On the Margin

The quiet, early indicator of restaurant-industry problems

This post is part of the On the Margin blog.

Here’s one sign of the restaurant industry’s current struggles: More of them are renegotiating credit agreements.

Noodles & Company did just that earlier this week. Under the deal, the fast-casual chain’s lender agreed to loosen certain financial requirements, known as covenants, in exchange for other restrictions — such as reduced capital spending — and a higher interest rate.

Most of the covenant changes enable Noodles to operate with a reduced cash flow. The company’s earnings before interest, taxes, depreciation and amortization has fallen in recent quarters because of weak sales at existing locations and poor performance at new units.

In short, the new credit terms are indicative of a company with financial problems.

The move to renegotiate did not go unnoticed. Noodles’ stock price is down 21 percent this week, continuing the company’s stock price freefall since its 2013 initial public offering. The stock has lost nearly two-thirds of its value this week — and 93 percent since its value skyrocketed to a high of $52 a share in the days following the IPO.

Noodles can take at least some solace: It is not alone, at least in amending its lending deal. Papa Murphy’s amended its credit agreement last week to provide the company with more “financial flexibility” to advertise its concept nationwide.

Famous Dave’s of America Inc. likewise renegotiated its credit agreement last year after the Minneapolis-based barbecue chain defaulted on some loan covenants.

While bankruptcies among high profile companies like Logan’s Roadhouse, Cosi Inc. and Garden Fresh Restaurants have received most of the headlines, renegotiated credit deals are also a quieter, early indicator of industry problems.

And the industry definitely has issues. Same-store sales have been weak this year. And that’s clearly hurting the profits at some companies with high debt loads or lease expenses or capital costs.

Many companies have relied on debt to fund expansion in recent years or to pay dividends to shareholders. Lenders, however, include financial requirements in their credit agreements to ensure that the borrower is financially capable of paying off its loan.

As sales have fallen, earnings for many chains have fallen, too. In Famous Dave’s case, earnings fell so far that the company violated its credit agreement. During the recession, when nobody was loaning money to the industry, that event might have triggered a bankruptcy and a sale. Because credit is readily available now, the lender agreed to renegotiate the deal.

In the cases of Noodles and Papa Murphy’s, sales weakness and earnings weakness, limited the ability of the chains to fund initiatives to reverse their respective fortunes.

Noodles wants to close or refranchise lower-performing locations to improve profitability, but the chain can’t pay landlords for the right to get out of leases without violating its credit agreement.

In Papa Murphy’s case, the chain wants to spend money on advertising nationwide but cannot pay for the ads.

Of course, lenders don’t simply loosen these requirements without getting something in return, usually in the form of higher interest rates and various payments.

And in that sense, the chains are hoping that their efforts will yield better sales and earnings. They could, of course. But that will be tougher to do if the environment remains as challenging as it is now.

Jonathan Maze, Nation’s Restaurant News senior financial editor, does not directly own stock or interest in a restaurant company.

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

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