Deconstructing Unit Economics: A Granular Approach to Restaurant Valuation
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The Importance of Unit-Level Profitability
While Wall Street often focuses on consolidated financial statements, the true value of a restaurant chain is determined by the profitability of its individual units. This is where unit economics comes in. Unit economics is the analysis of the revenues and costs associated with a single restaurant location. By understanding the unit economics of a restaurant chain, traders can gain a much deeper understanding of its long-term growth potential and profitability.
Key Unit-Level Metrics
The three most important unit-level metrics are Cost of Goods Sold (COGS), labor costs, and occupancy costs. COGS represents the cost of the food and beverages sold by the restaurant. Labor costs include the wages and benefits of the restaurant's employees. Occupancy costs include rent, property taxes, and other expenses related to the physical location of the restaurant. Together, these three metrics are known as prime costs, and they typically account for 60-70% of a restaurant's total costs.
Building a Unit Economic Model
To build a unit economic model, you will need to gather data on a company's average unit volume (AUV), COGS, labor costs, and occupancy costs. This data can typically be found in the company's annual and quarterly reports. Once you have this data, you can calculate the restaurant-level contribution margin, which is the AUV minus the prime costs. The contribution margin represents the amount of money that each restaurant contributes to covering the company's corporate overhead and generating a profit.
Case Study: The Cheesecake Factory (CAKE)
The Cheesecake Factory is known for its massive menu and large, complex kitchens. This results in higher-than-average COGS and labor costs. However, the company is able to offset these higher costs with its high AUVs. By building a unit economic model for The Cheesecake Factory, traders can see how the interplay between these different factors affects the company's overall profitability.