On the Margin
How higher interest rates will affect restaurants

How higher interest rates will affect restaurants

This post is part of the On the Margin blog.

The U.S. Labor Department said on Friday that the economy created 211,000 jobs in November, keeping the unemployment rate at 5 percent.

The numbers were in line with expectations, and many believe it was enough to prompt the Federal Reserve to raise interest rates later this month. The Fed hasn’t raised rates in nine years. And the federal government has had a zero interest rate policy in place since the depths of the recession in 2008.

In theory, that could represent a big shift for the restaurant industry, which has spent the past seven years operating in this environment.

Lots of restaurant chains have debt on their books. So higher interest rates would hurt profits. In a study presented at last month’s Restaurant Finance & Development Conference, Wells Fargo noted that a 100 basis point increase in interest rates would reduce average net income in the restaurant industry by 0.6 percent.

But, the study said, companies with a lot of cash on their balance sheets could benefit from higher interest rates because that cash would make more money.

A bigger question is how much of an impact higher interest rates would have on the merger and acquisition market.

Higher interest rates could in theory reduce the number of mergers and acquisitions by increasing the cost of lending, which would make it less affordable for buyers to acquire restaurants — while reducing prices for acquisitions that could keep some sellers from selling This would be particularly true in the franchisee space, where the cost of lending has helped drive a lot of activity.

But that impact wouldn’t happen anytime soon. Lenders and other experts have suggested the impact of higher interest rates would likely be minimal in the short term because the Federal Reserve is expected to take things slow.

“We’ve been waiting for interest rates to rise for five to seven years,” said Brian Frank, who heads the restaurant-lending group at TD Bank. “It does not appear that it is going to be a significant rise. I don’t know that the initial rise will drive the marketplace.”

But, he said, that prediction changes if the Fed raises rates several times in a row like they did in the years leading up to the recession.

Higher interest rates could, however, impact the public markets. It might already have, in fact.

Adam Birnbaum, managing director with Grandwood Capital, said that institutional investors might be re-pricing valuation models on growth restaurant chains to reflect higher interest rates. “With the Fed sending strong signals that fed funds rate will be going up will likely require a re-evaluation of these pricing models,” he said.

That could also prompt a big change in the M&A market.

The hot IPO market has altered the market for restaurant companies by increasing the price for which growth chains can get from investors.

Many chains that once would have sold their concepts to private equity groups have instead sold to public investors through an initial public offering.

But, if the prices companies can get in an IPO falls, then some of these companies might opt to sell instead.

Habit Restaurants Inc. last month postponed its secondary offering, citing market conditions — the postponement was rare. It’s not just restaurants, either: The broader market for offerings has likewise been more difficult. “The IPO market is definitely getting very sloppy,” Birnbaum said.

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

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