40% of Restaurants Could Face Closure This Year

May 5/New York/Marketwire -- A new study by the global business-advisory firm AlixPartners LLP shows that, given the current economy plus current conditions in the industry, up to 40% of America's restaurant chains could face severe liquidity crises within the next 12 months. The study shows that restaurants are now saddled with a debt-to-equity ratio more than double what it was in 2006, that cash levels have dropped at a rate of 6.5% per annum since 2004 and that only in the lower-price end of the market have earnings and returns on investment been anything but worrisome.

AlixPartners studied 110 restaurant chains across four main categories: fine dining, casual dining (eateries with lower prices but that still offer full table service), fast-casual dining (those with no table service but with the promise of a higher quality of food and atmosphere than a fast-food restaurant) and quick-service restaurants (where food is ordered at a walk-up cash register or at a drive-through window). It also surveyed 1,000 consumers about their recent dining habits and expectations for future spending. Almost half (48%) of respondents said they plan to eat out less frequently in the coming year, and over half (51%) predicted their average spend per meal would be $10 or less, up from 42% for 2008.

Andy Eversbusch, a managing director at AlixPartners and leader of the firm's Restaurant and Food Services Practice, said, "While certainly there are healthy companies in every restaurant category, our analysis suggests that, without aggressive intervention, up to 40% of chains face the possibility of a severe liquidity crisis, which could mean failure, within a year. And if things worsen in the economy, that timeline could shrink to just a few months for many chains. Overall, we found declining growth rates and declining same-store sales in all four sectors, as well as declining EBITDA in three of the four sectors, with only quick-service restaurants bucking that latter trend.

"Moreover," continued Eversbusch, "our research suggests that fine-dining and casual restaurants in particular are likely to experience a further and potentially dramatic drop in earnings, cash and returns this year, as they find themselves caught in the vice of a recessionary economy and rising labor prices due to hikes in the minimum wage rate. As the survey part of our study shows, when it comes to dining out these days, Americans are saying either, 'Let's eat at home instead' or 'Let's eat cheap' -- or at least 'Let's get a lot more value for the money that we are willing to spend.'"

The AlixPartners study showed that the debt-to-equity ratio among restaurants has jumped to 1.38, up from 0.68 in 2006, leaving the industry little headroom to handle the current recession. It also shows that while overall industry cash levels have been dropping, operating cash flows (key to any company's day-to-day survival) have also been flat or declining in all sectors except quick-service -- and even in that category, on-hand cash has dropped precipitously since 2005. In terms of returns, it found that while fine dining has for some time endured the lowest return on capital employed (ROCE) among the four sectors, casual establishments are also lagging behind. Meantime, it found that while quick-service restaurants are enjoying the highest ROCE today, fast-casual restaurants have, since 2004, seen much greater sales growth.

Despite their challenges, restaurants do have a lot of opportunities today, according to AlixPartners. In addition to acquisition and market-share opportunities for stronger players, AlixPartners notes that applying "lean" principles to all restaurant operations, an approach first pioneered in manufacturing industries, may provide a lifeline for any player in this space.

Said Eversbusch, "While it's still the case that you can't 'save your way to prosperity' in the restaurant business, that ultimately consumer traffic makes or breaks a company, aggressively leaning-out costs at every level, including in the supply chain, can definitely help restaurants deal with this current environment."

Adam Werner, a director at AlixPartners and one of the authors of the study, noted, "Just as lean production has saved billions of dollars for leading manufacturing companies, our research and experience in the field shows that restaurants could also benefit greatly from the application of similar techniques, such as minimizing energy and water use, optimizing labor schedules, and controlling waste and inventory levels with improved demand forecasts. When combined with proven techniques in supply-chain and real-estate management, this could amount to savings of at least 15% against current costs."

"Those who run restaurants have, rightly so, traditionally focused on the customer experience," said Adam Fless, also a director at AlixPartners and another author of this study. "The main concern, whether it's a chain of quick-service restaurants or fine-dining establishments, has primarily been with the quality of the food, its presentation and so on. However, in today's environment, 'the meal' needs to be re-thought. It needs to be looked at not just as a consumer experience but also very much as a product, a product that needs to be optimally produced, sourced and delivered. To do any less is, really, to shortchange today's budget-conscious consumer."

From the May 11, 2009, Prepared Foods E-dition