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Odds of default ease for biggest US restaurants, but pandemic woes persist

The odds that the largest publicly traded U.S. restaurants will default fell in recent months as states allowed businesses closed by the coronavirus pandemic to reopen. But the ongoing financial hits from the virus and uncertainty over whether laid-off consumers will receive expended unemployment benefits continue to pressure the industry as more companies enter bankruptcy.

S&P Global Market Intelligence's median one-year market signal probability of default fell to 10% for U.S. restaurants in July after hitting 35% in April. The figures represent the odds that a company will default on its debt within the next year based on fluctuations in the company's share price and other country- and industry-related risks. As of Aug. 7, the odds that big publicly traded restaurants would default within a year stood at 12% from 8% on the same day a year ago.

The pandemic upended the restaurant industry and sped up delivery and takeout trends. Smaller, independent restaurants are more at risk than the large publicly traded restaurant companies, experts say. U.S. food service and drinking places added a half-million jobs in July, down from the 1.5 million jobs the industry added in both May and June, as the broader economic recovery slowed and coronavirus cases rose.

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Gaming and casual dining chain Dave & Buster's Entertainment Inc., Outback Steakhouse parent Bloomin' Brands Inc. and Denny's Corp. are among the largest publicly traded U.S. restaurant companies most likely to default, according to Market Intelligence data. But all the big publicly traded restaurant companies had their chances of default decline from the sector's peak in April.

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"Nearly every big chain has done something to support its balance sheet," James Rutherford, a vice president and research analyst at Stephens Inc., said in an interview. "The place I do see risk for default is going to be with franchisees."

Franchisees, primarily privately held ones, in some instances have less access to capital or could have taken on too much debt before the pandemic, Rutherford said.

NPC International Inc., a large franchisee of Pizza Hut and Wendy's restaurants in 30 U.S. states and the District of Columbia, and its affiliates filed for Chapter 11 bankruptcy July 1. NPC International faced increased labor and commodity costs, in addition to a higher level of financial leverage that the impact of the pandemic magnified, Jon Weber, CEO and president of NPC's Pizza Hut division, said in a July 1 news release.

California Pizza Kitchen Inc. said July 30 that it filed for Chapter 11 bankruptcy and entered into a restructuring agreement with its senior lenders that included $46.8 million in new financing to keep its restaurants open. Filing for bankruptcy would allow California Pizza Kitchen to reduce its long-term debt load, the company said, adding it hoped to complete the bankruptcy process in less than three months.

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The restaurant companies with the highest one-year probability of default scores as of Aug. 7 were Dave & Buster's at 16.1%, Bloomin' Brands at 13.2% and Denny's at 11.9%. The largest U.S. companies least likely to default included Chipotle Mexican Grill Inc. at 0.1%, McDonald's Corp. at 0.4% and Wingstop Inc. at 0.5%.

The figures are steep declines in the odds that big publicly traded restaurants could default from the sector's peak in April when many companies' chances of defaulting within a year rose above 16%. The restaurant sector's probability of default fell in May to the low 20% range, and in June, the odds continued to decline into the low teens.

Dave & Buster's on June 11 reported a net loss of $43.5 million for its first fiscal quarter ending May 3, missing analysts' expectations for the period, according to S&P Capital IQ. Dave & Buster's probability of default recently peaked at 61.5% on May 13. The company took steps to conserve cash, secure new equity capital and rethink its operating model, Brian Jenkins, Dave & Buster's CEO, said in a news release.

"With many competing 'eatertainment' concepts still struggling to reopen, Dave & Buster's appears poised to benefit from a more favorable competitive environment post-pandemic, following several years of pressure from the rapid expansion of myriad new concepts," Sharon Zackfia, a William Blair analyst, said in a June 12 note.

In an Aug. 14 statement to Market Intelligence, a Bloomin' Brands spokesperson said the company has more than $500 million in liquidity, which allowed it to provide relief pay for employees without furloughs or layoffs while restaurants were closed. That liquidity would support the company beyond a year even if the company returned to its peak cash burn rate during the closures and Bloomin' Brands is generating positive cash flow since dining rooms have reopened, the spokesperson said.

Bloomin' Brands recently posted what will likely be best-in-class same-store sales recovery progress since early May. Still, the company's recovery moderated in July, and demand challenges could be on the horizon for the casual dining segment in the months ahead, Jeff Farmer, a Gordon Haskett Research Advisors analyst, said in a July 24 report. Factors that could weigh on demand include reduced federal stimulus efforts, reduced outdoor seating flexibility from colder weather and "an election season that will intensify election coverage consumption and lead to fewer meals outside of the house," Farmer said.

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U.S. restaurants are among the hardest hit businesses, with the pandemic and lockdowns forcing dining rooms to close. Sales at U.S. food services and drinking places were down 26.3% in June from the year-ago period. U.S. banks are adjusting their exposure to the restaurant industry.

Restaurants could be impacted after expanded unemployment benefits expired and as Congress continues hashing out the details of another rescue package, analysts say.

"The more stable we can keep the consumer, the better it is for these businesses," Jason Ware, partner and chief investment officer at Albion Financial Group, said in an interview, adding that he expects some form of relief to get passed. "Ultimately, we think that Congress will do what's necessary."