Full-Service Restaurant Valuations – June 2022
Valuations of the publicly-traded full-service restaurant players were volatile between June 2021 and June 2022. We noted a substantial increase in valuations over financial performance in June 2021, followed by a pullback in valuations by December 2021. By June 2022, valuations had declined further. This article will examine some of the factors that appear to have impacted the valuations in the industry.
This article updates our December 2021 analysis.
Important notes: This article examines potential driving factors for full-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. Luby’s was eliminated from the group for this update as it was liquidating its operations.
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”).
The latest fiscal year is notated “LFY” (2021), while the latest 12-month period is labeled “LTM” (the latest available information as of June 30, 2022).
As can be seen in Figure 1, the industry’s historical revenue and EBITDA dipped significantly in the LFY-1 (2020) period due to the COVID-19 pandemic before recovering in 2021. Revenue and EBITDA continued to grow through June 30, 2022, albeit at slower rates. Valuations for the industry declined significantly (nearly 30%) from December 2021 to June 2022. This decline was almost universal among the 17 companies analyzed. Only Flanigan’s and Ark Restaurants generated improvements in valuation 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 revenue and EBITDA multiples.
As can be seen in Figures 2 and 3, median valuation multiples declined sharply from the end of 2021 to June 2022. Between December 2021 and June 2022, revenue multiples moved lower for all 17 companies in the group, while EBITDA multiples for 16 of the 17 public full-service restaurant companies declined. This decline is to be expected as valuations declined despite of an increase in revenue and EBITDA.
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 2022 for most companies).
In Figures 4 and 5, the orange line represents data as of June 30, 2021. Projections for the NFY period (i.e., 2021) at the time called for sharp increases in revenue and EBITDA as pandemic-related restrictions were lifted. As the blue lines (current data) in Figures 4 and 5 illustrate, the industry performed to expectations in 2021.
Current projected revenue and EBITDA trends are muted relative to a year prior but still call for growth over the next few years.
We also looked to identify a meaningful relationship between growth and observed revenue and EBITDA multiples. We could not discern a significant trend between growth rates and revenue or EBITDA multiples, as shown in Figures 6 and 7, respectively.
The seemingly random distribution of multiples relative to their associated projected growth rates in Figures 6 and 7 would suggest that growth does not have a singular impact on the valuation multiples for the industry.
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 revenue multiples in Figure 8.
As can be seen in Figure 8, there may have been some tendency for larger companies to trade at higher valuation multiples. However, we noted a wide spread in valuation multiples among companies of all sizes, indicating that any relationship between size and revenue multiples to be weak.
The Profitability Story
Revenue multiples are typically heavily influenced by profitability. We usually observe higher revenue multiples in companies with higher levels of profitability. We observed a correlation between LTM EBITDA margins and LTM revenue multiples, as shown in Figure 9 below.
In Figure 9, companies generating greater levels of margin appeared to trade at higher revenue 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) issued to equity holders. In Figure 10, we plot LTM revenue multiples against their associated debt-to-total capital ratios.
In Figure 9, there appeared to be some loose correlation between revenue multiples and leverage ratios. However, the relationship between these ratios and valuation multiples was not consistently observed throughout the dataset.
Tying it All Together
The trends discussed in this article suggest that profitability and (possibly) size and leverage are influencing 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 health of the broad U.S. economy, the future 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 made in our December 2021 analysis.
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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