Why Your Favorite Restaurant Could Soon Be Doomed

A dream becomes a nightmare... This story isn't isolated to San Francisco... Why your favorite restaurant could soon be doomed... A one-two punch that will drive costs higher... The most vulnerable companies in this industry...

Azhar Hashem knows all too well how hard it can be to operate a restaurant...

In June 2016, the Jordan native and former Google executive opened Tawla in the Mission District neighborhood of San Francisco.

Hashem dreamed of building a full-service restaurant that served her own interpretations of Middle Eastern favorites. Going in, she knew it would be a challenge... But as Hashem told local news website Mission Local just before Tawla opened: "I'm in it for the long haul."

Initially, the restaurant exceeded her expectations. It became an instant hit...

In August 2016, the San Francisco Chronicle dubbed Tawla "the Mediterranean restaurant that S.F. needed." And about seven weeks later, Mission Local raved that Hashem "had the foresight... to make sure her opening and the weeks that followed were flawless."

However, Hashem's dream was short-lived...

Running Tawla quickly turned into a nightmare. The restaurant soon experienced major staffing problems. As I (Bill McGilton) explained to my Stansberry's Big Trade subscribers back in July...

Hashem did her best to pay competitive wages. She subsidized employee meals and commuting costs. She even imposed a 20% service charge on Tawla patrons in lieu of tips. (By law, tips could only be paid to the waitstaff. The service charge could be paid out to the kitchen as well.)

But Tawla's waitstaff – who averaged $38 an hour, or the equivalent of $70,000 to $80,000 a year – saw the service charge as taking money out of their pockets.

Now, I know what you're probably thinking... $80,000 a year for waiting tables seems like a lot. Keep in mind, though, we're talking about San Francisco...

The monthly rent on a one-bedroom apartment in the city cost an average of nearly $3,500 last year. That's $42,000 a year for one of the most basic housing arrangements.

In other words, Tawla's employees needed to spend more than half of their income on rent. They had a "housing-cost burden" – when 30% or more of a person's income is spent on housing – at roughly twice the amount the U.S. government considers to be normal.

At their income levels, most of Tawla's highest-paid waitstaff couldn't afford more than $2,000 per month in rent. For example, a long-tenured line cook who averaged $24 an hour (around $50,000 per year) couldn't afford an apartment for his large family... Instead, he moved from place to place with his wife and four kids, sleeping on friends' couches.

Hashem eventually switched to a hybrid model for her staff...

This new model included tipping and a reduced 6% service charge. The tips allowed Tawla's waitstaff to collect more income, while the smaller service charge still allowed the restaurant to supplement its kitchen staff.

With the move, the servers' pay increased to around $45 an hour (or roughly $90,000 per year). Hashem thought the change was a good compromise for everyone involved.

But in the end, it didn't matter...

It simply cost too much for Hashem to keep things running smoothly.

Tawla's staff was always hunting for better job opportunities. Turnover was high... Only three of the restaurant's original 25 staff members remained at the end of last year.

Hashem told online magazine The Bold Italic in February that the massive turnover rate in the industry crushes many restaurants – particularly in San Francisco. As she wrote...

The situation in this industry has created a mercenary frenzy whereby everyone is running around trying to maximize what they're able to make per hour. According to culinary hiring service Instawork, annual turnover in the restaurant business in San Francisco has reached as high as 90%, and operators pay about $3,000 to rehire and train a new hourly employee. For context, the national restaurant industry turnover was a little over 70% during the last two years.

From our experience, the associated cost of turnover for an employee who left came in at about $2,600–$3,200. This cost included sourcing a new employee, training them until they were able to be independent contributors and paying any overtime associated with another staff member covering the labor shortage. In total, our business saw a 10% increase in labor costs due to turnover alone.

Tawla served its final meal of puffy house pita bread and mezze Mediterranean snack platters last December. Hashem's culinary endeavor only survived two and a half years.

The thing is, this story isn't isolated to San Francisco...

The restaurant industry has always been a tough business to succeed in. It's a challenge to own and staff restaurants whether you're in New York City or Wichita, Kansas.

And nowadays, these businesses face even harsher realities... With the unemployment rate near a record low, it's getting even harder for restaurants to find, train, and retain workers.

The pay across the industry is typically low. And of course, simply paying higher wages would drive up costs... which would drive up menu prices... which would drive out patrons.

As I'll explain in today's Digest, though, most restaurants have no choice but to try to adapt to the changing times in the country. They must figure out how to cut costs – while keeping the same level of quality – in order to remain attractive to American consumers.

If they can't do that, they're doomed to suffer the same fate as Tawla. Whether we're talking about the smallest hole-in-the-wall joints in your area or the biggest national chains, one thing is clear... Things will soon get much worse for the restaurant industry.

Hoping to attract workers without raising wages, many restaurants are 'getting creative'...

For example, in an attempt to attract prospective employees, fast-food chain Taco Bell – owned by Yum Brands (YUM) – has started hosting "hiring parties" with free food and gear. On its website, the company notes that its hiring parties are "not your average job fair."

In April, Taco Bell held roughly 600 of these events across 44 states in one week. The company sought to fill thousands of open jobs. Taco Bell has run into trouble sourcing the needed labor to meet its ambitious goal of creating 100,000 new jobs in the U.S. from 2016 to 2022.

And Taco Bell isn't the only restaurant chain that has used additional perks in recent years to boost or reward its workforce in lieu of offering higher wages...

Fast-food pioneer McDonald's (MCD) announced in March 2018 that it would "allocate $150 million over five years to its global 'Archways to Opportunity' education program."

In February, pizza maker Papa John's International (PZZA) said it would cover tuition for undergraduate and graduate online degree programs for its roughly 20,000 employees. The program is offered in partnership with Purdue University.

And in June, burrito maker Chipotle Mexican Grill (CMG) implemented a performance-bonus program for employees who help meet sales targets and other goals. The company said in August that more than 2,600 workers had qualified to earn up to an extra week of pay.

However, these efforts can only go so far. That's because restaurants are all facing an uphill battle.

You see, there's a major labor problem going on in the U.S. right now...

The U.S. Department of Labor started tracking the difference between job openings and available workers about two decades ago.

Since then, the country has always had more available workers than job openings. So it was much easier for companies to find needed help. But that all changed recently...

The number of available jobs exceeded the number of people looking for work for the first time in March 2018. And as you can see in the following chart, the trend has continued...

As of September, approximately 5.8 million people were seeking employment in the U.S. And at the same time, we had roughly 7 million unfilled jobs across the country.

In other words, we're facing a significant labor shortage in the U.S.

While this labor shortage affects all sectors, it's especially evident in blue-collar and services-industry jobs – the so-called "dirty" work – like car mechanics, health care aides... and restaurant workers. That's true because of two factors...

1. More people are pursuing college degrees than ever before, making it less likely that they'll choose blue-collar jobs.

2. Baby Boomers – who held a disproportionate number of the country's blue-collar jobs – are retiring, leaving many unfilled jobs across those industries.

Fewer people are willing to do these jobs. Nowadays, most folks prefer professional jobs.

And as you can see in the following chart from nonpartisan think tank Pew Research Center, another major problem is impacting the U.S. labor market today... In short, fewer young people are joining the workforce than in previous decades. Take a look...

According to Pew Research, in 2018, less than 20% of the country's 15- to 17-year-olds said they held a job at some point in the prior year. In 2002, 30% of 15- to 17-year-olds were employed. And back in 1968 – when the earliest Baby Boomers were entering the workforce – it was around 48%.

It's the same story with 18- to 21-year-olds... About 58% of that age group said in 2018 that they held a job at some point in the prior year. That's significantly less than the 72% for the same ages back in 2002.

It's a disturbing trend for restaurants that depend on young folks to fill their workforces. They'll either need to keep finding more ways to "get creative" with additional benefits... or give in and raise wages, which will drive up their costs.

That puts extra stress on the business owners, which ultimately filters down with higher costs for customers. And a labor shortage isn't the only problem for restaurants today...

Politicians are on the attack, pushing for a much higher federal minimum wage...

In July, the Democratic-controlled House of Representatives approved the "Raise the Wage Act," which would raise the federal minimum wage to $15 per hour by October 2025. That's more than double the current amount of $7.25 per hour.

For now, it's unlikely that the Republican-controlled Senate will pass the bill. But it's only a matter of time before the federal minimum wage moves higher... In the coming years, it could change things in a big way if power shifts to the Democrats in the Senate.

Plus, cities and states are already phasing in higher minimum wages on their own...

This year, the minimum wage increased in 21 states and Washington, D.C.

The minimum wage climbed to $14 per hour in D.C., while California, Massachusetts, and Washington state all hiked their lowest hourly pay to $12. Five other states – Arizona, Colorado, Maine, New York, and Oregon – have minimum wages of at least $11 per hour.

And the push for higher wages will only grow stronger moving forward...

California, Connecticut, Illinois, Maryland, Massachusetts, New Jersey, New York, and Washington, D.C., all plan to phase in a $15 minimum wage even if it isn't enacted at the federal level. The hikes in these locations will all be in effect by 2025.

A rising minimum wage will be disastrous for the restaurant industry...

In a study published in March, the U.S. Bureau of Labor Statistics ("BLS") found that 7.1 million people were paid at an hourly rate in "food preparation and serving related occupations" last year. About 14% – or roughly 1 million of those workers – were paid at or below the federal minimum wage.

And earlier this year, workplace management software company Harri polled 173 restaurant owners about the effects of a higher minimum wage on their businesses. The respondents operate a total of more than 4,000 locations across the country.

According to Harri's survey, 87% of these companies said they needed to raise wages for their entire staff by 5% to 15% to keep incentives properly aligned. That was even true for employees who were already making more than the minimum wage.

A tight labor market and rising minimum wages will keep driving costs higher for restaurants...

Independent restaurants like Tawla won't be the only victims. The bigger restaurant chains will suffer, too.

In the following table, you can see a list of publicly traded restaurant chains, as well as the percentage of their locations that will be negatively impacted by a higher minimum wage.

These restaurant chains will see minimum wage hikes across a significant portion of their current locations. The minimum wage hikes will drive their labor costs higher – which already amount to more than 30% of sales in most cases. Take a look...

By combining the restaurant chains with the highest percentage of locations that are vulnerable to a rising minimum wage with the ones that spend the most on labor, you can see which ones will likely suffer the most in the coming years. BJ's Restaurants (BJRI) tops the list, while Cheesecake Factory (CAKE) will also likely struggle with rising costs.

To pay higher wages, restaurants will need to offset the costs somehow...

If they raise their menu prices, they risk driving customers away. If they keep prices the same, their margins will get squeezed. Either way, it will crush many of these businesses.

Like Tawla, if a restaurant chain has too much exposure to rising wages and limited ability to increase its menu prices, it will need to scale back its operations in order to survive. In other words, these restaurant chains are likely headed for a lot of pain in the years ahead.

At a minimum, you should avoid investing in these companies today. And if you're comfortable with short-selling, you could consider using the strategy as a way to profit from their downfalls.

Speaking of dying businesses, my colleague Mike DiBiase highlighted another in the Digest on Monday...

We believe 117-year-old struggling department-store chain JC Penney (JCP) will eventually go bankrupt. But as Mike explained, we don't believe it will happen for another few years.

Because our research showed that this dying business will keep hanging on, we were able to uncover a tremendous opportunity for our Stansberry's Credit Opportunities subscribers...

Back in June, we alerted subscribers to one of JC Penney's bonds that traded at the time for a substantial discount from its $1,000 par value. In short, folks could make a 30% return in one year just by buying this distressed bond and holding it through maturity in June 2020.

And in the end, the investment turned out even better than we expected...

JC Penney trimmed its losses last quarter and raised its profit forecast. It quickly became clear to the market that the company's June 2020 bond was safe, so its price moved higher. We officially closed the position in the middle of last month for an annualized gain of 54%.

My point is... You can often find ways to profit – even with dying businesses.

Some businesses – like JC Penney – take much longer to die than people think they will. With patience and research, you can identify these opportunities... and make big profits.

That's exactly what we aim to do with our work in Stansberry's Credit Opportunities. If you're not already a subscriber, we encourage you to become one today...

Right now, you can subscribe to Stansberry's Credit Opportunities at 50% off the normal one-year price. It's the lowest price we've ever offered. And that's not all... Through Friday at midnight, we're including a special "holiday bonus" worth $1,200. Get started right here.

New 52-week highs (as of 12/3/19): Hologic (HOLX), iPath Series B Bloomberg Coffee Subindex Total Return ETN (JO), Pan American Silver (PAAS), ALPS Medical Breakthroughs Fund (SBIO), and Silvercorp Metals (SVM).

In today's mailbag, we share thoughts on the latest developments in the U.S.-China "trade war"... Do you have a question or comment? As usual, you can send your notes to feedback@stansberryresearch.com.

"Herbert Hoover's Trade War resulted in the Great Depression. Donald Trump's seems to be developing a little slower, but should have an even worse outcome." – Paid-up subscriber Chuck B.

"I would just say that my positions in China are relatively small (less than 3%) and I am in for the long run. I am guessing that the market up and down reactions to this seemingly weekly issue are those that are new to their China positions, or those that may be taking significant positions [and] trying to make a large profit quickly. Anyway, the fact that the president can upset the market with random comments seems troubling to me." – Paid-up subscriber Mike D.

"I love today's Wednesday Morning Market Comments [in the Stansberry NewsWire]!!! Great summary of what is happening with the China-U.S. trade today with its analogy of the 'Game of Chicken.' Even better, the 'Translations' at the end of paragraph. I enjoyed today's article!!" – Stansberry Alliance member Stephen S.

Corey McLaughlin comment: We also enjoyed NewsWire editor C. Scott Garliss' analysis of where the trade war stands and the damage it could do to the global economy. If you haven't read Scott's commentary already, it's well worth the read...

And as always, be sure to check out the NewsWire for more around-the-clock news and expert analysis on the trade war and everything else moving the markets. It's absolutely free to sign up. Learn more here.

Regards,

Bill McGilton
Kiev, Ukraine
December 4, 2019