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Restaurant Chains: On a Knife Edge?

August has provided a small sigh of relief for many mid-market restaurant chains that have been badly hit during the pandemic. Eat Out to Help Out and a desperation to get out after a long lockdown has aided retail footfall and brought customers back into restaurants. Helped by summer weather, footfall rose four-fold between the second and third weeks of August, according to Springboard. However, almost two months after reopening, restaurants face into life with significant limitations on capacity as a result of social distancing. This is squeezing revenue per site in a sector already trading dangerously close to the edge as a result of over expansion, increased competition and margins tightening with a cascade of costs hitting the sector from increased property rates to rising wages. As we head into the autumn, chains are now faced with the anticipated impacts of recession and a likely second wave as they work out how to navigate uncertainty in the near term and restructure to survive longer term issues.

In a sector dominated by an increasing proliferation of bland offerings, only a few operators, such as Wagamama, were well-positioned for lockdown. Coronavirus has accelerated the negative trends hitting the sector and operators have struggled to react with models designed for high consumer density: Pret A Manger is a high-profile case of this. Crisis has called for innovation – some operators have used so called ‘dark’ kitchens to capitalise on the boost in delivery, operating during normal times with delivery-only capacity, at lower cost sites than inner city restaurants. Wagamama is poised to benefit from its pre-COVID plans to open three such dark kitchens.

'Deliveroo Editions' are a network of dark kitchens run by Deliveroo that allow restaurants to expand their coverage. Source: Property Week In a market in crisis the pressures on restaurants across the board remain enormous. For most operators surviving lockdown has in reality been about getting to the end of the beginning. Next comes the challenge of reopening in an uncertain market which may see both further localised lockdowns and demand hit by economic downturn. In all of this, the costs of reopening are often formidable with lockdown draining already limited cash reserves and weaking the ability of operators to face reopening costs and potential losses of trading with reduced sales capacity. The mathematics are simple. The breakeven for most restaurant means operating at 75% capacity at least in order to turn any profit whilst open. The only way out for many has been filing for administration to restructure cost bases. Casual Dining Group, sold to Epiris in a pre-pack deal, is closing 91 restaurants permanently leaving 159 intact. CDG’s brand Café Rouge has high exposure to airports – the deal will close twelve of these outlets. Even the fast-casual chains that typically have better margins, such as Wasabi – now considering a CVA, have been hit by the drop off in demand. However, CVAs don’t provide a free ride. They’re a route for firms to reduce costs to survive the crisis by renegotiating debt, reducing their estates by discarding underperforming sites and revising problematic lease terms. But CVAs normally result in a radically different footprint and often changed ownership, and a loss of money for former owners. Restaurant owners and staff aren’t the only ones hit by the crisis. The train of restaurants facing CVAs or bankruptcies is testament to the crisis facing landlords and tenants alike. Commercial landlords are confronting £3bn of unpaid rent hangover from the past six months. Especially in the context of a CVA, chains retain negotiating leverage in being able to walk away from a given location if landlords refuse to be flexible. Grosvenor has offered subsidies for sites continuing Eat Out to Help Out, suffering from a dense map of London properties that will likely suffer a sustained drop off in inner city footfall at the end of the program. On the more generous end, options for landlords include revenue-determined rates or deferrals, allowing the space to remain occupied with no likely alternative tenant. Five trade bodies, including the British Retail Consortium, have together called for a ‘Bounceback Grant’ to ease the rent crisis. Under this scheme the government would assist restaurants in paying 50 percent of rent over the six-month period from March. As the end of the evictions moratorium looms, the subsidy would prevent a tsunami of closures and a potential disaster for staff. The scheme could satisfy both tenants and landlords: the five bodies pushing it estimate a saving of 375,000 jobs across the hospitality industry and a cost of £1.75bn to the government but a significant return in terms of tax revenue of up to £7bn. In reality the pandemic, however, has been only the tipping point for a sector that was already on the edge. The past five years have been characterised by well publicised increasing cost pressures from staff costs and property rates. At the same time, Brexit uncertainty, wage erosion and low confidence tightened the consumer’s belt. Restaurant insolvencies were up 25 pc last year, including the very public demise Jamie Oliver’s restaurants, which encountered a 28 pc rise in business rates before its collapse. The problem however extends beyond cost pressure. In casual mid-market dining, private equity saw scalable and liquid investment opportunities, producing significant M&A activity over the past ten years. But the mid-market restaurant space is vastly oversaturated by tired and undifferentiated brands. The quick and costly expansion desired by investors made businesses vulnerable to revenue fluctuations. Expansion produced big restaurants operating at under capacity with a susceptibility to poorly management and understaffing, especially given a general drop off in capex. Chains are also challenged by significant cultural change. Deliveroo and UberEats have also provided a platform for small fast casual restaurants, encouraging a culture amongst younger consumers favouring independent restaurants, taking customers away from once-popular full-service restaurants. Pizza Express is a tale of a chain now struggling to keep up the fresh face of fast casual dining. Not only is its image and menu tired, but older brands like Pizza Express suffer disproportionately from delivery models: their larger menu structure is reliant on a full-service experience to entice customers into ordering more profitable items. The restaurant attempted to keep up by launching an exclusive partnership with Deliveroo in 2018 and the launch of an entirely vegan menu, but are facing competition from the well-executed, curated experiences of fresh brands such as Franco Manca. Only a limited few larger brands remain stars in this space, including Wagamama and Nando’s both of which have shown robust performance. Nando’s sales had jumped 7.1% last year, surpassing £1bn as it expanded. Both have a distinct image and a tight hold on consumers. Source: The Independent The future for many remains fairly bleak: restaurants face into tough winter as the healthcare industry races to find a solution to the virus. Eat Out to Help Out has had the equivalent uptake of a meal per person in the UK, buoying year-on-year performance for August to the point where some restaurants have even struggled to meet demand. Nevertheless, retail footfall in general still falls vastly below last year, suggesting the deal is a good temporary offering for a population desperate to get out and spend some disposable furlough cash. As the scheme ends, rising economic pressure on the consumer leaves chains on a knife edge. As they restructure, the focus will be on delivery – a long-term trend that will only continue as consumers become increasingly wary of Coronavirus rule relaxation. Contact-reducing measures, such as Deliveroo’s Table Service, will also be crucial solutions to facilitate social distancing where restaurants remain open. To what extent a massacre is impending, unless the government takes unprecedented action, is still in question. Will damaged restaurants manage to stay intact and raise fresh capital, or will the high street see a drastically consolidated set of brands? Those that survive winter will be forced to reduce estates, focus on their key product and experience and long-term delivery capabilities. As the pandemic ends, restaurants will return as consumers will again crave variety. But what, exactly, will customers return to