Quick-Service Restaurant Valuations – December 2021 Update
In our last update as of June 30, 2021, we noted that quick-service restaurant (QSR) valuations had increased with improvements in revenue and cash flow. Values at the end of 2021 pulled back dramatically. This article will examine some of the factors that appear to have impacted valuations in this industry and why valuations declined toward the end of the year.
This article updates our June 30, 2021 article. See also our December 2021 update for the full-service restaurant industry.
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 December 28, 2021.
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”).
We notate the latest fiscal year as “LFY” (2020), and the latest 12 months as “LTM” (latest available information as of December 28, 2021).
The total enterprise values of the publicly traded quick-service restaurants grew over the last five fiscal years and through December 28, 2021. However, valuations pulled back towards the end of the year as compared to June 30, 2021 despite further improvements to revenue growth. One explanation potentially lies in general market concerns related to COVID variants, such as Delta and Omicron, which caused some market volatility in December 2021. Another potential factor are capacity constraints due to labor shortages felt across the broad restaurant industry.
When digging a bit deeper and looking at how prices changed for each company in the group, we noted that seven of the 15 companies experienced declines in stock price. Most of these companies saw declines of 20-30% in value between June 30, 2021 and December 28, 2021. The most drastic decline was observed in the price per share for Carrol’s Restaurant Group, which fell over 50% between the two dates. Since declines were only observed for certain companies, the overall loss of value across the quick-service restaurants may be isolated to individual companies and may not necessarily reflect a broad decline in investor sentiment toward the quick-service restaurant industry.
Valuation Multiples
Figures 2 and 3 present the historical trend of median revenue and EBITDA multiples for the industry.
The variation in LTM multiples reflects some inconsistency in how valuations have moved relative to historical financial performance. We will examine the factors that may be impacting the valuations of the 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 2021 for most companies).
In Figures 4 and 5, the orange line represents data as of the end of 2020. NFY projections for the industry at the time (i.e., for 2020) called for flat growth in revenue and a minor decline in EBITDA. As evidenced in the trends illustrated by the blue line (current data), actual 2020 revenue were in line with expectations. However, the public quick-service restaurants experienced slight EBITDA growth and beat expectations from the prior year. These companies expect to continue to generate growth through NFY+1 (2022) and beyond.
In assessing what may have caused the declines in valuations for certain companies between June and December 2021, we noticed that projected EBITDA growth expectations for NFY+1 (2021), on the other hand, is expected to decelerate. In fact, almost all of the companies with lower valuations in December 2021 also had lower projected EBITDA.
If you have been reading these articles, you know that we next look to identify a meaningful relationship between projected growth and valuation multiples. We found a relationship between EBITDA multiples and projected growth rates. That analysis can be seen in Figure 6 below.
Interestingly, when we had analyzed the industry as of December 31, 2020 and June 30, 2021, we had noted EBITDA multiples to be correlated with longer run EBITDA growth rates. Investors now appear to be pricing the public quick-service restaurant groups based on shorter-term EBITDA growth rates.
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 among the smallest public quick-service companies.
The relationship between size and valuation multiples is not consistent across the observed dataset. The variation in multiples among the largest companies may be due to other factors (such as growth, profitability, or leverage) 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 quick-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. trades at relatively high LTM revenue multiple (6.7x) despite having lower expected EBITDA margins. However, Chipotle Mexican Grill ranks among the largest of the group and expects substantial revenue and EBITDA growth over the next several years. Investors in Chipotle have likely placed more emphasis on these factors rather than LTM EBITDA margins.
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 LTM EBITDA multiples against their associated 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, companies with the highest interest coverage ratios appeared to trade at the highest EBITDA multiples. The relationship between interest coverage ratios and EBITDA multiples is not consistent throughout the dataset and would suggest that other factors, such as growth, have more influence over how these companies are valued.
Tying it All Together
The trends observed in this article would tend to suggest that growth, size, profitability, and leverage all impact the valuations of the publicly-traded quick-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.
While growth expectations continue to play a primary role in how the publicly-traded quick-service companies are valued, investors now appear to be focused on near-term performance. This factor appears to have specifically influenced investor sentiment towards certain companies within the industry as was discussed earlier. In addition, we observed that size, profitability and leverage also appear to influence the magnitude of valuation multiples, possibly suggesting movement toward more risk mitigation among investors.
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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