Finance | May 2015 | By Julie Knudson

Time to Spend Again

Restaurants take advantage of good market conditions to refresh, energize their brands.
Quick service operators spend more in expenditures in stronger market environment.
Good Times Burgers & Frozen Custard is in the midst of a system-wide remodel that should be completed in 2016. Good Times Burgers & Frozen Custard

Things are looking up for capital spending in the quick-service and fast-casual sectors. A long spell of wariness is finally lifting as more operators look to invest capital in remodels, new equipment, and other improvements.

Among the brands taking advantage of favorable market conditions and attractive interest rates is Golden, Colorado–based Good Times Burgers & Frozen Custard, which is in the midst of a system-wide remodeling.

“We started thinking about it all the way back in probably 2011,” says Boyd Hoback, president and CEO of parent company Good Times Restaurants Inc. “Then we started late in 2012, and it really began in earnest with remodeling the stores in 2013 and 2014.” About 40 percent of the way through the existing store base now, Hoback says, the company expects to finish the project in 2016.

Recently released data from the National Restaurant Association (NRA) mirrors that optimism. The latest Restaurant Performance Index (RPI) shows that 70 percent of operators reported an increase in same-store sales between January 2014 and January 2015, and 66 percent reported increased customer traffic.

“The overall environment for capital spending in the restaurant industry now is definitely more positive than it was several years ago,” says Hudson Riehle, senior vice president of research at the NRA. Fifty-seven percent of operators in the latest RPI survey said they’re planning to spend capital dollars—on expansion, remodeling, or equipment—in the next six months alone. “Fifty-one percent actually made a capital expenditure over the past three months,” Riehle adds.

Ted Lynch, managing director of global commercial banking at Bank of America Merrill Lynch, says his team’s conversations with restaurant clients are incredibly positive. Many operators are surprised by not only how well their brands fared in 2014, but also how much capital spending is actually occurring.

“They’re doing this because it’s a normal part of their routine, but when you actually look at raw, whole numbers, there’s a small sense of amazement at how costly the business can be,” Lynch says.

When determining the best financing vehicle, the amount of capital that will be going toward equipment versus how much is scheduled for building and leasehold—structural assets such as HVAC systems that belong to the building, not the company—could sway the decision. “For us, a large portion of it was on the leasehold and building side, so we’re funding it out of both cash flow as well as a small senior debt piece, and specifically a cash-flow lender [an institution that lends based on company cash flow], not an asset-based lender,” Hoback says of the remodel project happening throughout his brand’s system. “I think there’s more money available from cash-flow lenders that understand the business and that understand the returns available from remodeling.”

As in other industries, there remains a fair bit of pent-up demand for capital spending, experts say. Businesses are finally feeling confident enough to commit significant dollars to worthwhile projects, and lending conditions are making money easier to get. Hoback says Good Times’ remodel project is already paying off, with older stores receiving a much-needed update to keep pace with the brand’s market position. “As we bring our entire system up to current brand standards, we think there’s a real synergistic effect that goes beyond any individual store remodel,” Hoback says.

In addition to the usual market drivers, such as gaining a competitive edge and keeping the brand’s image current, external pressures are also leading restaurant companies to take on capital projects that may have been sitting on the back burner. Attractive interest rates are one factor, and rising labor costs in this labor-intensive sector are another.

“Historically, productivity in the industry has been challenged,” Riehle says. “That means a high return in terms of boosting the efficiency and effectiveness of that operation.” Capital spending can positively impact revenues far into the future, making it a particularly smart option in an environment where outside costs are continually increasing. “Those external factors now play a greater role than they would have several years ago,” Riehle says of capital spending decisions.

Though a majority of operators report making capital expenditures in recent months, Lynch says, they must still be mindful to spend money where it will count the most. Defensive spending—typically those purchases that reduce or avoid ongoing maintenance and repair costs—may not draw customers into the restaurant, but they still contribute significantly to the bottom line. “You need to make certain that the defensive expenditure you’re doing is being done as efficiently as possible,” Lynch says.

It’s that forward-looking perspective that drives capital projects large and small. As Riehle says, “Operator confidence in future business conditions is obviously one of the more important determinants in the decision to spend on capital goods.”

And with interest rates down and consumer spending up, capital projects continue to offer good returns for restaurant brands.

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