Restaurants

Summary of Valuation Approaches

There are four different types of valuation methods that can be used to value restaurant companies, these methods are:

1. Asset-based valuation
   The basic formula to use for this method is: The fair market value of a company's assets less the fair market value of its liabilities = the fair market value of a company’s equity.
2. Income approach to value (capitalization of earnings)
   This method is most the accurate for restaurants, which usually have a constant growth of earnings. The capitalization rates for restaurants range from anywhere from 20% up to 100%.
3. Income approach to value (discounted cash flow)
   The value of equity utilizing this method is equal to the present value of free cash flows available to equity holders over the life of the business.
4. Market approach to value
   This method utilizes market indications of value such as publicly traded comparable restaurant company stock and acquisitions of privately held restaurants.

Description of the Industry

The restaurant industry is a diverse and labor intensive industry. This industry falls into the SIC code of 5812 and NAICS Code of 7221. Full service restaurants have three main characteristics that differentiate them from fast-food or other dining places. The first is that they have a full menu of appetizers, entrees, desserts, and beverages. Second is that the food is cooked to order rather than pre-prepared or cafeteria style. Third is that customers are waited on, seated, and served. According to the National Restaurant Association (NRA) the restaurant industry as a whole will have annual sales of approximately $566 billion and includes about 945,000 locations. According to the National Restaurant Association, sales for US restaurants are anticipated to rise 2.5% in 2009. Some of the biggest players in the restaurant industry, both private and public, include:

1. Cheesecake Factory
2. Denny's
3. Applebee's
4. Outback Steakhouse
5. Benihana
6. T.G.I Friday’s
7. P.F. Chang’s China Bistro
8. California Pizza Kitchen

Industry Trends

There are several main trends that arose in the restaurant industry during 2008 and are continuing through 2009. A few of the most popular trends are:

1. Organic Produce
   As many more Americans are becoming environmentally and health conscious, more restaurants are using organic produce in their dishes. This trend is to appeal to those people who like to know that they are not putting any pesticides in their bodies or the environment and are eating produce in its most natural form. This also appeals to people who may have allergies and are more sensitive to preservatives and pesticides than others.
2. Bite-Size/mini desserts
   Bite-size desserts are a big hit at many restaurants. Their small size and price compared to regular desserts is very appealing to customers who didn’t save enough room for dessert but still want something sweet at the end of their meal. They also lure in people who normally don’t order dessert at restaurants but can afford to be adventurous with these smaller portioned sweets.
3. Super-fruits
   More and more restaurants are adding exotic fruits such as acai, goji berry, and mangosteen to their menus. These super-fruits have become very popular for the health benefits that are attributed to them. As many people are now putting more importance and attention on their health, this new menu item draws many customers in.

The restaurant industry has been negatively affected by the current recessionary market conditions in the U.S. The reduction of discretionary income in the US has resulted in lower sales and profits in 2008 and 2009.

Key Performance Metrics

1. Hourly sales per restaurant
2. Cash Flow
3. The percentage of repeat customers
4. Staff turnover
5. Table-turn
6. Tip percentages
7. Payment mix (cash vs. credit card)

Benchmark Statistics

The following benchmarking data is based on studies from various restaurants within the industry and represents average performance:

As noted above, the dealership industry experiences a relatively high degree of leverage due to the large amount of physical assets that can be used by lenders to secure loans.

Industry Organizations and Publications

1. National Restaurant Association
2. Restaurant News Resource
3. Nation's Restaurant News

Availability of Publicly Traded Guideline Firms

There are approximately 37 publicly traded companies in the U.S. restaurant industry. The sales of these companies range from $0.01million to $22,787 million dollars and market capital ranges from $0.26 million to $6,627 million dollars. The average P/E ratio is 11.9 times while the median is only 3.65 times. The average price to free cash flow is 2.0 times.

The top five publicly traded full service restaurant companies ranked by sales are:

1. Darden Restaurants Inc.
2. Brinker International Inc.
3. Bob Evans Farms Inc.
4. The Cheesecake Factory Inc.
5. Ruby Tuesday Inc.

Availability of Purchase Transactions

According to one database that tracks restaurant company purchase transactions there have been 268 full-service restaurant purchases in the U.S. from January 1, 2000 to present. The size of these private companies varied enormously, both in terms of their vehicle sales volume, and the purchase price paid for the companies. From 2000 to 2008, the ratio of:

1. Market value of invested capital (MVIC) to Net Sales ranged from 0.05 to 4.7 times
2. MVIC to earnings before interest, taxes and depreciation (EBITDA) ranged from 2 to 7 times.

This range of market multiples is too variant to be useful without further analysis. A proper value for the company that you are assessing should be based on the performance of the subject enterprise, compared to the performance of others in the same industry. Industry economic conditions also vary at different times, which obviously affect restaurants as investment opportunities.

Fulcrum Inquiry performs business appraisals for restaurants, and other businesses.