Table for Two, Six Feet Apart

Friday Reflections

Table for Two, Six Feet Apart

The market remains hungry for good news that can help sustain the recovery rally, but the data tells a more complicated story. As one analyst put it, the tension between people’s desire to return to normalcy and the public health guidelines designed to prevent an overwhelming second wave of Covid cases will “help keep volatility high and markets violently flat near term.”¹ Broad stock prices pushed higher earlier this week on retail sales data headed in the right direction, but remain flat for the month of June.

While pieces of positive news emerged this week on three fronts – the Fed, virus treatment, and retail sales data – it is still an open question if virus resurgence will slow the path to recovery. The Fed began the next phase of stimulus with their first direct purchases of corporate bonds, propping up prices to investor delight. On the treatment front, a major study showed that the steroid dexamethasone reduced deaths by a third for COVID patients on ventilators.² Hardly a vaccine, but progress is a positive. Retail sales data from May provided a further boost, showing a 17.7% increase from April³ as consumers proved willing and able to spend as shelter-in-place measures began to lift. This optimism was tempered, though, by an alarming surge in coronavirus cases in many US states.

We have written before of the historic levels of uncertainty that seem at odds with near historic price levels, as well as the wisdom of keeping our portfolios focused on the long-term. In a time of economic recession, with an expected 7% decline in US 2020 GDP, the market nevertheless sees the silver lining of recovery – often earlier than Main Street. Is this a moment when the market is simply early, or does the double whammy of the Covid pandemic make today’s situation different?

One good candidate to explore this question is the restaurant industry, where the tension between economic recovery and new public health demands have hit particularly hard. Supporting public health practice while recovering profitability is, so far, a puzzle without a solution. Food consumption patterns at all price points and cuisines have long been interwoven with public health, but the current pandemic has moved the discussion beyond obesity trends, cultural preference, and food safety to a discussion of whether it is safe to be physically near other people – risking the loss of essential social gathering spaces that restaurants provide

Breakfast, Fine Dining Struggles – and Pizza Thrives

The underlying data from the jump in retail sales referenced above reveals dramatic variations – consumer spending habits are shifting as we head into a homebound summer season. Travel and jewelry purchases remain depressed, but sales at home improvement stores, furniture retailers, and even orders for backyard pool installations are seeing strong surges.⁴ These new spending patterns are reactions to the dramatic uptick in time spent at home. This phenomenon of changing routine and regulation creates significant impacts on the restaurant industry.

Consumers no longer have to rush out the door in a mad dash to work, which means more time to make a simple breakfast and brew a fresh cup of coffee. Without these ritual purchases by morning commuters, coffee shop sales declined by 70% versus the prior year and breakfast restaurants have struggled disproportionately with minimal take-out or delivery interest. At the other end of the meal spectrum, fine dining has also seen 85% declines in sales compared to a year ago. These higher-end eateries are impacted not only by restrictions on dining capacity, but many consumers are “cutting back on indulgences; now a date night is a long walk and sharing a bottle of wine, not dinner in an expensive restaurant.” Natural cost cutting during a recession period is being amplified.

One bright spot has been pizza restaurants. We’ve written previously about the advantage of businesses that already had an established digital presence (see: Amazon and Netflix). Pizza restaurants had a similar advantage – a pre-existing business model and customer base built on delivery, recession-friendly price points, and packaging that is recyclable. A recent national report showed that these advantages meant that pizza restaurants as a category actually showed a 5% increase in sales during the COVID crisis.⁵

Twice the Costs, Half the Revenues

The restaurant business has never been an easy one. The margins are razor thin – averaging 6.2%⁶ – and the failure rate is fairly high.⁷ Restaurants that survive have a successful niche, a following, and a financial model that works, even if not hugely successful. These functioning financial models, built on dine-in service, have been turned upside down post pandemic. With access to Payroll Protection Program loans, some have limped from zero service to a curbside pick-up model and reliance on food delivery apps, but their overhead makes this unsustainable longer term. Others have already failed, especially if they were facing ownership succession issues; retirement became the easiest option. Given the chance, many are making an attempt to re-open when county health orders allow – and are learning exactly how difficult the new environment is.

Tamer Hamawi, co-owner of a Napa based restaurant, explained that after removing 50% of their tables to comply with social distancing, and spending significantly on sanitation supplies now required to operate safely, their re-opening only lasted one week. He laid out simply that “even at the bare minimum of staffing levels, we ran a labor cost of 57% of sales in our first week, food and beverage costs at roughly 30% and direct operating expenses at 25% – that’s a net loss of 12%.” Further, restaurant staff “essentially became front-line workers with the increased risk of exposure to the virus while making half the usual tips”⁸  This is compounded by the fact that most of the staff was receiving more in unemployment benefits than they were able to earn during these reduced capacity shifts. The economics didn’t make sense for the business owner or the employees.

The Daily Special: Adaptation and Experimentation

Despite current headwinds, restauranteurs were already well-acquainted with the cycle of failure, transformation, and launching new culinary ventures. Brave adaptation is already underway to meet these shifts in consumer preference and the directives of county health regulations. Outdoor dining, with certain new protocols, has been deemed safe in many areas. It is a lifeline to the industry given limitations on customer spacing; restaurants nationwide have expanded their outdoor footprint in creative ways. Many restaurants, including famed Chicago pizzeria chain Lou Malnati’s, have set up tables 6 feet apart in their parking lots to expand available seating. Certain urban areas, including Berkeley,⁹ have closed specific roads and reduced red tape for use of street parking to increase outdoor dining space and embrace a plaza model similar to café centric European cities. Experimentation is underway.

Data from online reservation service, OpenTable, showed a 10x increase in outdoor seatings nationwide at restaurants this spring (April 24 to May 18) compared with the same period a year ago.¹⁰ How this will impact long term urban planning and space usage is hard to say. Certainly shifting the locus of gathering outdoors is a healthier option in these pandemic times, and may be the only path to operating profitability if consumers stay home due to fear of exposure in enclosed spaces..

A Hard Prune for the Rosebush

One core tenet of a capitalist free market, and of gardening, is that pruning leads to more resilient future growth. As Maude put it in the cult favorite “Harold & Maude,” while affectionately eyeing plants as she wanders through a greenhouse, “things grow and bloom and fade and die and change into something else.”¹¹ Like a rose bush that creates a structural focus in a garden, restaurants play a key role in many communities. From staff employment, to the strength of vendors and suppliers, to the important mental health benefits from a celebratory meal out – many different stakeholders are invested in the ongoing success of the industry. This restaurant industry metaphor, and the process of creative adaptation, provides a view into the pruning – in the context of the entire garden – that may be needed across the broader economy, and the innovative changes necessary to collectively move forward in a world where pandemic concerns remain.

Individual businesses may or may not pivot forward in creative ways – Eastman Kodak stumbled badly when photography went digital, and even Apple stumbled for years before original founder Steve Jobs returned and ramped up their commitment to innovation. Pivot they will, though, in collaboration with consumers’ changed habits and differing public health practices. Businesses will adapt to new regulation, change their offerings, and “grow and bloom and fade and die” in a myriad of ways. Consumer spending will continue to evolve as stay-home orders are loosened and lifted, and city life will be different.

We are hopeful that many of our local favorites will be able to weather the storm, but also know that there will be new and dynamic choices, and we’ll all continue to have options, whether to order food online and pick up, or dine al fresco as we are able to, in support of our community.

¹ Dennis DeBusschere, Macro Research Analyst at Evercore ISI. Market outlook note published 6/15/20.

² Steroid Treatment Saves One Third Of Most Severe COVID-19 Cases: Trial;  Barron’s Online, Agence France Presse, June 16, 2020

³ U.S. Census Bureau, ADVANCE MONTHLY SALES FOR RETAIL AND FOOD SERVICES, MAY 2020; https://www.census.gov/retail/marts/www/marts_current.pdf

⁴ Boats, Pools and Home Furnishings: How the Lockdown Transformed Our Spending Habits; WSJ, Matthew Dalton and Suzanne Kapner, June 16, 2020

⁵ Bernstein Research; Datassential; Earnest Research; McKinsey research and analysis. McKinsey & Company: How restaurants can thrive in the next normal

⁶ Rory Crawford, Restaurant Profitability and Failure Rates:  What You Need to Know, FSR Magazine, April, 2019.

⁷ While urban legends on high restaurant failure rates may not be true, especially smaller ventures with fewer than 20 employees fail at a fairly rapid clip – approximately 20-30% in the first year, and up to 50% after three years.  These first year rates are similar to failure rates for new real estate agents, insurance agencies, landscapers and auto repair ventures.  See Adam Ozimek’s decisive and thorough study from 2014, No, Most Restaurants Don’t Fail In The First Year, Forbes, January 29, 2017, and G Sidney, Restaurant Failure Rates Recounted:  Where Do They Get Those Numbers? RestaurantOWNER.com, 2003.

⁸ https://www.sfgate.com/food/article/Bay-Area-restaurant-owner-closed-again-15341979.php

⁹ https://sf.eater.com/2020/5/14/21258980/berkeley-coronavirus-covid-19-jesse-arreguin-street-closures

¹⁰ Restaurants Scramble To Make Outdoor Dining Safer; Dees Stribling, Bisnow National, June 17, 2020

¹¹ Colin Higgins, “Harold and Maude,” published as both a screenplay and a book in 1971, and produced as a film starring Ruth Gordon and Bud Cort.