Investors and managers use return on assets (ROA) — the percentage profit (after tax) being earned on all of a company’s assets — to gauge how efficiently an operation uses its resources to generate returns. This is one of the key ratios
It is calculated using the following expression:
Net profit is derived from the income statement while the assets, which include items such as cash, inventory, accounts receivable, plant, property, and equipment (PP&E), and intangible assets such as trademarks and goodwill, come from the company’s balance sheet.
While investors typically pay more attention to return on equity (ROE) than ROA, restaurant executives track this figure closely because it indicates how efficiently company resources are generating profit. The higher the ratio, the better the management; the more capital intensive an operation is, the harder it will be to attain a high ROA ratio.
Some of the factors that could negatively impact the ROA include:
- Declining revenue
- Increasing costs
- Shrinking profit margins
- Underutilized long-term assets
- Fixed asset build-up in preparation for growth
- Increased M&A activity
Cost-Efficient Store Models and Simplified Menus Can Greatly Improve Restaurant Return On Assets
ROA for top-quartile public companies is 2.3x the industry median.
Leading the pack, Domino’s Pizza’s ROA is 7x the foodservice industry’s median, largely thanks to its streamlined store model. Characterized by delivery and carry-out, Domino’s store design has low capital and asset requirements. As a result of the chain’s focused business model and menu, locations are small (around 1,500 square feet on average) and fairly economical to build, furnish, and maintain. Adopting a simplified menu helped reduce friction in production and delivery processes as well as maximized economies of scale.
Companies in the bottom quartile are losing at least $0.04 on each dollar invested in assets, up to Rave Restaurant Group, which lost $1.30 on every invested dollar in 2017.
Rave has been struggling for years to grow its profitability. Its enlarged net loss over 2017 mainly came from a loss on the sale of assets, additional impairment, and closed store expenses totaling $7m. The company is also suffering from meager sales, and company-owned Pie Five stores in newer markets have had poor financial performances.
QSR and Pizza Segments Efficiently Utilize Assets to Generate Profit
Most of the companies operating in the QSR and pizza segments are heavily franchised.
With a median ROA of 9.5%, QSR chains including McDonald’s and Wendy’s witnessed an increase in their income thanks to higher royalties from their growing number of international franchised restaurants. Their refranchising efforts are also allowing them to switch to an asset-light model, saving hundreds of millions of dollars in annual general and administrative costs while also passing much of the price of building, remodeling, and maintaining restaurants on to franchisee.
With a median ROA of 9.2%, pizza companies such as Domino’s and Papa John’s do not typically offer dine-in, which reduces their capital investment and labor costs.
Companies in the upscale segment generally invest heavily on buildings, décor, staff training, and ingredients in order to offer guests the best and most memorable experiences. These high operational costs impact these operations’ bottom lines and limit their bargaining power with suppliers.
ROA changes radically between segments and operational models, and there is often high variability within each category as well. A challenge for investors and management alike is to identify when missing these benchmarks is justified — as a result of a particular asset-intensive initiative, for example — and when it indicates more serious inefficiencies.
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 in sales, span all six inhabited continents and 100+ countries, with locations totaling tens of thousands.