then Monday arrived.

Two recognizable full-service brands, gastropub Bar Louie and Village Inn owner American Blue Ribbon Holdings, filed for Chapter 11 as they shuttered 30-plus restaurants apiece. The two situations are very different, as we’ll get into below, but there is a common thread. In each case, the chains faced rising competition not just from brands in their own sector, but also from convenience-fueled outlets, like delivery. All the while trying to combat rising wage rates and higher costs across the balance sheet.

There’s no easy way to approach this, other than to admit many chains are going to retract. Today’s climate isn’t ripe for widescale growth, at least not for the majority of concepts. The days of boosting revenue by opening another restaurant, on another street corner in America, are pretty much behind us. Subway is a good example. Prime real estate, better-run restaurants, and units designed for an evolving customer are taking precedent over sheer scale. It’s why Subway is finding more success today with remodels than new unit growth. And getting its “Fresh Forward” design into as many units as possible, as quick as possible.

So, what can we expect moving forward? I think it will be far more common to see restaurants work on operations in favor of throwing massive growth numbers at the board. Even McDonald’s is mostly just expanding internationally right now as it spreads Experience of the Future models across its domestic system. The winners in 2020 will be the chains with the best employee-value proposition, who have implemented systems to survive rising labor costs, understand their guest data and know how to use it, and those who simply out execute the competition. Not to mention have footprints and systems capable of capitalizing on off-premises volume, and not at the cost of dine-in operations.

The bottom line is there is simply very little margin for error these days. Thus, focusing on the units a brand does have might be a better path than trying to add others. But it all depends on the situation.

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Let’s start with the bankruptcies

Bar Louie shuttered 38 of its 134 restaurants and declared bankruptcy, although the company noted in filings there are multiple offers on the table to buy the chain. As for what went wrong, it was a product of using cash flow to fund new-unit expansion, among other things. And then, when underperforming units started to drag the system, Bar Louie didn’t have the capital to fix these restaurants. In 2018, the company hired a new CEO and assembled a fresh management team. The group developed a turnaround strategy centered on improving guest experience through better customer service and store maintenance; improving food quality to better complement its beverage program; and redefining Bar Louie’s brand essence by developing a new advertising campaign.

Some current directives include its Louie Nation Loyalty Program; the construction of private dining rooms where feasible; adding covered patios to limit the impact of weather on outdoor seating areas; the implementation of store-level party planning sales managers; and corporate gift card partnerships.

This all sounds great, and it worked in 72 of Bar Louie’s 110 corporate locations, the company said. However, despite execution of these programs, 38 stores continued to lose money at an accelerating pace.

The declines forced a reduction of expenses and other investments, “with the inevitable impact being felt throughout the whole system.”

And that’s where the lack of available liquidity came into play. Despite the success of the initiatives, Bar Louie said, not having investable capital on hand “resulted in delays to the broader roll out of these initiatives to other locations and curtailed the ability to implement further marketing related activities compared to others in the industry,” leading to a drop in same-store sales.

Those 38 units reported comps declines of 10.9 percent last year. The rest of Bar Louie’s system dropped 1.4 percent. And the spike came in Q4 when “when financial conditions and a lack of liquidity forced management to significantly reduce marketing spend.”

Bar Louie said traffic declines were more pronounced at stores near shopping locations and malls, which led to sales falling short of forecasts. “These customer declines were also driven by major changes in consumer behavior, including the general national trend away from casual dining,” it added in the filing.

So, this is one of those perfect-storm situations. Bar Louie had issues at hand, but no capital to market its way out of the traffic problem or remodel units and implement much-needed changes. And, in turn, the brand had to file for Chapter 11 so it could facilitate a sale.

The situation at American Blue Ribbon Holdings, which closed 33 stores ahead of its filing, was quite different. The company, which also runs Bakers Square, had mounting losses it was working through thanks to the financial help of ABRH (a company separate from American Blue Ribbon. Yes, it’s a little confusing).

ABRH and other non-debtor affiliate companies said they were no longer willing to fund American Blue Ribbon’s operations. Per filings, American Blue Ribbon did not have any secured debt, but ABRH not being involved moving forward led to the filing. It said it does not have the “contracts, infrastructure or human resources,” to independently maintain operations without services and staffing provided by ABRH.

American Blue Ribbon sustained operating losses of $11 million in 2018 and $7 million in 2019. Projections for fiscal year 2020 indicted losses at $5 million “if American Blue Ribbon continued to operate according to status quo,” the company said.

What went wrong here? That part aligns with other recent examples in the industry. The company said financial trends have tracked negative 2017 as restaurant operations struggled with declining sales and acceptable margins. It called out “higher wage rates,” as a main culprit. In filings, the company said rising labor costs counted for a $2 million impact in the past two years. “Dramatic increases” were seen in 67 of American Blue Ribbon’s then-130 restaurants, located in Minnesota, Colorado, Illinois, and Arizona.

Additionally, American Blue Ribbon had an increasing number of unprofitable restaurants due to, among other things, “unfavorable trade area locations and above-market rents or otherwise high occupancy costs.”

Other reasons: “There been increased competition in the restaurant business and particularly in the segment thereof in which the family dining business competes” in recent years.

The company pointed to “growth from existing larger family dining companies,” like IHOP and Denny’s, “that have substantial advertising expenditures to message consumers,” as well as increasing competition from grocers “as the gap between consumers’ cost of food away from home remains elevated from cost of dining at home, including grocery stores’ expanded prepared meal offerings.”

Again, we’re going to hear more than once this year. But, as always, there’s opportunity in the challenges ahead.

Starbucks closes 2,000 stores in China (temporarily)

If not for the news Starbucks had to shutter more than half of its 4,292 China restaurants due to the coronavirus outbreak, we would be talking about one of the more positive quarterly reports of the season. But the unfortunate turn—and its possible future impact—overshadowed Starbucks’ strong performance a bit.

China accounts for roughly 10 percent of the company’s total sales, more than 10 percent of operating profit, and about half of its international comp. It’s pretty difficult to gauge what the impact is going to look like, and Starbucks said it probably won’t know until early March. Wage costs are going to be a challenge.

Moving past this turn, though, Starbucks lit up another positive run in Q1, with global same-store sales climbing 5 percent. In the U.S., comps bumped 6 percent. But what’s notable here is that Starbucks, unlike many chains today, split that figure down the middle with check and traffic. Meaning transactions rose 3 percent, the third consecutive quarter they have done so. Starbucks successfully rerouted conversations about its progress after same-store sales crawled 1 percent in Q3 2018. Since, the chain hasn’t fallen below 4 percent on the top line and continues to do so from a healthy set of initiatives.

Among them: beverage innovation, especially with cold drinks. The segment has led Starbucks’ comps for six straight periods, pushing about 5 points of Q1’s result with strength across all beverage categories. Starbucks witnessed transaction growth in the morning and afternoon dayparts for the third consecutive quarter and its highest quarterly peak transaction growth in three years.

Starbucks added 1.4 million customers to its 90-day active Starbucks Rewards member base in Q1, which marked an internal record for the company and the strongest growth rate in three years. It brought Starbucks’ industry-leading platform to 18.9 million active members, up 16 percent over last year. The chain’s mobile order and pay business grew to 17 percent of U.S. mix.

One reason Starbucks’ current trajectory suggests stability is a shift in product strategy. In recent quarters, the company moved away from Frappuccino-centric LTO deals to platform innovation. All the while expanding nitro throughout its base. In Q1, this strategy manifested via cold brew and cold foam creations—Pumpkin Cream Cold Brew and Irish Cream Cold Brew. The strategy allows Starbucks to build around a menu construct customers are familiar with instead of trying to pulse new news into a product launch each time. Importantly, it also reduces strain on Starbucks’ supply chain and training at the store level—a critical push as the brand looks to reduce task hours for employees so they can focus more on customer-facing activities and separate Starbucks from independents and convenience-fueled competitors.

And the best part? It’s a path with endless runway.

McDonald’s opens up the checkbook

The fast-food giant’s Q4 result—same-store sales of 5.9 percent—marked its best performance in over a decade. U.S. gains of 5.1 percent were the best in 13 years. How do you get there? Over the past three years, McDonald’s has spent roughly $7 billion on growth initiatives.

And in 2020, the company said it expects SG&A expenses to increase 5–7 percent as it invests in new technology and absorbs costs related to an upcoming convention. The total bill will run about $2.4 billion, with $1.3 billion dedicated just to McDonald’s U.S. business—a segment that continues to counter declining traffic with higher check, and dropped in store count from 13,914 to 13,846 this past year.

McDonald’s said more than half of its $1.3 billion U.S. target will be allocated to 1,800 Experience of the Future redesigns. Globally, the chain plans to open 1,400 or so restaurants and net 1,000 (basically all outside of the U.S.).

Yet as all this unfolds, the brand will continue to try to improve domestic traffic. McDonald’s U.S. comparable guest counts declined 1.9 percent in 2019 after falling 2.2. percent in 2018. The figure has tracked negative all but one year since 2012.

And this is all going to start at breakfast. CEO Chris Kempczinski didn’t give away many details, only saying menu innovation was coming, with a focus on value. Also, McDonald’s would work on boosting speed of service and improving operations, especially at the drive thru.

“… we have a really good understanding of what it’s going to take for us to drive guest counts to positive in the U.S.,” he said. “It starts with breakfast. Breakfast is the only daypart in the industry that’s seeing traffic growth. We have to win at breakfast.”

That about says it all. Also, on the always relevant topic of chicken sandwiches, McDonald’s said “I think we’re getting close to having something that we’re excited to bring to customers.”

Stay tuned.

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