Franchisee Bankruptcy Risk Emerges

Consistent with our bankruptcy theme and my comments from the bankruptcy conference call that the biggest risk to the QSR companies is franchisees going bankrupt, Midland Food Services, LLC, one of the largest Pizza Hut franchisees in the U.S. filed for Chapter 11 bankruptcy earlier this week. YUM is particularly exposed to this franchisee risk due to the massive amount of stores the company has sold over the last five years (YUM has a target to reduce its company ownership mix to below 10% by 2010 from about 20% currently and nearly 30% in 2002). Franchisees have used significant leverage to buy stores, which already puts them at greater risk. Making matters worse, YUM’s U.S. company-owned store base has recently experienced significant margin declines. KFC has been particularly weak recently, and chicken prices will only be moving higher.

Another phrase that will join the list of commonly used phrases by the restaurant industry is “the health of the franchise system.”