Three years into COVID hitting the U.S., the number of restaurants per capita is at its lowest point in 25 years—a stunning figure that bodes well for chains, says Nick Cole, head of restaurant and hospitality finance at Mitsubishi UFJ Financial Group (MUFG). 

Companies view it as the time to fill whitespace, although it isn’t easy with the backdrop of higher borrowing costs and prices of construction materials and real estate. Cole says it can be difficult to get return on capital for new unit development in today’s macroeconomic environment. 

But restaurants, innovating with smaller footprints and second-generation spaces, are using alternatives to build more because they see what’s ahead. 

“They want to grow because they do see the opportunity particularly coming out of a recession to hit that demand curve [from consumers] when it starts snapping back,” Cole says. 

Cole notes that fewer food and drink locations mean concepts have an easier time passing higher operating costs onto consumers in the form of price increases. At the same time, the labor market appears to be improving (restaurants accounted for 12.17 million jobs last month, down 1.3 percent from 12.34 million in February 2020) and inflation is trending in the right direction. 

So maybe the recession won’t be as impactful in the foodservice industry? 

“This dream of the soft landing and recovery, maybe this will be the first time we actually see that play out or hopefully, knock on wood,” Cole says. 

FSR recently spoke with Cole to gather his thoughts on restaurants and how they fit into the country’s overall economic cycle. The conversation touches on restaurant supply, price increases, and the future of M&A and IPOs. 

What’s happening to the supply of restaurants? 

You hit this point in 2020 where we really fell to the lowest supply relative to population that we’ve seen in a very long time. So the per capita supply of restaurants dropped to this all-time low. That’s not the norm because normally when you’re in an economic expansion, your supply is high and then we haven’t really hit the recession part yet. We’re starting to see that now as the Fed is tightening and we’re dealing with inflation and we’re going into this economic cycle driven by the Fed into potential recession scenario where the restaurant supply is low, not high. So that’s a little bit weird.

Normally coming out of a recession, the recovery period usually happens pretty fast for the restaurant industry and you’re at your best point in time for traffic growth. That might still be a year, year-and-a-half away if in fact we find ourselves going into some form of recession in the first half of this year. But what I think will happen is that the snapback will be even more dramatic because consumer demand will come back in, but the supply will be still quite low.

Pouring over data and all that you come across, are you able to get a sense of how much market share these bigger chains have been able to gain across the pandemic? 

I think overall, the drop in total restaurant supply in 2020 was around 7 percent, but the drop in chain restaurant supply was was more like 2-2.5 percent. 

Do you see a turning point sometime this year in which consumers start going elsewhere as opposed to restaurants because of higher prices?

I think there are a couple of factors to think about when we’re looking at that. I mean first, usually that demand cycle is directly related to the unemployment trend. So we haven’t seen an uptick in unemployment yet. Also, everything’s relative. So the prices of food at home have been going up as much, if not slightly faster than away from home. So the big chains—purchasing power and efficiencies and all that—can manage through that period of time of inflation a little bit better in some ways. So they have certain advantages, but there’s no fighting against the simple facts of an economic cycle that if unemployment does start to tick up a little bit and the consumer hasn’t seen increases in wages at the same pace as increases in expenses, there becomes a pinch on discretionary spending.

You are starting to see layoffs. I mean we’ve mostly read about it around higher-paying jobs and tech sector things, but you are starting to see that. And certainly most would say that the pressure for increasing wages isn’t as high today as it was a year ago. So I do think we’re at the early stages of starting to see whether the consumer will pull back, but I think it’ll be a little bit selective depending on where you sit on the pricing spectrum of the industry. You look across the burger segment for instance, and the difference between the high-price premium burger guys and what that costs and and the more efficient value-focused, bigger fast-food chains—which are going to see the pullback in demand first? It’s probably pretty obvious.

Talk about your thoughts on 2023 maybe being a better environment for restaurants to enter the M&A space and IPO space? 

Yeah, I definitely think so. No one wants to sell their business when performance is down. Everyone sits there and looks at says, “Well I could have sold it when my business is doing better and got more money for it.” It’s intuitive that you’d rather sell when business is on the uptick than on the downtick, unless you have to. So a lot of the M&A activity in 2022 was more stuff where something had to happen either because a business was struggling and you had to recapitalize and and those kinds of restructuring situations or just stuff happens like a business founder/shareholder passes away. That was really the extent of M&A activity in ’22.

I think [the IPO market] is a little bit of a different dynamic. I would say CAVA is early in the IPO cycle. Normally, capital pours into early stage recovery industry investments when we start to feel the economic recovery starting. That’s when equity owners buy opportunistically into industries like restaurants. And so capital coming into equity, evaluations picking up, I would think that’s more of a 2024-2025 phenomenon than it is the second half of this year.

Was there anything that we we didn’t touch on about your outlook and the future of the industry that you would like to add?

I do think it will be interesting to see how the delivery business works their way through this recession when we talk about discretionary spending and where the consumer might pull back. I think that the premium that you pay for delivery is probably something that will be an early stage consumer pullback item. It’s just very expensive when you tack on that delivery premium to value-based food. That’s something I would pay attention to.