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On the Margin
Falling sales could make leases troublesome

Falling sales could make leases troublesome

This post is part of the On the Margin blog.

We recently asked Jeff Garrett why sales are up at his soon-to-be-10-unit California-based family- dining chain Lumberjacks. One of his explanations surprised us a bit: Patience.

Specifically, his concept waits out until sites open up at rates that are reasonable enough to make a profit even in a downturn.

“In California, it’s hard to find a spot,” Garrett said. “Everyone wants $3 to $3.50 per square foot. You can’t go into that spot and remodel and pay rent with the minimum wage going up.

“A lot of these restaurants over the next five years are going out of business.”

In March, we wrote about rising lease costs amid intense demand from rapidly growing fast-casual chains and others looking at similar locations. We noted that demands for high rents could cause serious profitability problems if sales fall.

Since then, almost on cue, same-store sales have slowed. Publicly traded chains on average reported same-store sales in the spring that were 170 basis points slower than the previous quarter. The biggest slowdown has come at fast-casual chains where lease costs are especially high given heavy demand for the spaces those restaurants occupy.

According to Black Box Intelligence, only a third of fast-casual chains reported a same-store sales increase in the second quarter. And this is with one of the biggest concepts in that space, Chipotle Mexican Grill, was down well over 20 percent.

Same-store sales continue to slow down. According to MillerPulse, same-store sales have fallen for three straight months since at least 2010. Traffic is down 2.8 percent across the board. That’s a major loss of customers.

High lease costs could be contributing to this issue. There is a widening gap in menu price inflation between restaurants and grocers, and many of us believe the lower prices are providing those grocers with an advantage.

Operators are raising prices in part out of fear of rising labor costs. But those operators also have these leases to worry about. And so they push prices higher in the name of maintaining margins.

There’s little indication that sales are reversing. If the industry is truly into a recession, as people like Stifel Analyst Paul Westra believe, then a longish period of sales weakness could cause serious problems for some concepts that have a lot of locations with high lease rates.

That’s not the only liability, either. Many franchisees in particular have borrowed tens of millions of dollars to acquire locations and remodel old locations. That debt level could be pushing operators to raise prices even amid declining food costs to meet cash flow covenants.

That debt, too, could look awfully expensive as sales continue to fall.

Contact Jonathan Maze at [email protected]
Follow him on Twitter at @jonathanmaze

TAGS: Sales Trends
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