Casual Dining is a Hot Mess. Part VI. (Short Franchisees).

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We’ve previously written about Kona Grill Inc. ($KONA) and Luby’s Inc. ($LUB) here. Indeed, we marked the former’s now-inevitable descent into bankruptcy as far back as April 2018. Subsequently, we’ve followed each quarter with interest only to witness the conflagration get bigger and bigger along the way. This sucker is certainly headed into bankruptcy.

Here is what’s new: Kona hired an Alvarez & Marsal Managing Director as its CEO — its fifth CEO in less than a year. It publicly indicated that it may have to file for bankruptcy. And Nasdaq delisted it. Stick a fork in it.

Likewise, we first highlighted Luby’s in July 2018. In a follow-up in January, we wrote:

And then there is Luby’s Inc. ($LUB). We featured the chain back in July, highlighting continued overall same store sales and total sales decreases. We did note, however, that the company has the advantage of owning a lot of its locations and that asset sales, therefore, could help buy the company time and assuage lender concerns. Real estate sales have, in fact, been a significant part of the company’s strategy. And so the lenders haven’t been its problem. Activist shareholders have been.

But that’s not entirely the full picture. We also noted that the company’s numbers “suck.” Which begs the question: now that another quarter has gone by, has anything changed?

On the performance side, not particularly.

Same store sales decreased 3.3%. Restaurant sales were down 12.1% (offset slightly by culinary contract services sales). Every single restaurant brand performed poorly: Luby’s Cafeterias were down 6.1%, Cheeseburger in Paradise (TERRIBLE name) down 76%, F*cked-ruckers…uh, Fuddruckers, was down 19%, and combo locations were down 7%. Basically this was an absolute bloodbath. Fuddruckers same-store sales were -5.3%. Analysts don’t even bother covering the stock. The company trades at $1.50/share at the time of this writing.

But things have changed a bit on the cost side. The company has closed 27 underperforming restaurants and sold $34.7mm in assets. It has also moved forward with its plans to refranchise many company-owned Fuddruckers, converting five units to franchisors who are clearly gluttons for punishment. The company has also engaged in food and operating cost cutting initiatives. Who is helping them out with this? Duh…the new CEO and Alvarez & Marsal’s “performance improvement” group! 

PETITION Note: we always find “PI” projects spearheaded by divisions out of large turnaround advisory firms to be interesting beasts. Imagine the conversations behind closed doors:

PI Managing Director: “Yeah, bro, we just took $0.2mm of SG&A out of the business and we believe there is more room to run there once we beat up the supply chain a bit, postpone repairs and maintenance, adjust employee hours, and make food cuts.”

Restructuring Managing Director: “Food cuts, huh?”

PI Managing Director: “Yeah, we DEFINITELY wouldn’t recommend you eat there.”

Restructuring Managing Director: “Got it. So, uh, this is obviously a bit delicate but, uh, here’s the real question: how can you guys continue to take SOME costs out of the business and look like heroes…without…uh…improving performance…you know…TOO MUCH?”

Boisterous bro-tastic laughs, winks and secret handshakes ensue.

Now, sure, sure, that’s cynical AF and not at all fair here: we’re not at all saying that anyone is doing anything untoward here. Yet, we wouldn’t be surprised, however, if conversations such as these happen though. Just saying.

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The (Hard) Business of Eating

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Long VC Subsidies & Facebook's Copying Skills

Generally speaking, there are four categories in the dining space. First, there are the QSRs (quick service restaurants). Your run-of-the-mill fast food spots fall into this space. For the most part, these guys are doing okay: McDonald's ($MCD) and Wendy's ($WEN), for instance, have both seen great stock performance in the TTM. Second, there's the fast casual space. Competition here is fast and furious covering all manner of ethnicities and varieties. Chipotle ($CMG) and Panera Bread are probably the two best known representatives of this category. The former has gotten SMOKED and the latter got taken private. Generally speaking, there'll be some shakeout here, but the category as a whole has been holding its own. Third, there's the fine dining space. This is a tough space to play in but there are clear cut winners and losers (Le Cirque, see below): not a lot of chains fall in to this category. And, finally, there is the casual dining category. Here is where there's been a ton of shakeout. This past week, for instance, Ruby Tuesday Inc. ($RT) - the ubiquitous casual dining restaurant loosely associated with bad New Jersey strip malls - got bailed out...uh, taken private by NRD Capital at a fraction of its once $30/share price. (There was some assumed debt, too, to be fair). Moreover, Romano's Macaroni Grill filed for chapter 11 bankruptcy. In RMG's bankruptcy papers, the company's Chief Restructuring Officer said the following, "The Debtors’ operations and financial performance have been adversely affected by a number of economic factors, but perhaps most notably by an overall downturn for the casual dining industry. The preferences of such customers have shifted to cheaper, faster alternatives. On the other end of the spectrum, there is a trend among younger customers to spend their disposable income at non-chain “experience-driven” restaurants, even if slightly more expensive." No. Bueno. See below for a more in-depth (and slightly repetitive summary) of this particular bankruptcy filing. 

Unfortunately, the restaurant world received some other (slightly under-the-radar) bad news this past week: UberEATS, Uber's food delivery service, reportedly generated 10% of the company's total global bookings in Q2 - which, extrapolated, equates to $3b in gross sales for the year. That's a lot of food delivery to a lot of people sitting at home doing the "Netflix-and-chill" thing instead of the eat-microwaved-mozzarella-sticks-at-the-local-Ruby-Tuesday-thing. Of course, this is attributable to Softbank and other venture capitalists who are subsidizing this money-losing endeavor: UberEATS is unprofitable in 75% of the cities it services. On the other hand, do you know what IS profitable? Facebook ($FB). Yeah, Facebook is profitable. And Facebook is going after this space too; it released its plans to get into the online food ordering business earlier this week. And many suspect that this may be a precursor to a foray into food delivery as well. Why? Perhaps Mark Zuckerberg saw Cowen's prediction that US food delivery would grow 79% in the next several years. Delivery or not, anything that helps make online food ordering easier and more mainstream is an obvious headwind to the casual dining spots. Given that this area is already troubled and many casual dining spots have already fallen victim to bankruptcy, there don't seem to be many indications of a near-term reversal of fortune. Headwinds for the casual dining space correlate to tailwinds for restructuring professionals. Sick? Yeah. Sad? Sure. But true.