Record-high food prices could be the tipping point this year for U.S. restaurants already struggling with high debt loads and tight-fisted consumers.
The economic downturn and drop in consumer spending has sent a handful of restaurant chains -- such as Uno Chicago Grill pizza, Fuddruckers and Charlie Brown's Steakhouse -- into bankruptcy court during the past year. And 2011 is not likely to be much better, experts say.
"There are many companies that can absorb an increase in food costs," said Steven Simms, a senior managing director at FTI Consulting who has worked on restaurant restructurings. "For companies that are teetering on the edge though, it's just one more pressure point that they are going to experience as it relates to profitability and their ability to service debt."
Food prices have soared as consumers in emerging economies have grown richer and erratic climate conditions have hurt supplies. Wheat prices have surged 60 percent this year, and restaurants have also been hit by increases in beef, cheese, cooking oil and produce costs.
Larger companies with strong finances are not seen falling under these pressures. Chains such as McDonald's Corp (MCD.N), Starbucks Corp (SBUX.O) and Yum Brands Inc (YUM.N) can selectively raise prices to offset higher food costs. They also can use hedging strategies to lock in food prices.
Restaurants that have not locked in prices can feel the effects of food cost increases on their profits within a week, Simms said. It also can be difficult for smaller chains to obtain new financing, he said.
Pizza chain Sbarro Inc [SBARO.UL] is among the companies already publicly struggling with debt loads. The company has restaurants in shopping malls and airports around the globe -- from Athens, Georgia, to Athens, Greece.
Sbarro has been in standstill agreements with its lenders -- which prevent them from pushing the company into bankruptcy -- since the beginning of the year. It missed a debt target at the end of 2010 and an interest payment in February.
The company, which disclosed in January that it had hired bankruptcy and restructuring advisers and lawyers, had a deadline on that latest standstill agreement on March 3. Sbarro did not respond to a request for comment.
Its lenders include Bank of America (BAC.N) and private equity owner MidOcean Partners, which purchased the company through a more than $400 million leveraged buyout in 2007.
It is just one of a handful of restaurant companies that Standard & Poor's ratings agency has on its watch list with ratings of triple-C.
Also on the list are El Pollo Loco Inc, a 400-store Mexican restaurant chain, and Perkins & Marie Callender's Inc, which runs the Perkins and Marie Callender restaurants in the United States and Canada. The companies did not respond to requests for comment.
El Pollo is owned by private equity funds Trimaran Capital partners and Freeman Spogli. It faces a redemption in May of $11 million on its notes, according to Standard & Poor's. It had a cash balance of only $12 million as of Sept. 29, 2010.
Perkins has two interest payments due this year totaling about $19 million, according to Standard & Poor's. There is a risk that it will not make those payments on a timely basis, the ratings agency wrote in a February note on the company.
IN OR OUT OF COURT
Whether these companies are able to restructure debt outside of bankruptcy depends on their aims.
In bankruptcy court, a company can break leases on underperforming locations. That helps restaurants that have expanded too much, said Lisa Donahue, co-head of the turnaround and restructuring services at advisory firm AlixPartners.
Other operational efficiencies or menu changes can easily be done out of court, Donahue said.
The decision to restructure or file for bankruptcy may also depend on how much cash a company has on hand -- and how much time it has to come to a deal with lenders.
"It's not impossible to do an out-of-court deal but the more widely held the (debt) issuance is, the more difficult it is to get 100 percent agreement," Donahue said.
The most common way out of bankruptcy for a restaurant is a sale. Fuddruckers was saved when it was bought by Luby's Inc. (LUB.N) Uno Restaurant Holdings was able to reduce its debt load and exit bankruptcy when its creditors bought it.
Charlie Brown's was due to have an auction on Monday in which Landry's Restaurants will bid on its Bugaboo Creek Steak House business. Landry's also bought the Claim Jumper casual dining chain out of the bankruptcy process last year.