Full-Service Restaurants: Pummeled by the Pandemic

In Part 1 of this Restaurant series, I briefly summarized some of the key financial metrics that appeared to impact valuation multiples for publicly-traded limited-service restaurant operators. This article will focus on full-service restaurant operators in the public space.

Important notes: This article briefly investigates what may be driving valuations in the industry from a financial statement perspective. An actual valuation of a company requires an in-depth analysis of the business operations and associated risk factors that cannot always be directly considered through the data on the financial statements. Also, in order to keep the length manageable, this article will focus on what I interpreted to be the primary value drivers and 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 criteria for selecting industry constituents for this analysis was similar to that of my prior article. I focused on U.S. full-service restaurant companies that were traded on major exchanges for at least a year with a stock price equivalent of $1 or more. I excluded companies with significant operations outside of the restaurant industry (e.g., manufacturing foods for distribution in a retail environment, etc.). The effective date of this analysis is December 31, 2020.

The full-service restaurant groups’ median enterprise value (“TEV”), median revenues, and median EBITDA are summarized in Figure 1. For clarity, last fiscal year is abbreviated “LFY” and latest 12 months is abbreviated “LTM”.

Figure 1 shows us that enterprise values in the full-service restaurant industry have generally declined over the last five fiscal years despite stable revenue growth through the LFY period. This reduction reflects the gradual loss of market share to the growing fast-casual segment of the broad industry.  Full-service restaurant operators experienced more dramatic declines in revenue and EBITDA in the LTM as compared to their limited-service counterparts due to being ill-suited to adapting to pandemic-related challenges and restrictions. Despite the deterioration in financial performance, enterprise values declined only slightly from the end of 2019 to the end of 2020. What is missing from Figure 1 is the significant declines in stock prices that were observed throughout the industry in March 2020 and a gradual recovery through the end of 2020. As will be seen below, the recovery in valuations is likely driven by a broad assumption among investors that the industry will recover over the next few years.

The discrepancy between the sharp declines in financial performance and a relatively stable enterprise value means that multiples increased over the LTM period, as presented in Figures 2 and 3 below.

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 2020 for most companies).

It makes sense to focus on growth after the NFY (2020) period. Not surprisingly, full-service restaurant groups are expected to generate a sizable revenue and EBITDA recovery after a sharp downturn in 2020. This is likely a consideration in how these companies are priced in the market.

NFY EBITDA multiples are presented relative to projected EBITDA growth rates in 2022 in Figure 6 below.

The data presented in Figure 6 shows some tendency for companies with greater levels of projected growth to trade at higher EBITDA multiples. There are certainly some inconsistencies in the data, which suggest that other factors are impacting these companies’ valuations. Similar to limited-service restaurants, I did not observe any meaningful correlation between EBITDA growth in the NFY+1 period and EBITDA multiples, which again may indicate that investors have increased focus on the longer-term growth prospects for these types of companies. As was noted for limited-service restaurants, companies that survive the challenges presented during the pandemic are likely to benefit in the long-term from decreased competition.

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. Therein, size can be used to measure a multitude of relevant risk factors. In this case, I did not observe a discernable relationship between size and LTM revenue or EBITDA multiples, which suggests that other factors (such as growth, profitability, or some other qualitative considerations) have a greater impact on how investors view this subset of the industry. While this is not to say that size is completely ignored, it appears to be overshadowed by other factors as of December 31, 2020.

The Profitability Story

Revenue multiples are typically heavily influenced by profitability, as higher levels of profitability indicate more return per dollar of revenue. Investors are usually willing to pay more per dollar of revenue and, thus, higher revenue multiples can be observed in companies with higher levels of profitability. This relationship between LTM revenue multiples and LTM EBITDA margins can be observed in Figure 7 below.

Tying it All Together

The trends discussed in this article suggest that valuations of full-service restaurant companies are impacted by growth and profitability and less by size. This is generally consistent with my observations of the limited-service restaurant companies in my prior article. The overall historical and expected future performance of full-service restaurants, however, differs significantly to limited-service operators. In addition, the market appeared to give greater consideration to size for the smallest limited-service restaurant companies, which was not a trend observed among the full-service restaurant operators.

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