Closing Time: You Don’t Have to Go Home, but You Can’t Eat Here

Insight by Andrew Charles, Brian Vieten, Andrew Crespo, George Mihalosand Jaret Seiberg

THE COWEN INSIGHT

Our U.S. restaurant industry model suggests $39B of cumulative sales is up for grabs through 2022 due to 7.5% net restaurant closures in 2020-21. Limited service chains are most ripe to benefit given digital prowess, off-premise oriented operations and a lower ticket vs. full service.

Key adaptations needed in a post COVID-19 world include New Prototypes, Ghost Kitchens, Third-Party Delivery, Curbside Pickup, and Sustainability. Based on category fragmentation, cash/cash ROIC & urban/suburban mix, we are most bullish on category leaders with a digital advantage.

COVID-19 Is Accelerating Key Restaurant Industry Trends Previously In Place

From a behavioral perspective, our model is largely predicated on the pandemic accelerating structural industry trends that were already in place. Primarily this is the Top 500 concepts (aka chains) off-premise outperformance due to the stickiness of digital ordering. We believe digital and operational initiatives offered to promote safety during the pandemic, such as third-party delivery and digital ordering for curbside pick-up, will be en vogue post-pandemic due to consumer desire for convenience.

Looking beyond the Top 500's digital prowess, we believe the share shift to the Top 500 is compounded at least in the near term. Their scale leads to competitive advantages in value, marketing and higher margin structures.

Perhaps the biggest surprise to investors will be the elevated level of development we expect the Top 500 concepts to achieve from 2020-21's given the outsized number of industry closures. We expect this to be skewed toward well-capitalized, limited service (LSR) concepts that can design a more flexible store prototype.

5 Key Industry Adaptations for a Brave New World

We highlight the 5 following points of adaptation necessary for restaurant industry CEOs to consider in a post-COVID-19 backdrop, as well as aspects that we anticipate for successful new concepts born during or after the pandemic.

• New Store Prototypes: Within our industry forecasts, we expect future restaurant prototypes to reflect greater access points for off-premise such as drive-thrus, curbside pick-up, and smaller dining rooms to help boost ROIC.
• Ghost Kitchens:Ghost kitchens offer a thematic industry solution to fulfilling off-premise sales amid rising rents (pre-COVID-19) and scarce labor. Our math suggests breakeven sales of $428,400 for ghost kitchen restaurant tenants. This leads us to view ghost kitchens as a more effective solution to alleviating off-premise congestion near high volume brick & mortar locations rather than for restaurants looking to seed capital-light development.
• Third-Party Delivery: Our proprietary monthly survey data indicates 33% of unique respondents utilized a delivery from DoorDash, Grubhub, Postmates or Uber Eats in 3Q20. We expect a greater focus from the restaurant industry in 2021 on owning the customer ordering experience and using third-party delivery providers strictly for fulfillment purposes.
• Curbside Pick-Up: National grocers and big box retailers are raising the bar for customer convenience with curbside pick-up. We expect this to permeate to restaurants. Curbside pick-up also promotes consumer safety and convenience for sites that can not support a drive-thru. We argue concepts with the highest digital sales mix will naturally see the greatest success near term with curbside pick-up, though longer term curbside is a broad necessity.
• Sustainability: As highlighted in Gen Z/Millennials: Sustainability Supports Durability Ahead of the Curve® report, sustainability is a key influencer of Gen Z/Millennial purchasing decisions across industries. This can take several forms in the restaurant industry including no additives or artificial ingredients, humanely raised proteins/locally sourced produce, plant-based alternatives, etc. Whatever the avenue, we believe they should be marketed to appeal more to younger demographics.