If you missed Part I, here is the link (Part I)
The restaurant business has extremely low barriers to entry. Although the failure rate for restaurants is high, new ones open all the time. This revolving door of restaurants is great for variety, not for building loyalty. Margins in this business are structurally low, to begin with. The pressure to discount and to spend more on sales and marketing costs eats away at any remaining profitability. With this backdrop, even a minor hit to sales pushes this business to be unprofitable.
COVID is a crushing blow to the sole restaurant entrepreneur – one who was long on grit - and short on resources. It is virtually impossible to sustain a small restaurant business, operating only at 70% capacity for an extended period (here is why). Therefore, the National Restaurant Association expects tens of thousands of small restaurant operators to permanently close their doors.
Large chains can tap into multiple resources that small operators lack. They have bank borrowing lines, the ability to raise alternative capital, and the scale to negotiate with landlords for rent relief or deferral. These chains have invested in the right partitioning of the dining room for safety, built patios to enlarge seating space, and focused on building own delivery channels to complement the aggregators. Chains are share gainers again. A crisis also provides the urgency to streamline. Smaller menus, tighter operating procedures, and removal of all non-essential costs amount to real savings. These chains are already reporting surprisingly high margins for the low level of sales. Most of these eliminated costs will take a long time to creep back. The experience after the Great Recession clearly demonstrated this. The large chains with deep pockets have significant scale advantages, and they are flexing their muscle to their full capacity.
Let us step back for a minute and think about supply and demand curves, or Economics 101. When supply in a certain market is overbuilt, two things must take place to reach market equilibrium: 1) a rise in demand, or 2) an exit of supply. Generally, both happen slowly, and over time. However, the case today is not in any Economics textbook.
They supply of restaurants will exit the market as the pandemic continues. Demand for eating out dropped 90% in the initial weeks of the pandemic, has improved in the subsequent months, and is now running at negative 40%. At this rate, it is still incredibly difficult for most small chains to continue operating, bringing more attrition. At some point in the future, a vaccine or a health care solution will come to the market. We all intuitively understand the pent-up demand for the forbidden fruit! Who does not want to go out with friends and relax over a meal? Demand for dining out will snap back – overnight! Restaurants that have survived, will boom. The chains will eat most of this share. These restaurant chains will earn higher revenues at higher margins. However, the supply of restaurants will return much slower. Therefore, revenue and profit growth will sustain at a higher level, for much longer than most are willing to believe.
The Dine-out industry will bloom again. The survivors will reap the benefits. The Chains will be massive winners. Markets are short term oriented and do not believe this outcome. There will indeed be lots of ups and downs. However, thinking long term is the only path to success in investing.
Over time, the forbidden fruit will have juicy returns.
This material does not constitute an offer or solicitation to purchase an interest in Latticework Partners, LP (the "Fund"). Such an offer will only be made by means of a confidential offering memorandum and only in those jurisdictions where permitted by law. An investment in the Fund is speculative and is subject to a risk of loss, including a risk of loss of principal. There is no secondary market for interests in the Fund and none is expected to develop. No assurance can be given that the Fund will achieve its objective or that an investor will receive a return of all or part of its investment.
This material contains certain forward-looking statements and projections regarding the future performance and asset allocation of the Fund. These projections are included for illustrative purposes only, are inherently speculative as they relate to future events, and may not be realized as described. These forward-looking statements will not be updated in future.
I am an investor and these are my personal thoughts on investing, behavioral finance, markets, and sports viewed through the prism of a Latticework