Full-Service Restaurant Valuations – December 2021 Update
In our previous update on the full-service restaurant industry, we made note of the substantial improvement in valuations that outpaced historical financial performance. We attributed the rise in valuations to improved growth expectations over the next few years. Valuations at the end of 2021 were lower than they were in the summer. This article will examine some of the factors that appear to have impacted the valuations of the publicly-traded full-service restaurant groups at the end of 2021.
This article updates our June 30, 2021 analysis for the full-service restaurant industry. See also our December 2021 update for the quick-service restaurants.
Important notes: This article examines potential driving factors for 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 December 28, 2021. The group is smaller in this update due SPB Hospitality’s acquisition of J. Alexander (now excluded from the analysis).
Figure 1 summarizes three items for the full-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”).
We notate the latest fiscal year as “LFY” (2020), and the latest 12 months as “LTM” (latest available information as of December 28, 2021).
As can be seen in Figure 1, the industry’s historical revenue and EBITDA has been volatile. LFY represents a period low for the publicly-traded full-service restaurant groups due to the pandemic. Valuations and financial performance in the LTM period increased drastically as economic and social restrictions were lifted.
While financial performance continued to improve through the end of the year, valuations broadly declined. Darden Restaurants and The ONE Group Hospitality were the only companies that saw increases in their enterprise values from June 30, 2021 to December 28, 2021.
One explanation potentially lies in investor sentiment toward full-service restaurants as COVID variants, such as Delta and Omicron, generate some uncertainty for this segment of the broad restaurant industry. Another potential factor are capacity constraints due to labor shortages felt across the broad restaurant industry, which tends to have more significant impacts in the full-service restaurant segment.
Valuation Multiples
Figures 2 and 3 present the historical trend of revenue and EBITDA multiples for the industry.
As financial performance has outpaced growth in values, multiples decreased sharply in the LTM. We will examine some of the factors that may be impacting the enterprise values of the publicly-traded full-service restaurant groups.
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 the end of 2020. Projections for the NFY period (i.e., 2020) called for modest revenue growth and broad declines in EBITDA. As the blue lines (current data) in Figures 4 and 5 illustrate, the industry saw substantial declines in both revenue and EBITDA. However, the recovery projected for 2021 far exceeds expectations as of the end of 2020.
Projected revenue and EBITDA trends as of the end of 2021 are similar to expectations as of June 2021, suggesting that the broad decline in valuations across the companies analyzed may be driven by investor sentiment and a perception of higher risk in the industry.
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 revenue or EBITDA multiples. LTM EBITDA multiples are plotted against 2-year projected EBITDA growth rates in Figure 6.
The seemingly random distribution of multiples relative to their associated projected growth rates would suggest that growth does not have a singular impact on the valuation multiples for the industry. It is important to point out that EBITDA projections only existed for 11 of the 18 companies.
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. Size (as measured by market capitalization) is plotted against LTM EBITDA multiples in Figure 7.
As can be seen in Figure 7, as of the end of 2021, we did not observe a meaningful relationship between size and valuation multiples.
The Profitability Story
Revenue multiples are typically heavily influenced by profitability. We usually observe higher revenue multiples in companies with higher levels of profitability. A correlation appeared to exist between LTM EBITDA margins and LTM revenue multiples, as shown in Figure 8 below.
Multiples tend to cluster around 0.5x to 1.5x NFY revenue for those companies expected to generate between 5.0% and 12.0% of EBITDA margin. Companies with 12.0% to 17.0% EBITDA margins appear to trade at NFY revenue multiples between 1.5x and 2.5x. Finally, the companies with 20.0% or more in EBITDA margin traded at NFY revenue multiples of 3.0x or more.
The Leverage Story (***New***)
New to this update, we consider the impact of financial leverage (or the companies’ use of debt) and their impact on the valuation multiples. In the last year, we have noticed an increasing trend of risk mitigation among investors, both in the private and public markets. Therefore, we have included financial leverage among the considerations we analyze to explain the observed valuation multiples.
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) issued to equity holders. In Figure 9, we plot NFY EBITDA multiples against their associated LTM interest coverage ratios (as available).
The interest coverage ratio measures a company’s ability to pay its interest obligations. The higher the ratio, the greater the company’s ability to cover its interest expense with its operating income. In Figure 9, there is (possibly) some loose correlation between EBITDA multiples and interest coverage ratios. The relationship between interest coverage ratios and EBITDA multiples is not consistent throughout the dataset and would suggest that other factors have more influence over how these companies are valued.
Tying it All Together
The trends discussed in this article suggest that profitability and leverage may impact the current valuations of the publicly-traded full-service restaurant companies. The lack of correlation observed between growth and valuation multiples seems to suggest that investors are focused on other variables, such as the impact of COVID variants and/or capacity issues due to continued labor shortages. These factors would increase the risk of achieving the projected results.
A summary of the observations above is presented below and compared to those we made as of December 31, 2020.
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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