Quick thoughts on QSRs: downside protection / unique stickiness?

I’ve been doing some work on different quick service restaurants (QSRs, or fast food; think McDonalds) on and off over the past few months (particularly on the heels of my “Is $QSR a quality bubble candidate?” post), and something has jumped out at me as I’ve been working on them: I cannot think of a scaled national level QSR that has failed, and that has me wondering if there’s something uniquely downside protected / resilient about scaled QSRs.

Let me back up and qualify that statement a bit: I’m not a restaurant analyst who’s covered the sector for 30 years or anything, so it’s entirely possible my memory is hazy or I’m missing one. But I honestly can’t think of a national scale QSR chain that has failed or even seen dramatic shrinkage over time.

Now, there is one exception to that rule: the national sandwich shops have had some real disasters: Quiznos shrunk from almost 5k stores at peak to basically nothing today, and Subway has had some real struggles recently.

But I don’t think that’s an exception at all. In fact, I mention it because I think the national sandwich shop struggles shows how resilient the “real” QSRs are.

Let’s start with a definition: when I say no national scale QSR has failed, I’m really thinking hamburgers or fried chicken concepts (think McDonalds, Wendy’s, Popeyes, etc.), and I’m thinking ones that have hit, say, 1k boxes across the U.S. (there’s nothing scientific about that number; 1k boxes is just a number that a lot of retailers cap out at so I’m using it here…. plus, it’s nice and round). You could make an argument to toss pizza in here too, and I think the same arguments would probably apply…. but the pizza business is so unique given the delivery angle that I’ll set it off to the side.

Anyway, looking at those QSRs and thinking about how they’re different than sandwich shops I think starts to reveal why the QSRs are so unique.

Sandwich shops are very simple to run. You basically take some cold cut meats, store it in the fridge, and then slap it on some bread. These things don’t require a ton of staff, equipment, or logistics; Subways generally don’t need to be staffed by more than two or three people at a time, and I know a lot of Subways where the franchisee / owner (and their family) serve as the majority of the employees. And I believe most sales come from “walk in” orders.

In contrast, a hamburger / chicken QSR is pretty labor intensive. You need about a half dozen to a dozen people at all times; someone to take the walk in orders, someone taking the drive through orders, someone operating the burgers, the fries, etc. Think about a sandwich shop: one person generally takes your order from start to finish and walks you down the line. So they’ll grab your bread, put your turkey on, the slap your lettuce and tomatoes and mayo, and then probably ring you up. That simply doesn’t work in fast food: if the same person grilled your burger and fried your frenches, the meal would take forever and/or half the food would be cold by the time it got to you.

Those differences create two moats for a QSR:

1. From a capital and labor perspective, it is much easier for a mom and pop sandwich shop to open up and compete. You and I could pretty easily open a sandwich shop tomorrow and staff it ourselves… opening a QSR requires a pretty significant investment in terms of staffing, equipment, etc.

2. Given the mini-logistical complexity of a QSR, a proven model / operating help is probably of a lot more help in QSR than in sandwich shops. That’s not to say the operating model is rocket science or anything; obviously there’s a standard playbook that works and it could be recreated by a new entrant. But it’s just another small moat that keeps mom and pops / small start ups from really easily entering.

Now, you could argue both of those mini-moats I just discussed for QSRs would apply to sit down restaurants as well…. and that doesn’t keep restaurants from being a hellscape of capital destruction with plenty of examples of nationally scaled restaurants that have failed (Red Lobster, TGI Fridays, and the list goes on).

But, again, I think there’s something unique about QSRs. McDonalds used to note that a 6 second improvement in order time resulted in a 1% increase in sales; the restaurant business is tough and logistics are important, but a thirty second difference in order time isn’t changing anyone’s world in a sit-down restaurant. In contrast, in QSR, thirty seconds per order is the difference between a wildly profitable unit and an unprofitable one. So I think that “seconds matter” moat is a key difference between the longevity and moat of QSRs versus the brutality of restaurant chains.

That’s not to say fast food has some impenetrable moat; there have obviously been plenty of new entrants over the years (raising canes and five guys have both grown pretty quickly over the past few years, though I think you’d be surprised how small they still are versus the big guys¹ / how long it’s taken!).

But, once a QSR chain has scaled, it seems like it gets pretty ingrained. Again, I could be missing one (and I’d love to hear from you if I am!), but I can’t think of any scaled QSRs that have failed or even dramatically shrunk.

And, if I’m right, that’s got some pretty interesting investing implications. In particular, there’s a group of “high quality” companies that investors treat as bonds and trade at very high multiples because of the stability / safety of their cash flows; think Coke trading at 30x forward FCF or COST trading at >50x FCF. As I write this, Wendy’s (WEN) trades for a mid-teens price to earnings or free cash flow (a bit higher on earnings, a bit lower on FCF) with an almost 6% dividend yield and a decent sized share buyback program; QSR (the Burger King parent) is in the same multiple neighborhood. If QSRs are as sticky / downside protected as I’m arguing, then both companies multiples should be much, much higher.

Let’s wrap this up with something: what could change my alleged downside protected nature of QSRs? A few major risks come to mind:

• You could imagine GLP-1s dropping the demand for fast food across the board

• As digital ordering and delivery get more important, you could imagine that “seconds matter” edge coming down, and location selection / availability (another big edge for a national player versus a mom and pop) getting less important (in fact, you could imagine a world where delivery becomes more important and legacy chains are actually disadvantaged given their footprint locks them in to more expensive areas with high foot traffic that might not be ideal for a delivery first world)….. but I suspect if this was going to prove a major negative, it would already have played out given how wide spread digital became during the pandemic.

• This might be a bit more out there…. but one big edge national chains have / had is that they could afford “mass market” advertising (think buying national ads during football games) and a smaller competitor couldn’t. As we move more to a streaming world with dynamic ad insertion, maybe smaller / regional player can compete more in that space, which decreases brand strength?

But, at current multiples and with the trends we’ve seen historically, those risks seem pretty minimal / like investors are more than getting paid for them.

Anyway, I’m just starting to look at the QSRs again, and I don’t have a position in any of the ones mentioned…. but, if you’re knowledgeable on the space or have thoughts where I’m way off (or dramatically right!), I’d love to hear them.

PS- most of the scaled QSRs are franchised systems, and they did that so they could grow quickly…. but I also wonder if that’s part of the reason QSR systems prove so resilient. Imagine you’re a 1k unit chain that owns / operates all of their units. Imagine that all 1k units are profitable…. but suddenly your operations start to slip for some reason and 50 units go from profitable to unprofitable. If you own and operate all those stores, it’s easy to ignore that degradation; after all, on the whole you’re still wildly profitable, and I’m sure you can come up with plenty of easy excuses (“the store manager is bad”, “that region’s economy is performing poorly,” etc.) and not really make any changes. In contrast, if you’re a franchised system, you’re going to be getting furious phone calls from 50 angry franchisees talking about how you’re ruining their livelihood, and the reason the stores are unprofitable is because your competitors are running a value promotion that’s taking share and the new advertising campaign is falling flat. I could be off, but I do wonder if having franchisees who will get angry / vocal the moment things seem off serves a self-correction force for these scaled QSRs if they start to lose their way.

Again, I’m not an expert / just spitballing and researching the space / no position in any of the stocks mentioned…. would love to chat if you have any thoughts!

1. Canes, for example, was founded in 1996 and has just over 800 restaurants; Popeyes is around 3k domestic boxes.