The current recession has severely impacted restaurants in the U.S. The industry is vast, however, and quick service restaurants (QSRs) – commonly known as “fast food” – have navigated the challenging economic environment relatively well. The Janus Henderson securitized products and corporate credit teams discuss why this is happening and what the opportunities are for bond investors.
- The current recession has severely impacted restaurants given the need for social distancing amid the COVID-19 pandemic. The industry is vast, however, and quick service restaurants (QSRs) – commonly known as “fast food” – have fared much better than their full-service counterparts.
- Quick service restaurants had a significant advantage heading into the pandemic: They were better prepared to leverage online sales and were already geared toward offering takeout, which helped them meet social distancing requirements with less adaptation.
- Like technology companies, fast food is a sector that has benefited from the changes wrought on the U.S. economy. With the larger, longer-term trends in fast food’s favor, we remain positive on its outlook and believe exposure through whole business securitizations (WBS) could be attractive to some investors.
The U.S. restaurant industry has traditionally fared well through recessions, but the COVID-19 virus has incited no ordinary recession. The impact on restaurants has been particularly acute given the need for social distancing throughout the pandemic. By mid-September, nearly one in six U.S. restaurants have either closed permanently or expect to remain closed for the foreseeable future.1 With around 650,000 restaurants in the country, that is approximately 100,000 restaurants that may never reopen. And, with around 1 in 10 Americans working (before COVID hit) in the restaurant industry, the toll on consumers has been severe. However, the industry is vast and the aggregate figures mask significant variations within the sector. Quick service restaurants (QSRs) – commonly known as “fast food” – have navigated the challenging economic environment relatively well and their future looks, well, appetizing.
Already Ready To-Go
In the early months of the crisis, restaurants’ survival – almost overnight – depended on their ability to get meals to customers while adhering to new health and safety guidelines. Quick service restaurants had a significant advantage insofar as they were already more geared toward offering takeout than full-service casual dining or family restaurants. Furthermore, takeout was largely anathema to fine dining establishments, where ambiance and quality of service were critical to the experience, and thus the revenue.
Additionally, many fast-food companies already had drive-through service prior to COVID, which allowed them to meet social distancing requirements without any adaptation, thereby reducing the impact on their bottom line. In March, when large swaths of the economy ground to a halt, sales from drive-throughs actually increased, from $8 billion last year to $8.3 billion.2 Similarly, online ordering and delivery services allowed more sales within the confines of social distancing, and again the fast-food industry was quick to transition. In January 2018, around 5% of restaurant meals were ordered online in the U.S. By April 2020, that figure rose to 20%. In May, digital orders increased a whopping 138% from April.3
“We’re starting to think of ourselves as an e-commerce company that sells pizza.”
-- Dennis Maloney, Vice President of Multimedia Marketing at Domino’s4
Dennis Maloney said those words in 2015. It is hard to imagine your local family-owned restaurant or fine dining establishment thinking along those lines five years ago. Indeed, more than 70% of America’s restaurants are single-unit operations and more than 90% of them have fewer than 50 employees.5 These are not companies that can ask the boys in marketing to whip up an app, nor do they have the advertising budget to market a new digital service. On the contrary, it was the larger chain restaurants (and 65% of QSRs are chains6) that were, pre-pandemic, more developed in their digital presence. They also had the size to build strategic partnerships with third-party groups that specialized in either online food ordering or delivery. And, ultimately, fast food already caters to people looking for quick service (i.e., people who are more inclined to press a button to get their treat).
Price, and Supply, Begets Demand
Fast food has always benefited from being cheaper. As a sector, quick service restaurants are in the lowest cost category among restaurants, at between $4 and $7 per meal – less than half the cost of your typical casual dining restaurant, which averages closer to $15 a meal. Given the recession, it is understandable that the natural inclination to thrift would drive more customers to cheaper QSRs. And with more fine and casual dining restaurants temporarily or permanently closed, demand for quick service restaurants has benefited simply because QSRs were often the only places open.
The average ticket price, or total cost of the order, at fast-food restaurants rose dramatically during the second quarter, suggesting that more families who might have otherwise preferred casual dining opted for fast food instead.7 The net effect of all these factors, for some QSRs, was rising same-store sales, and rising margins, during the height of the pandemic.8
Demographic Changes Have Supported Fast Food
For the past few decades, trends favorable to fast food have been gaining momentum. Mealtimes are shortening across the globe, and the frequency of family dinners in the U.S. has declined 33% over the last 20 years.9 Meanwhile, the percentage of 18- to 34-year-old Americans who are single (i.e., who “have no steady partner”) has risen from 35% in 1986 to 51% in 2018. For the restaurant industry, this trend is significant as single people spend around 50% more on food (and more on eating out) than a family of four does (per person), and single people are less likely to sit alone in a casual or fine dining restaurant.
The net result of these trends for fast food has been dramatic. The share of all meals purchased from restaurants in the U.S. taken by fast food has climbed to over 80%.10 Unsurprisingly, casual dining has struggled with demand, with the mid-scale family-orientated dining sector losing over 500 million visits over the last five years, mostly to fast food.11 And finally, the restaurant industry as a whole has been shrinking at around 0.5% each year for the last three years.12 The pie (no pun intended) has been shrinking, and fast food has been taking increasingly larger slices.
The Importance of Dating to the Bottom Line
Sit-down dining for most people is more about the experience than the food. Going to a casual restaurant is an opportunity to catch up with family or friends. A fine dining establishment is a good place to take a date. In either case, you want to linger, to order more wine (and probably more expensive wine if you are on a date) and talk more over dessert. For many restaurants, the largest profit margins are in those extras. But when people order online, they tend not to choose to add a bottle of wine or two slices of cake. They probably already ordered from the wine shop and plan to rummage in the cupboards for cookies.
Regardless, over 80% of casual dining has historically been done on premises, while 80% of fast food is consumed off premises. That is, fast-food restaurants had already orientated their business model to be profitable selling the basics, while traditional restaurants were dependent on the extras. Indeed, the pandemic helped boost profitability at some quick service restaurants as growing takeout orders reduced their drink costs (because customers couldn’t take advantage of refills) and larger orders reduced their total paper costs because packaging per order declined.
The Bottom Line
Recent earnings reports indicate that many QSR franchisees managed to remain cash-flow positive throughout the crisis, even when seeing 20% to 30% declines in revenue during the first 4 to 5 weeks of the pandemic. In our view, the ability to be profitable in the worst recession since the Great Depression is impressive. Furthermore, fast food’s quick bounce back – many franchises recently set record sales levels – suggests QSRs ought to be well positioned to navigate further economic uncertainty. Like technology companies, fast food has benefited from the changes wrought on the U.S. economy. With the larger, longer-term trends in fast food’s favor, we remain positive on its outlook.
Unsurprisingly, the fast-food sector has performed relatively well year to date in the corporate bond and securitized markets. Yields, in our view, remain attractive for quick service restaurants in the high-yield market, but QSR-related whole business securitizations (WBS) are generally yielding more than comparably rated investment grade corporate bonds. We believe this is largely because demand for the WBS asset class is driven by insurance companies, which are less inclined to dive into the details of relative valuation across restaurant sub-sectors. Furthermore, WBS, in general, is a small market ($30 billion total, although about two-thirds is restaurant related) and thus offers both a liquidity premium and an information premium to those who have the time and fundamental expertise to do in-depth research.
1National Restaurant Association, September 2020
2NPD Group, as cited in the NY Times 1 May 2020
3NPD Group, “Covid Accelerates the Digital Evolution in Food and Foodservice Industries” July 2020
4Digiday, “Dominos Now E-Commerce Company Sells Pizza” April 2015
5National Restaurant Association 2020 Factbook
6NPD Recount as cited in Barclays, 27 May 2020
7Jeffries, August 2020
8Inspire, NPD Salestrack
92014 Eating & Health Module, Bureau of Labor and Statistics and the NPD Group
10Barclays, as of June 2020
11NPD, August 2020
12Barclays, “Industry Unit Count… Closures Severe With Comp & Share Up for Grabs”, May 2020
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