Restaurant Debt Ratios

Restaurant Debt Ratios

The restaurant industry is a diverse one — and with so many different types of companies (large, small, franchised, company-owned, etc.), the indebtedness of chains varies widely. Investors often monitor this indebtedness to navigate the risks (and, in many cases, rewards) associated with the chains themselves. Recent bankruptcies further highlight the risks faced by equity holders when it comes to the financial flexibility of some of the world’s largest chains. Below, we dig deeper into restaurant Debt Ratios, including what they are and how they stack up among US chains.

How Much in Debt are Public Restaurants?

There are two ratios that can be used to determine the financial leverage of a public restaurant company: Debt-to-Assets (called Debt Ratio) and Debt-to-EBITDA. The Debt-to-Assets ratio is calculated by dividing a corporation’s total liabilities by its total assets. The higher the ratio, the higher the degree of leverage and the greater the financial risk. The Debt-to-EBITDA ratio demonstrates how many years it would take for a company to pay back its debt if debt and EBITDA remain constant. For every dollar in assets, publicly traded restaurants in the US have a median 62 cents worth of liabilities. Some analysts agree that Debt Ratios higher than 0.5 can be dangerous, as it means more than half of the business assets are financed by debt. High debt ratios translate into large portions of cash flow committed to pay for principal and interests, rather than reinvested in the business.

Among US chains, Domino’s leads the pack, with a Debt Ratio of 363% (the pizza chain had total liabilities of $2.6 billion and total assets of $716 million in Fiscal Year 2016). A large portion of its liabilities are in Long-Term Debt, though that’s not a stressful position in the short-term. If its Debt Ratio were to be too low, on the other hand (like Luby’s and Potbelly), that could be indicative that the company is not taking advantage of leverage to improve profitability (or worse, that it doesn’t know how to do so).

Total Liabilities to EBITDA Public Restaurants

Debt-To-Assets, however, can not be viewed in isolation. Companies with high bottom-line growth will find it easier to off debt than those with stagnant growth. It would take roughly 4.4 years for a publicly traded restaurant company to pay off all its liablities at current EBITDA levels (disregarding depreciation and interest payments). However, this varies depending on the company’s size: large caps have a median Liabilities-to-EBITDA ratio of 3.7, meaning it takes a large cap restaurant company about 3.7 years to pay off all its debt at current EBITDA levels. Mid-caps, meanwhile, have less leverage (a 17% lower ratio). Small-caps, on the other hand, have total liabilities of 4.4 times their EBITDA (Noodles & Co. and Ruby Tuesday are the most compromised).

It would take roughly 4.4 years for a publicly traded restaurant company to pay off all its liablities at current EBITDA levels.

Shot-Term Debt vs. Long-Term Debt

Short-term debt is defined by the “current liabilities” portion of a company’s balance sheet, and comprised of any debt due within one year (i.e short-term bank loans, etc.). Long-term debt includes loans and financial obligations lasting more than one year (i.e. financing or leasing obligations that will be due in a greater than 12-month period).More than half (63%) of public US foodservice companies have a current, or short-term, debt ratio lower than 1, indicative of poor financial health (i.e. companies are not liquid).

Illiquidity is a common cause of business failure because, put simply, companies perish without cash. Unsurprisingly, mid- and small-caps tend to have lower ratios than large-caps. Bravo Brio, Chanticleer, and Del Taco are the weakest performers.On average, publicly traded restaurants have 65% of their liabilities allocated in long-term debt and 20% in current liabilities (or short-term debt, which is due within one year). This also means they have, on average, 3.2 times as much long-term debt as short-term debt. The remainder corresponds to other liabilities, such as deferred long term liability charges, minority interest, negative goodwill, and deferred taxes.

Domino’s and Yum! Brands, for instance, have more than 80% of their liabilities in long-term debt, while other companies (Yum! China and Bob Evans, for instance) have close to 80% in current liabilities, which can compromise a large portion of cash flow.

The Importance of Restaurant Debt Ratios

Restaurant debt ratios can have significant impacts on a company’s bottom line — and its reputation. In 2015, Standard & Poor’s Ratings Services announced it had cut its rating on Yum! Brands Inc.’s debt by three levels, bringing it to a junk rating. Moody’s downgraded the company’s debt, too, after Yum! announced that it would spin off its Yum China Division into an independent publicly-traded company through a tax free distribution to shareholders. In a report, Moody’s announced its view that the initiatives were “expected to result in a highly leveraged capital structure and limit Yum!’s financial flexibility.”

Greg Creed restaurant debt ratios

The average Debt Ratio is around 62%, though we often see ratios much higher (and lower) than that. Yum!’s, for instance, is 203%. Considering the capital expenditures that go into opening a new restaurant — the equipment required to retro-fit a space, the cost of commercial real estate, and labor costs associated with hiring and training workers — the wide variety isn’t that surprising.Using restaurant debt ratios to determine a chain’s financial leverage allows for a more complete picture in terms of how sustainable that chain’s growth is. High leverage can cause a business to grow more slowly, due to the substantial burden of debt that prevents resources to be re-invested in the company. On the other extreme, having no leverage can indicate that the management team is unable to find growth opportunities.

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About Aaron Allen & Associates

Aaron Allen & Associates is a leading global restaurant industry consultancy specializing in growth strategy, marketing, branding, and commercial due diligence for emerging restaurant chains and prestigious private equity firms. We work alongside senior executives of some of the world’s most successful foodservice and hospitality companies to visualize, plan and implement innovative ideas for leapfrogging the competition. Collectively, our clients post more than $100 billion, span all 6 inhabited continents and 100+ countries, with locations totaling tens of thousands.

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