E Why Is Restaurant CapEx Spending Assistance To Franchisees On The Upswing?

Another issue: the level of capital expenditures necessary to remodel restaurants and add new brand mandated systems and equipment has become big numbers. Our calculations show that depreciation expense—the typical proxy for capital spending that is a tax deduction and a non cash expense—isn’t enough to provide a fund. The actual outlay of cash required is greater than that. Even if restricted cash is available to pay for future remodels and upgrades, the effect of inflation on construction and equipment would require even more funds than were originally earmarked to get the same purchasing power. Keep in mind that most franchisees have a store development agreement in place, whereby building new stores or purchasing new stores competes for funding with remodels. Bank debt can partially suffice unless lending covenants are already stretched.

Finally, franchisees are typically in 'wait and see' mode on remodels and new sales platforms until the franchisor executes it themselves and proves that it works. That builds in delays--time of implementation lags. If the franchisor has company stores (some do not, such as Dunkin Brands (DNKN) and Subway, for example), it takes time for brands to get proof to market and get the franchisees on board. This has happened with all of the leading franchisors—McDonald’s, Wendy’s (WEN), Burger King (QSR), Sonic (SONC) and many others. 

As a result, some franchisors have taken the lead in making co-capital investments with franchisees to jump start future progress. A partial list follows: 

  • Since McDonald's (MCD) owns most of its real estate, it can justify partially funding franchisee costs. This occurred in 2008/2009, with the McCafe co-investments (about $150K per store), and then in 2016/2017 with its Experience of the Future Investment (about $6 billion in total franchisor/franchisee investment over 2018-2020, with the franchisor funding about 55% of that.[2]
  • Via its parent YUM Brands (YUM), Pizza Hut made a basket of investments in 2017 ($130M)[3]and 2018 ($200M)[4] to enhance restaurant operations, marketing and remodeling. This was done to ease the burden on franchisees and to ensure improvements were implemented more quickly.
  • Dunkin Brands (DNKN) recently set aside about $65M for CAPEX and equipment to help fund test store’s expansion to its Next Generation store types.[5]
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Disclosure: The author has no positions in any stocks mentioned.

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