Limited-Service Restaurant Valuations – June 30, 2021 Update
The broad restaurant industry met significant hurdles in 2020. Limited-service restaurants were better suited than full-service restaurants to adapt to changes in consumer behaviors due to the pandemic and social distancing requirements. During the first six months of 2021, valuations of limited-service restaurants increased with improvements in revenue and cash flow. This article will examine some of the factors that appear to impact limited-service restaurant valuations.
This article updates our December 31, 2020 analysis.
Important notes: This article examines potential driving factors for limited-service restaurant company valuations from a financial statement perspective. An actual business valuation requires an in-depth analysis of the business operations and associated risk factors that are not always evident from the data on financial statements. Also, to keep the length manageable, this article will focus on what the author interpreted as the primary value drivers. It will not touch on every observation in the data. For a quick read on the basic concepts of risk and return and how they apply in the context of this article, please visit: What is Value? and Risk and Return in the Market Approach.
The industry constituents for this analysis are listed below. The effective date of this analysis is June 30, 2021.
Figure 1 summarizes the limited-service restaurant companies’ median total enterprise value (“TEV”), median revenues, and median earnings before interest, taxes, depreciation, and amortization (“EBITDA”). Latest fiscal year is notated “LFY” (2020) and “LTM” means latest 12 months (latest available information as of June 30, 2021).
The TEV of the limited-service restaurants grew over the last five fiscal years and through June 30, 2021. In the LFY, the pandemic and social distancing requirements muted the industry’s financial performance. However, despite some contraction in revenue and EBITDA, TEV of these companies continued to grow. We attributed this growth in our December 31, 2020 analysis to expectations of significant growth two to three years in the future.
In the LTM, the median TEV increased as EBITDA recovered and revenue growth began to show signs of acceleration. There are significant risks in the industry, including a resurgence of COVID-19 cases due to variants and ongoing challenges associated with widespread labor shortages. Amanda McNamara wrote an excellent article for Toast that you can read here on recent labor issues in the restaurant industry.
Valuation Multiples
Figures 2 and 3 present the historical trend of revenue and EBITDA multiples for the industry.
With the recent increase in enterprise values and flat revenue growth through June 30, 2021, the median revenue multiple increased in the LTM. Interestingly, the median EBITDA multiple for the industry declined. We will examine the factors that may be impacting the valuations of the publicly-traded limited-service restaurant companies.
The Growth Story
Growth often has a strong influence on how multiples differ among companies in an industry. A summary of the consensus forecasts for each group is presented in Figures 4 and 5 below (note that “NFY” means next fiscal year; NFY = calendar 2021 for most companies).
In Figures 4 and 5, the orange line represents data as of June 30, 2020, reflecting some of the worst times of the pandemic. NFY projections for the industry at the time (i.e., for 2020) called for sharp declines in revenue and EBITDA. These declines are evident in the LFY period (2020) via the blue line (though more muted than was projected).
Current revenue and EBITDA projections indicate that the publicly-traded limited-service restaurant companies will stage their comeback in 2021.
We also looked to identify a meaningful relationship between growth and observed LTM revenue and EBITDA multiples. We could not discern a significant trend between growth rates and LTM revenue multiples. However, we noticed a tendency for companies with higher projected growth rates to trade at higher EBITDA multiples. Figure 6 highlights this trend below.
Interestingly, the relationship between growth and EBITDA multiples was most evident when comparing NFY multiples against NFY+2 (2023) growth rates. Higher multiples are generally associated with companies that generate higher levels of growth. Significantly, Figure 6 is limited to a certain degree by the availability of information. Only nine of the 15 companies analyzed had data to plot in the chart.
The Size Story
Larger companies are generally perceived to have lower levels of risk relative to smaller companies due to improved product or geographic diversification, deeper management teams, access to a variety of distribution channels, and better availability of capital, among other factors.
Figure 7 shows a possible correlation between size (measured by market capitalization) and LTM revenue multiples.
The relationship between size and revenue multiples is most evident among the smallest companies in the industry group. The variation in multiples among the largest companies may be due to other factors (such as profitability) impacting how companies in this space are valued.
The Profitability Story
Revenue multiples are typically heavily influenced by profitability. We usually observe higher revenue multiples in companies with higher levels of profitability. This relationship appears to loosely hold true for the limited-service restaurant industry, as shown in Figure 8 below.
While there appears to be a (rough) relationship between profitability and revenue multiples, there are certainly outliers. Chipotle Mexican Grill, Inc. and Shake Shack Inc. trade at relatively high LTM revenue multiples (6.7x and 7.6x) despite having generated lower EBITDA margins in the LTM period. However, both of these companies rank among the largest of the group and expect substantial revenue and EBITDA growth over the next several years. Investors in Chipotle and Shake Shack have likely placed more emphasis on these factors rather than LTM EBITDA margins.
Tying it All Together
The trends observed in this article would tend to suggest that growth, size, and profitability all impact the valuations of the publicly-traded limited-service restaurant companies. However, variations appear in how much weight investors are placing in each factor (or other factors not discussed in this article).
A summary of these observations is presented below and compared to those made as of December 31, 2020.
Expectations of strong future growth and recent and anticipated improvements in profitability appear to have played a part in the continued growth in the limited-service restaurant industry. However, uncertainties remain and could threaten future growth, such as a resurgence in COVID-19 cases due to variants and labor shortages.
I hope you found this analysis helpful. All input, feedback, suggestions, and questions (including disagreements with my high-level analysis) are welcome! Thanks for reading.
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