Nearly Two-Thirds of Public Restaurants Are “At Risk” for Bankruptcy
We found that more than six every ten restaurant chains are in the “distress zone” when using this calculation (highly leveraged, low earnings, or a combination of both). While this is not a direct indicator of bankruptcy risk — and there are significant differences in operating models for these companies (franchisors versus more corporate-owned locations, etc.) — there are some fascinating findings.
Even with the injection of liquidity, it is not enough to cover what the losses are — with the industry down tens of billions per month right now it’s going to be very hard to get back, even once restaurants are at full capacity.
Short Runway for Many Chains Already Impacting 2020 Restaurant Bankruptcies
Restaurant bankruptcies are multiplying in 2020 and several chains filed for chapter 11 or debt protection across all segments: from quick-service restaurants Krystal Burger (declared bankruptcy back in January), to fast-casual chains Vapiano, Cosi and Le Pain Quotidien to buffet Garden Fresh Restaurant.
Smaller Chains were at Higher Risk of Bankruptcy
It’s usually the case that smaller companies are more vulnerable to economic shocks than large companies. Among U.S. public restaurants, the risk of bankruptcy increases by more than a third when comparing small-, micro-, and nano-caps to large caps. While 50% of large caps are in the distress zone according to Altman’s Z’’-score, the share of companies in the red zone increases to 69% for public restaurants with less than $2b in market cap.
The retooling that was already in motion is accelerating and the industry will look very different a few years from now.
Negative Working Capital Impacting Restaurant Operators’ Performance
Companies with negative working capital are most likely to face liquidity issues because they lack sufficient current assets to cover current debt. In the U.S., publicly traded restaurants have a total of $1.5b in working capital (46 companies). However, 65% of chains have negative working capital (accounting for a deficit of $6.1b).
The restaurant industry received 9% of the first Paycheck Protection Program (PPP) loan batch ($31b) and it’s not nearly enough to cover what the losses are. Greater consolidation will happen than in any of the recessions before.
How Franchising Impacts Operating Margin for Restaurant Companies
There are many proof-points to demonstrate the differences in approach of top-quartile and bottom-quartile performers. When we look at Operating Margins, the differences are staggering. In moderately and lightly franchised publicly traded restaurants in the U.S., the top-quartile Operating Margin is 9x the margin for the bottom-quartile. For highly franchised restaurants, the top-quartile makes twice the profit margin of the bottom-quartile.
The top performers are also putting more toward R&D and building proprietary systems that are reinforcing the moat around their business and locking out their competition. This is a great time to make operations faster, leaner, and more agile to optimize margins and achieve top-quartile performance.
How A Solvency Crisis Factors Into the Likelihood of Restaurant Bankruptcies
The Working Capital to Total Assets ratio reveals the percentage of remaining liquid assets, once Total Current Liabilities are paid out, compared to the company’s Total Assets. As a rule of thumb, ratios lower than 15% are generally considered unsatisfactory, and negative values are considered critical. 93% of U.S. publicly restaurants are in these zones. For many restaurant chains, investors will have to step in to solve the liquidity crisis ahead of other critical initiatives focused on innovation and re-inventing the economic model.
Restaurants Lacking the Ability to Cover Short-Term Debt with Current Assets
The higher the Current Ratio (Current Assets to Current Liabilities), the more able a company is to pay short-term debt. In the restaurant industry, the current ratio reached a median of 0.72 (FY 2019 for publicly traded companies in the U.S.) and for three-quarters of the industry, the current assets are not enough to cover all short-term debt. Some foodservice companies in the bottom quartile had current ratios lower than 0.50 (current assets covering less than half of current debt).
While liquidity pumping into the economy is buying time, many restaurants won’t be able to sustain their existing debt levels. This scenario will likely lead to plenty of distressed restaurant assets in the near future, which will spur activity as the global pause on M&A lifts as travel restrictions are loosened.
Restaurant Bankruptcy Rates Outpace Other Industries
A sobering stat: the restaurant industry has been the sector with the most bankruptcies in the last three months, with 12% of U.S. bankruptcies (more than 300) coming from this industry alone.
More consolidation will happen than in any previous recession. We think 10-15% of restaurants in America will close permanently by the end of the year (with that potentially increasing to 20% if another wave of the virus hits and without further government assistance). The bulk of that will be Casual Dining, full-service restaurants and independents.
Highlights of this analysis were featured in Bloomberg News.