As consumers become more confident and increase spending, the restaurant industry is well positioned to begin growing in 2011. In spite of margin pressures caused by rising commodity prices, the industry should also see increasing capital expenditures as well as strong merger and acquisition (M&A) activity this year, according to the 21st edition of the Chain Restaurant Industry Review, released at last week’s Restaurant Leadership Conference by GE Capital, Franchise Finance.

“The restaurant industry is seeing slow and steady improvement as consumers begin to spend a bit more and the economy continues to improve,” says Agustin Carcoba, president and CEO of GE Capital, Franchise Finance. “With low interest rates, accessible real estate values and more liquidity in the financial markets, franchisees have an opportunity to develop an asset strategy, be it through remodeling, conversions, transitioning existing units to new locations or building new units.”

As operators grow more optimistic about the future due to improving same-store sales and restaurant traffic, it’s no surprise that approximately half of the operators surveyed by the National Restaurant Association (NRA) said they are planning capital expenditures in the first half of 2011. In fact, the NRA predicts the overall foodservice industry will see its first real growth in four years, resulting in sales up to $604 billion.

A survey of the largest 150 operators and top 100 chains that is included in GE Capital’s Industry Review went one step further. It found that respondents are concentrating on expanding within their current markets (44.4%) and reimaging units (31.1%).

These cap-ex opportunities coincide with a strategic shift at the franchisor level. Earlier in the decade, brands had focused on building co-owned units. More recently, they have shifted their asset strategy to franchising to capitalize on a targeted brand focus, achieve a steadier revenue stream and mitigate risk, thereby creating opportunities for well-established franchisees.

“As franchisors turn to the support of operators to grow their brands, GE Capital stands ready to help finance these middle market entrepreneurs,” said Trey Brown, sales leader of GE Capital, Franchise Finance.

Other important trends in the franchise restaurant industry include the following:

IMPROVED CONSUMER SPENDING: Consumers are more price-sensitive than before the economic downturn, seeking out bargains and using social media to research restaurants and find deals. Operators are responding by offering bundled value meals and changing their menus to emphasize less expensive ingredients due to commodity price increases. The most sophisticated operators are using social media as an inexpensive way to market their new offerings as add-ons to traditional marketing activities.

RISING COMMODITY PRICES: Despite significant increases in the prices of pork, wheat and coffee in the second half of last year, the industry overall saw the slowest annual rate of menu price increases in 55 years. Concerned about driving away price-sensitive consumers, many operators elected not to pass along the price increases and instead absorbed the higher costs themselves. That’s expected to change this year; 60% of operators as well as several chains have already announced plans to raise menu prices. Franchisors are also getting more savvy around menu mixes and promotions to retain the value-oriented customer while raising prices for certain products.

The Industry Review’s survey found that 88.9% of operators see commodities as the No. 1 factor that will impact their business in 2011, followed by financial markets and gas prices (tied at 33.3%).

MARGIN PRESSURES: The franchise restaurant industry continues to prove that it can be quite nimble. To cope with the margin pressures caused by rising commodity prices and price-conscious consumers, operators are reacting with menu modifications, emphasizing less expensive ingredients, such as chicken over pork and beef. They are also locking in supply contracts and improving operations.

INCREASED M&A ACTIVITY: U.S. restaurant M&A activity is expected to continue to be strong in 2011 due to the improved credit environment and increased liquidity. Sponsor-backed M&A deals jumped 578.2% in 2010 while non-sponsor deals rose 44.3%. Private equity firms are looking to put capital into the restaurant industry due to its unit growth potential, strong cash flow generation and strong cash-on-cash returns.

A copy of the Industry Review can be obtained by subscribing to www.gefranchisefinance.com and clicking on “Access Industry Expertise.”

Source:  GE Capital, Franchise Finance