John Gordon

Long/short equity, growth, contrarian, value
John Gordon
Long/short equity, growth, contrarian, value
Contributor since: 2008
Company: Pacific Management Consulting Group
Exactly, this was not a surprise to educated observers. I appreciate the nice SA summary but it was very plainly expected by the many analysts who do live field checks. However, not every analyst downgraded !
John A. Gordon
Masked Author: wow, I'd hate to have you run my restaurant or investment portfolio. As Jim Cramer, said, "you know nothing". Your logic in points one and two is faulty beyond imagination. Refranchising is simply financial engineering; it is a sign of weakness. And in terms of all day breakfast--which is a US initiative by the way and you claim to be in Europe-- is a move for sure but I doubt you have any consumer research to know its long term effect.
John A. Gordon
Sorry, I cant agree with this logic. MCD Franchisees do not much spend on technology CAPEX, they do spend on bricks and mortar CAPEX. That is the overwhelming near term cash requirement reality. The brand should control and disburse most of the technology IT backbone CAPEX, centrally.
The point is someone must pay for the invariable REIT rent step ups. SBUX is principally company operated and is not a good comp. The REIT almost certainly would increase the cash burden on franchisees, because the brand is 90% franchised !
John A. Gordon
Pacific Management Consulting Group
I appreciate the writer's time; unfortunately, there is no discussion on the impact on the base MCD corporation (the non REIT core) going forward (who pays the rent step ups, who pays when units arent viable anymore?) and on the franchisees. If you are 90% franchised worldwide, whatever you do needs to support that model.
John A. Gordon
Pacific Management Consulting Group
Howard, nicely written. One comment and one question:
Comment One: that the restaurant average check must overall rise going forward is a given given the cost headwinds going forward, especially labor and the magnitude CAPEX economic disbursements. The trick seems to be to raise check via additional add on purchases versus price increases, or for management to improve brand perception and relevance. Some, but not all players in our space almost ignore add on selling. The question is not traffic versus ticket, it is traffic and ticket.
Question One: the five stages narrative above was well written. Where do you see MCD on that scale?
John A. Gordon
Pacific Management Consulting Group
Well written note, but refranchising is a sign of more problems to come and not at all a solution !
John A. Gordon
http://bit.ly/m8ad9
What writer misses in his pro-REIT commentary is the following. Here are five questions for further thought:
(1) what is the rent step up--higher rent costs that the MCD entity no doubt would have to pay to meet the REIT entity's needs in the outyears. Virtually all sale/leaseback terms that I've seen over time invariably have a step up. Can the restaurant cash flow handle it? What is the negative impact upon the MCD entity?
(2) What about real estate portfolio breakage? Lets face it, with so many restaurants in the US, the effective economic useful life of a restaurant is highly dependent on visibility and locational factors. Locations need to close and be sold, sometimes quickly. Will the MCD entity be on the hook for paying dead rent on dead sites?
(3) Can MCD shareholders get more than $5 billion in earnings annually from the REIT ownership, tax savings or stock appreciation as that is the MCD real estate margin currently? Check out the MCD 10K in detail.
(4) Why are there no restaurant REITs now?
(5) How did that gaming REIT, Penn National (PENN) work out?
John A. Gordon
Pacific Management Consulting Group
chain restaurant analysis and advisory
http://bit.ly/m8ad9
I generally agree with writer above that Zoes's is a strong brand and there is a long positive pathway for Zoes's to develop.
However, Colorado fundamentally misunderstands the economics of franchising. At an early stage, when the brand is growing with great unit level economics, restaurants should develop company owned store models because the profitability is greater than that of franchising. Franchising yields only a small royalty stream per store. It is later, when the brand matures, and is overbuilt, or when it should be expanded internationally, that franchising makes sense. One always takes dollars to the bank, not percentages.
John A. Gordon
Pacific Management Consulting Group
http://bit.ly/m8ad9
Very interesting piece. There is some FCF tightness, that's why MCD has said what it has lately. Of course, share counts will go down with buybacks.
However, what needs to be further aired out is CAPEX. CAPEX is only semi predictable, and for an older chain, should grow in cycles. While heavily franchised, its not enough to assume the franchisees will do it. They can't necessarily given the MCD real estate model.
John A. Gordon
http://bit.ly/m8ad9
I agree with author that Wall Street forgets about customers.
Author didn't note if his visit was to a v 2.0 store or not. But presume so.
Author has seemingly missed the 2014 and 2015 earnings calls, guidance and color that PNRA and the analytical community has provided for some time. Labor is going up, not down. Number of cashiers is not meaningful to the labor mix in store, due to other moving pieces. They are transitioning to a service delivery model ! That means something in an era of more expensive labor. Whether that service plus up will cause PNRA to stand out via a competitive niche will be seen over time.
Could digital or sales mix go up over time? Of course. If the dining room is less busy right now...that is not a good sign. That is January/February seasonality. It will take months to see the digital or catering sales mix moves up. Too soon to see it.
John A. Gordon
http://bit.ly/m8ad9
SBUX is a wonderful, powerful, creative consumer thought and business leader that can turn on a dime. However, i think the near term investor perception issue will be whether the mix between sales and transactions will show another narrowing of the transactions as we saw last quarter. Reports of down mall foot traffic should be watched.
John A. Gordon
Pacific Management Consulting Group
chain restaurant analysis and advisory
http://bit.ly/m8ad9
Ah, but the problem is that you can't carbon copy it everywhere. Retail, restaurants (any consumer business) have a strong geographical DNA; some things work, some don't. A franchisor can expand but the store level economics have to work. The US is a mature restaurant market, its not the wild west anymore.
Doug, thanks for your piece. For the Dunkin store economics to work, the sales mix must skew towards beverages, and then fill in products like breakfast sandwiches and lunch grab and go food items. If its all about donuts, the store economics will be suboptimal. Given this, does Dunkin have a play given that SBUX and others are present?
John A. Gordon
Restaurant Analyst
http://bit.ly/m8ad9
Happy Holidays, all !
Looks like the DNKN--DD US-- residual check weakness continues. Discounting is not buying traffic.
I agree with Denise. I'd add Texas Roadhouse (TXRH) to the standouts list: no breakfast, no lunch, no brunch; are buying back franchisees; incented and well compensated store partners, the heart of the system. No financial engineering, no gimmicks.
John A. Gordon
Pacific Management Consulting Group
http://bit.ly/m8ad9
Brad, I appreciate the comprehensive piece. I very much agree that BEF is very sellable. However, regarding real estate, several points that never seemingly get addressed by the pro-REIT advocates are:
(1) what do the inevitable outyear rent step ups do to the retail or restaurant entity profitability and free cash flow going forward? No one seemingly models that out through the outyears. Isn't it merely a wealth transfer from entity one to entity two?
The recent example of Penn National Gaming's deterioration is worth watching. Will the REIT sink it or the long term over expansion of gaming in the US?
(2) For an older legacy brand, like BOBE, that has older properties that it needs to get out of, how would a REIT affect company contractual outyear lease payments? Would they not be stuck with outyear lease payments on dead sites? Is a site by site analysis required?
John A. Gordon, MAFF
chain restaurant analysis and advisory
http://bit.ly/VLcJUr
Denise: as always, a very wise perspective, thank you.
On value and $1 items, for many reasons, not the least of which is minimum wage hikes, the US (and many international markets) simply can't afford $1 items anymore. It's got to find a new platform that features price but that is not only about price.
Getting breakfast to work 24/7 (see: JACK) and a real digital program are way overdue.
John A. Gordon
Pacific Management Consulting Group
http://bit.ly/m8ad9
If there is a followon discussion on MCD real estate, what might be useful is to track the rent and occupancy proceeds generated per franchise unit and the effect that produces on franchisees. In the past, MCD used rent as a "shock absorber" to help even out early term development hurdles. That does not seem to be happening in recent years. In some cases, the MCD rent overage collected above a threshold is 18% of sales. Good for franchisor corporation, bad for franchisees.
MCD is over 80% franchised, and trending higher as we learned this week, and franchisee free cash flow matters to the good of the whole.
Bloomberg and I collaborated on such a review in 2013, see it on my website, below.
John A. Gordon
Pacific Management Consulting Group
http://bit.ly/m8ad9
Thanks for note--but this is what DRI has reported in its earnings calls.
In the CAPEX intense restaurant space, I've seen more problems using EBITDA --both investment decisions and compensation decisions for example-- than any other single measurement metric. Taxes, debt service and maintenance CAPEX and routine CAPEX have to be counted.
John A. Gordon
http://bit.ly/m8ad9
Very impressive discussion template, but the comment that $50-75K in EBITDA per US franchisee is 'sustainable' is flawed. By definition, EBITDA misses debt service (principal and interest), taxes and CAPEX requirements. DPZ recently updated that to $82K in 2013, which is app. 10% of unit sales.
National Pizza Company, the best proxy for Us Pizza Hut performance, just reported store EBITDA of 8%, partially due to rising meat and cheese costs.
The asset light franchise model is great so long as franchisees can live off it and have enough cash flow to service their debt and remodel. This is the part of the narrative always missing.
John A. Gordon
http://bit.ly/m8ad9
ARG1, I'm a fundamentals analyst and motivated only by making the right analytical call. DRI price movements the last 10 trading days haven't moved at all, even with today's uptick.
Right, understood your point and sentiment.
Now, hope you will lay out proper long term value logic, looking beyond the real estate, including, whether a private equity solution is not appropriate for Darden itself.
http://bit.ly/1jvNGht
Shaun: the Market is not so precise and does not view individual company components together well, and a revenue based multiple is a poor yardstick. That seems to be causing the large Macaroni Grill negative value.
John A. Gordon
chain restaurant analysis and advisory
http://bit.ly/m8ad9
Actually, both Darden and the Activists have not made compelling points. One must look beyond the real estate, which is the focus of the activists and imagine other equity ownership outcomes where a Red Lobster spinoff might make sense.
The ownership scenarios proposed by Activists are not the only outcomes. Appearances are deceiving and one must take a longer view.
Unlocking value is Wall Street speak for financial engineering. Its rarely right for the long term.
See my article, Darden: Look Beyond the Real Estate, http://bit.ly/1t0uhNy.
John A. Gordon
chain restaurant analysis and advisory
http://bit.ly/m8ad9
Tim, I'd recommend thinking more about restaurants as integrated whole systems, rather than just separate company owned and franchisee pieces.
Everything affects everything else.
MCD is a (1) real estate operator (2) franchisor and (3) company operated unit business. The business model has to be strong enough for franchisees to absorb periodic wage increases....because if they can't, restaurants don't get remodeled and in time lose sales, market share, MCD loses royalty and real estate margin. You get the drift.
The Q for MCD the franchisor... is the business model being improved so the wage hikes are workable?
John A. Gordon
chain restaurant analysis and advisory
http://bit.ly/m8ad9
Hi Heather: Thanks for commenting on these complex topics. I'm just trying to track through some fine points:
Regarding the Ellison et al calorie study, how did they relate the number of calories to the number or type of entrees? As you can imagine, restaurant menu mix is quite complicated. A 2011 Starbucks/NYC labeling/calorie study showed a very tiny decline in the number of calories ordered, but that may or may not relate to product mix and average ticket.
Was the 2%/4% revenue shift pre and post a control?
Regarding the projected increase in the tipped wage, am trying to understand the basis of the calculation. Until there is a federal minimum wage change and/or federal tip credit change, the tip credit effect has to be a complex calculation of what the states do, unless there is over riding federal changes.
John A. Gordon
chain restaurant analysis and advisory
Pacific Management Consulting Group
http://bit.ly/m8ad9
Tom, very interesting piece and academic research. One question and two comments:
Question One: Who is the author of the undated/untitled restaurant academic paper?
Comment One: The effect on franchisee restaurant operating margins likely will be much greater than 1 percentage point. There will be pass through of course, but it will depend.
Comment Two: many factors have changed since the academic research time reference. The ratio of franchisee to company stores have changed, the number of restaurants has risen and the presence of dollar menus and the like all works to make this murky. The pass through has to be tested in today real world.
John A. Gordon
Pacific Management Consulting Group
chain restaurant analysis and advisory
http://bit.ly/m8ad9
Another long read on Darden (DRI) and REITs that does not discuss: (1) whats the change in the restaurant operating model due to spinning off restaurant real estate (2) that there are no restaurant REITS to serve as a proper benchmark.
John A. Gordon
Pacific Management Consulting group
http://bit.ly/m8ad9
chain restaurant analysis and advisory
I know its popular to pile on DRI currently but a deeper analysis than the above is required. DIN is a very poor peer for DRI. EAT may work, but, BLMN is closer.
John A. Gordon
http://bit.ly/m8ad9
chain restaurant analysis and advisory
Writer raises interesting questions, but a much longer, more detailed look is necessary if comparing DNKN v. SBUX, or any company owned versus franchised model.
Two comments:
(1) the stock trend is important, but only so relevant and representative to what's going on the fundamentals of the company. SBUX's EPS and SSS trends have been generally better, and its free cash flow exceeds that of DNKN by a factor of four.
(2) the value of a corporate directed franchisee advisory council is not that it exists, but how it influences franchisor stewardship and provides a useful platform for franchisees to own, invest and be more successful. That is a much more complicated story.
Writer and readers, just to clarify: "pre tax cash on cash ROI" as noted above is not a good metric because it does not count or match all of the cash outflows (debt service, taxes, CAPEX, overhead) associated with the initial investment to the inflows. its not even a cash on cash view. Only by a full allocated view will the total cost of capital be evaluated.
Back to WEN: it has a lot of potential: higher AUVs than others and a strong fresh food heritage. The inflection points comes when it consistently generates same stores sales via traffic gains, finds ways to get the franchisees remodeled economically, gets breakfast working and powers up international development. Not yet, but I hope for the best.
John A. Gordon
http://bit.ly/m8ad9