Hedgeye - RESTAURANT INSIGHTS | FWRG (+), Restaurant Activism

Fueling Growth and Innovation: How First Watch Restaurant Group Is Redefining Daytime Dining in 2024

FWRG's earnings call painted a picture of a brand successfully navigating the challenges of the current market environment and strategically positioning itself for sustained long-term growth. Key to this approach is disciplined expansion, leveraging technology for operational efficiency and customer experience, and maintaining a strong focus on profitability margins amidst growth. The company's proactive approach to expanding its footprint, enhancing operational efficiencies, and deepening consumer engagement positions it well for continued success in the competitive restaurant landscape.

Robust Growth and Expansion Strategy

Strong Sales Growth and Milestones: First Watch has demonstrated impressive sales growth, surpassing $1 billion in systemwide sales and consistently opening new locations, including reaching the 500th restaurant milestone. The brand's ability to maintain same-restaurant solid sales growth of 7.6% with positive traffic in 2023 underscores its appeal to customers and potential for further expansion.
Strategic Market Expansion: The announcement of entering new markets, such as Las Vegas and New England, indicates a strategic growth vision. First Watch's disciplined approach to expansion, focusing on markets where it can achieve significant scale and brand recognition, suggests a roadmap for sustained long-term growth. This expansion is supported by a proven concept of portability across diverse markets, hinting at untapped potential in new and existing markets.

Operational Excellence and Margin Expansion

Improved Profitability: Focusing on operational efficiencies, particularly in labor scheduling and food cost management, has improved restaurant-level operating profit margins. In 2023 (A), EBITDA growth of 44% YoY highlights effective cost control measures and the ability to leverage scale for improved profitability.
Investments in Technology: First Watch invests in customer-facing and operational technology, such as pay-at-the-table systems, which streamline operations and enhance the customer experience. These initiatives not only improve efficiency but also have the potential to drive incremental sales growth by reducing friction points for customers.

Strong Business Model

Daytime Dining Leadership: First Watch has established itself as a leader in the daytime dining segment, a niche that offers growth opportunities distinct from the broader restaurant industry. The brand's focus on breakfast, brunch, and lunch taps into growing consumer trends toward casual dining experiences with a focus on quality and freshness.
Strong Brand Differentiation: With a unique menu, a focus on fresh ingredients, and a differentiated dining experience, First Watch has cultivated a loyal customer base. This, combined with low employee turnover rates and a focus on high customer satisfaction scores, underscores a resilient business model with a competitive moat in the restaurant industry.

4Q23 Trends:

Strong Finish to 2023: The company reported accelerated growth in same-restaurant sales and traffic in Q4 versus Q3, indicating a robust year-end.
Milestone Achievements: First Watch surpassed $1 billion in systemwide sales, nearly $100 million in adjusted EBITDA, and celebrated the opening of their 500th restaurant.
Growth Metrics: Same-restaurant sales grew by 7.6%, with positive traffic for the year; total revenue increased by 22% YoY and has doubled since 2019.
New Market Expansion: The expansion announcement into Las Vegas and New England indicates confidence in brand portability and growth potential in these new markets.

Margins:

Improvement in Profitability: There was an improvement in restaurant-level profitability, highlighted by a restaurant-level operating profit margin of 20%.The restaurant-level operating profit margin was solid, reflecting 19.4% in 4Q23, a significant increase compared to the 16.7% last year. The improvement indicates enhanced operational efficiency and effective cost management.
Cost Management: As a percentage of sales, food and beverage costs improved, coming in at 22.5% in the fourth quarter, compared to 23.7% last year. This improvement was attributed to carried pricing of 5.7%, favorable mix, and lower-than-expected commodity inflation of 2.1%.
Labor Efficiency: Labor and related expenses as a percentage of sales also showed improvement. They were reported at 33.9% of sales for 4Q23, better than the 34.5% realized in the fourth quarter of 2022. This was primarily due to improved labor scheduling, which drove favorable variances in both regular and overtime hours, alongside benefits from total health insurance costs, partially offset by additional management headcount for planned new restaurant openings.
(A) EBITDA: 4Q23 was 10.1%, up from the 8.1% last year. This expansion in the adjusted EBITDA margin was attributed to the significant improvement in restaurant-level operating profit, the successful addition of 23 acquired restaurants, and benefits from the 53rd week in the fiscal calendar, contributing positively to the quarter's adjusted EBITDA.

Forward-Looking Commentary:

Continued Growth Expectation: First Watch is confident in maintaining low double-digit unit growth, aiming towards a long-term goal of 2,200 domestic restaurants.
2024 Outlook: The company projects total revenue growth from 18% to 20%, with the same restaurant sales growth expected to be 1% to 3%. They plan to open 51 to 57 net new systemwide restaurants.
Investments in Technology: Pay-at-the-table technology is expected to streamline customer experience and operational efficiency, positively impacting future sales.
Slow Start to the Year: The first quarter of 2024 began with unexpectedly harsh weather across many of First Watch's markets, contributing to a slow start.
Formidable Comparable (Comp): The company is up against a tough comparison from Q1 2023, where the year's first two months were solid. For reference, the same restaurant traffic was up 8.5% in the first two months of last year, and the same restaurant sales were up 15.7%.
Traffic Trends: Despite a challenging start, year-to-date, the same restaurant traffic improved in February compared to January. However, it is still down to mid-single digits, considered in the full-year guidance.
53rd Week Adjustment: The fiscal 2023 included a 53rd week, which fell between Christmas and New Year's, traditionally one of the most productive weeks of the entire year for First Watch. Due to the calendar shift, this week fell out of 2024, contributing to the comparative challenges 1Q24.
Adjusted EBITDA Expectation for 1Q24: Due to the combined effects of the slow start in the first few weeks of the year, the absence of the 53rd week in 2024, and the formidable comps, adjusted EBITDA for the first quarter of 2024 is expected to be a few million dollars below the previous year.
Confidence in Growth Prospects: Despite the slow start in 1Q24, management remains confident in the brand's growth prospects. The company reiterates its long-term annual financial targets, including percentage unit growth in the low double digits and mid-teens growth for restaurant sales and adjusted EBITDA.
Expectation of Recovery: The circumstances impacting the first quarter are seen as isolated, with the expectation that Q1 will be the only quarter this year with an adjusted EBITDA comparison below the prior year. The company is optimistic about a recovery and more robust performance in the subsequent quarters.

Themes from Q&A Section:

Operational Excellence: There was a focus on effective labor scheduling and management turnover improvement as critical factors in sustaining restaurant-level performance.
Technology and Customer Experience: The discussion highlighted ongoing investments in technology like pay-at-the-table to enhance customer experience and operational efficiency. There was curiosity about the possibility of introducing a loyalty program, although it was indicated that while building customer relationships is a priority, a traditional loyalty program is not imminent.
Market Expansion Strategy: Questions were raised about the strategy for entering new markets, particularly with higher operational costs like New England. The company emphasized a disciplined approach to growth, ensuring new locations meet return criteria without compromising the brand's standards.
Off-Premise Sales Trends: There was interest in stabilizing off-premise sales (delivery and takeout) and its impact on overall sales. While off-premise sales continue to adjust, in-restaurant dining traffic and per-person averages are viewed positively, indicating healthy consumer demand.
New Unit Performance: Inquiries about the performance of new units and whether recent openings are achieving higher volumes led to discussions around the site selection strategy, focusing on ensuring high returns regardless of the incremental investment in larger footprints or higher-cost markets.

Amid Investor Vigilance, BJ's Restaurants Enlists Ex-Darden Financial Maestro

Establishing a Committee for Shareholder Value Initiatives could signal potential moves to elevate shareholder value. Amid this backdrop, we spotlight Gerald W. Deitchle, the Board's Chairman, aged 72, who served as CEO of BJ's Restaurants, Inc. from February 2005 until his step down in February 2013. Meanwhile, the helm has been under Greg Levin since 2021, 56, a 19-year veteran at the company, seemingly securing their positions for the foreseeable future. This dynamic, however, casts a shadow on the prospects of selling the company outright. A pivot in management might be the logical next step considering the stagnation at the leadership level and stock underperformance, yet this remains a distant reality. One wonders, what course would Ron Shaic chart in such a scenario?

BJ's Restaurants has unveiled the enlistment of Brad Richmond, the ex-CFO of Darden Restaurants, onto its board in a bold response to shareholder scrutiny. This maneuver emerged after a pact with Fund 1 Investments, an activist shareholder with now considerable influence over the brewpub conglomerate. Richmond's tenure as CFO at Darden, from 2006 to 2015, gave him invaluable insights into the industry. His odyssey at Darden traces back to the dawn of the 1980s, navigating through various fiscal roles within household names like Olive Garden and Red Lobster. Richmond's integration escalates BJ's directorial board to a dozen members. Gerald Deitchle, the helm of BJ's Restaurants, lauded Richmond's induction, asserting it as a testament to the company's dedication to amalgamating diverse competencies and backgrounds within its board to spearhead prosperity. In alignment with its concord with Fund 1 Investments, also recognized as Pleasant Lake Partners, BJ's has committed to the inception of a novel committee tasked with amplifying shareholder returns. The investment entity, anchoring from Puerto Rico and now possessing an 11% claim in BJ's 216-establishment network, has been vociferous in demanding strategic alterations, including contemplation of a sale, to augment shareholder dividends. Jonathan Lennon, principal at Fund 1, heralded the accord and affirmed confidence in BJ's strategic navigation through fluctuating market terrains, underpinned by Richmond's seasoned leadership. This episode unfolds in the backdrop of similar activist engagement at Bloomin' Brands, overseer of Outback Steakhouse, where Starboard Value, an activist entity, clinched the incorporation of former Darden luminary Dave George into the board alongside the formation of a committee dedicated to strategic enhancements. With the strategic addition of Brad Richmond and the genesis of the Shareholder Value Initiatives Committee, BJ's Restaurants steers through the prevailing market vicissitudes, poised to sculpt its strategic trajectory and cement enduring value for its shareholders. The move came about a week after another BJ's investor, PW Partners, said the chain should shrink its board to seven members who would focus solely on boosting shareholder value. It also recommended cutting expenses by $50 million and buying back $100 million worth of stock. PW owns about 5% of BJ's outstanding shares.

Brewing a New Future: How Starbucks' Truce with Workers United Could Shape the Coffee Giant's Labor Relations

The recent developments at Starbucks could herald a new era in the company's handling of labor relations, potentially leading to more collaborative and less contentious interactions between corporate management and workers' representatives. Success in these negotiations could not only pave the way for improved working conditions and labor contracts at Starbucks. However, the process's complexity and the historical backdrop of disputes suggest that achieving lasting agreements requires both sides' patience, compromise, and commitment. Here's a breakdown of the critical elements and their implications:

Overview of Events

Withdrawal of Board Nominations: The union collaboratively withdrew its nominations for three seats on Starbucks' board, signaling a trust that Starbucks will engage in good-faith negotiations with Workers United.
Labor Representation: Workers United represents employees at 386 Starbucks locations, emphasizing the extent of unionization efforts within the company.
Truce Agreement: Both parties agreed to work toward negotiating labor contracts, marking a departure from their previous confrontational stance that involved legal battles.

Implications for Starbucks and Its Stakeholders

Labor Relations Strategy: The truce and withdrawal of board nominations represent a potential turning point in Starbucks' approach to labor relations. A successful negotiation could set a new standard for how the company interacts with organized labor.
Impact on Labor Contracts: The negotiation agreement might accelerate the finalizing of labor contracts for the 9,500 unit-level employees represented by Workers United. However, as mandated by the NLRB, the complexity of negotiating separate contracts for each cafe suggests challenges ahead.
Corporate Governance and Investor Relations: The withdrawal of nominations, following advice from shareholder advisory groups, may stabilize Starbucks' governance and reassure investors about the company's direction, potentially impacting stock performance positively.
Public Perception and Brand Image: Starbucks' commitment to negotiating labor agreements may improve its public image, particularly among consumers who value corporate responsibility and employee welfare.
Future of Labor Movements: This development could inspire or influence labor movements in similar retail and service industries, showcasing the potential for negotiated resolutions to labor disputes.

Challenges and Considerations

Negotiation Process: The preference for negotiation formats (public vs. closed-door) has been a point of contention. A compromise satisfying both parties' concerns will be crucial for constructive negotiations.
Legal and Regulatory Landscape: The backdrop of legal battles and regulatory scrutiny underscores the importance of adherence to labor laws and regulations during the negotiation process.
Monitoring and Accountability: The SOC's intention to continue monitoring Starbucks' board performance and approach to labor relations indicates ongoing scrutiny and the potential for future actions if the union perceives a deviation from good faith negotiations.

With this settlement, the new CEO appears to be trying to separate himself from the founder, Howard Schultz. Howard Schultz recently wrote a letter to the company's leadership team and board. We see the critical points from the letter:

Schultz defines the "soul of a brand" as the company's core purpose and reason for being, which he sees as enduring and resistant to fads or dynamics that could undermine it. The soul concerns the company's values, culture, excellence, and customer trust.
He argues Starbucks' soul stems from its unique ability to offer universal appeal and acceptance globally by belonging with its people and communities; it's nurtured by intent.
Schultz believes the "center," the soul of Starbucks and its brand, must hold despite pressures from a challenging operating environment, increased competition, and an undone world.
He encourages the leadership team to address systemic challenges the company is facing, but without compromising Starbucks' soul. The implication is they should be cautious in responding to union pressures to avoid undermining the company's core purpose.

In summary, Schultz is making an impassioned plea to Starbucks' leaders to stay true to the company's enduring values, culture, and "soul" while navigating complex challenges, which seems to allude to increased union organizing. He wants them to respond carefully to these pressures in a way that doesn't compromise what makes Starbucks unique. The message suggests Starbucks' strategy is to hold firm to its core identity even if it brings it into some conflict with union efforts.