Quick-Service Restaurant Valuations – June 2022
The publicly-traded quick-service restaurant (QSR) groups steadily grew over the last five fiscal years through 2021. While the COVID-19 pandemic hampered industry growth, QSRs overcame many challenges brought on by social distancing requirements and mask mandates. However, during the first six months of 2022, equity valuations across the broad market declined and the prospect of continued economic growth became more uncertain. This article will examine some factors specific to the companies in this industry that appear to be impacting valuations.
This article updates our December 2021 analysis.
See also: Full-Service Restaurant Valuations – June 2022.
Important notes: This article examines potential driving factors for quick-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, 2022.
Figure 1 summarizes three items for the quick-service restaurant companies:
- Total enterprise value calculated as the sum of market capitalization and interest-bearing debt less cash;
- Median revenues; and
- Median earnings before interest, taxes, depreciation, and amortization (“EBITDA”).
The latest fiscal year is notated “LFY” (2021), while the latest 12 months is labeled “LTM” (latest available information as of June 30, 2022).
The TEVs of the publicly traded quick-service restaurants grew over the last five fiscal years but had declined by over 25% by June 30, 2022. This decline coincided with broad market deterioration and decreases in the constituents’ EBITDA.
When digging a bit deeper into the data, we noted that the decline in enterprise values was nearly universal, except for Potbelly Corporation, which increased in value. Five of the 16 companies experienced declines in valuations of over 40%. The most drastic drop in enterprise valuations was Wingstop, Inc., with a 50% decrease between the end of 2021 and June 2022.
One possible explanation for the decline in valuations is a rising concern regarding the impact of inflation on consumer demand. Restaurant Dive summarizes some of this impact from an operational perspective in their June 6, 2022 article, “The restaurant industry is reaching a tipping point – here’s what to do now.” The cost of food and rising labor costs amid a labor shortage have led to significant price hikes. According to the National Restaurant Association’s 2022 State of the Restaurant Industry report, 90% of restaurant operators have indicated that food costs are higher now as a percentage of revenue than before the pandemic.
These trends may impact how frequently consumers choose to eat at restaurants and the level of profitability that restaurants will be able to generate going forward.
Valuation Multiples
Figures 2 and 3 present the industry’s historical trend of median revenue and EBITDA multiples.
Revenue and EBITDA multiples generally fell in the first six months of 2022. Median revenue multiples fell the most (i.e., from a median of 2.75x at the end of 2021 to 1.76x by June 2022). We will examine the factors that may be impacting the valuations of publicly-traded quick-service restaurant companies.
The Growth Story
Growth often strongly influences 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 2022 for most companies).
The orange line in Figures 4 and 5 represents data as of June 30, 2021. NFY projections for the industry at the time (i.e., 2021) called for solid revenue and EBITDA growth. As evidenced in the trends illustrated by the blue line (current data), actual 2021 revenue and EBITDA growth fell in line with expectations. The publicly-traded QSRs are expected to generate consistent growth in 2023 and 2024.
Next, we tried to identify a relationship between growth and valuation multiples. Our 2021 analysis identified a relatively consistent correlation between valuation multiples and EBITDA growth rates. However, as of June 2022, the relationship was much less evident. See Figures 6 and 7 below.
Revenue multiples were not measurably correlated with projected revenue growth. While companies with the highest growth rates tended to trade at the highest valuation multiples, that relationship for companies with growth rates between -10% and +10% was inconsistent.
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 8 shows a possible correlation between size (measured by market capitalization) and LTM revenue multiples among public quick-service companies.
There was some general clustering of multiples with various size groupings. Zooming into the smallest companies allows for a more consistent relationship between size and revenue multiples. See Figure 9 below.
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 hold for the QSRs, as shown in Figure 10 below.
While certain data points fall further from the trend line (i.e., Wingstop), companies with higher profit margins tended to trade at higher valuation multiples.
The Leverage Story
Debt usage tends to increase financial risk to equity holders. Debt holders have a senior position within a company’s capital structure, and debt servicing occurs before any cash flow benefits (i.e., dividends) are issued to equity holders. Figures 11 and 12 plot LTM revenue and EBITDA multiples against their associated debt to total capital ratios (as available).
While there are exceptions to the rule, companies with greater financial leverage tend to trade at the lowest valuation multiples. In contrast, companies with the least amounts of debt tended to trade at the highest valuation multiples. The wide spread in multiples across the spectrum of debt-to-capital ratios suggests that investors are likely considering other factors in conjunction with financial leverage when valuing companies in this industry.
Tying it All Together
The trends observed in this article suggest that size, profitability, and leverage all impact the valuations of the publicly-traded QSRs. However, variations appear in how much weight investors place on each factor (or other factors not discussed in this article).
A summary of these observations is presented below and compared to our December 2021 analysis.
Based on our analysis, investors appear to be more focused on risk mitigation than on the growth prospects of the QSRs as of June 30, 2022. This shift is consistent with some of the trends we have observed in other industries since the end of 2021. Size, profitability, and leverage appeared to more strongly influence the magnitude of valuation multiples.
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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