The COVID-19 pandemic negatively affected the restaurant industry more than many other sectors, and for obvious reason. People haven't been allowed in dining rooms for much of 2020, meaning most restaurant sales have come from to-go orders and delivery. That's fine for businesses like Domino's Pizza, which was already set up for that kind of operation, but for most others, it's been a hard blow.
Restaurant companies refuse to be caught unprepared for catastrophe a second time, and they're aggressively pursuing new operating models because of the coronavirus.
1. Ghost kitchens
A ghost kitchen is a setup designed to only allow to-go orders -- there's no dining room, no cash register, and no frills. Therefore, companies can set them up in locations unattractive for dine-in restaurant traffic but in close proximity to large populations. They can also be run with minimal labor costs.
Ghost kitchens were already on the radars of public restaurants pre-pandemic. Indeed, Wingstop (NASDAQ:WING) disclosed it that was experimenting with the idea in the United Kingdom in January. But the coronavirus has highlighted the operational benefits. It has since opened a second location in the U.K. and one in Texas. "The concept of a ghost kitchen makes sense for our business," said CEO Charlie Morrison in the second-quarter conference call.
Starbucks (NASDAQ:SBUX) and Shake Shack (NYSE:SHAK) are also adopting the ghost kitchen strategy. The coffee giant is closing 400 locations and replacing them with a new concept called Starbucks Pickup. In China, it's opening similar small-format cafes called Starbucks Now.
For Shake Shack, when its locations in London completely shut down for the coronavirus, it launched four ghost kitchens (or "cloud kitchens") in different neighborhoods to keep the brand alive. With the early success, we could see more of this from the fast-casual burger chain over time.
2. Virtual brands
Meet It's Just Wings and Tender Shack -- two brand new restaurant chains launched during the pandemic. While you may have never heard of them, you know their parent companies. It's Just Wings was launched by Brinker International (NYSE:EAT) and Tender Shack by Bloomin' Brands (NASDAQ:BLMN). But these aren't traditional chains -- they're known as virtual brands.
A virtual brand doesn't have a physical presence, existing only in third-party delivery apps like Grubhub or Uber Eats. The idea is for consumers to browse through the app, stumble upon the virtual brand, and make a purchase. Food is then prepared and picked up for delivery from a ghost kitchen. In the case of Brinker and Bloomin', they're both creating the stand-alone virtual brands and providing the kitchen space from existing real estate.
The advantage of a virtual brand is how fast it can be launched and scaled. In Brinker's case, it launched It's Just Wings in over 1,000 locations literally overnight in its Chili's and Maggiano's locations. Management believes the new brand can generate over $150 million in sales in the first year. CEO Wyman Roberts offered this perspective: hitting that $150 million annual-sales target would make It's Just Wings a top 200 restaurant brand.
3. Redesigned real estate
One of the few restaurant stock winners in 2020 is Chipotle Mexican Grill (NYSE:CMG). Part of Chipotle's success is due to its technology and real-estate strategy. Going forward, the blueprint for successful restaurant spaces will emulate Chipotle to include multiple ways to both order food and pick it up.
It's the blueprint employed by Restaurant Brands International's (NYSE:QSR) Burger King in the "Restaurant of Tomorrow." According to Nation's Restaurant News, this prototype includes multiple drive-thru lanes, dedicated curbside pickup spots, takeout lockers, and more. These locations will be equipped to handle an enormous amount of sales volume.
Shake Shack is making similar moves. It plans multiple enhancements like Burger King's, including opening its first drive-thru in 2021. The company has long embraced a community-gathering vibe, but this ideal may be a little too limiting. Shake Shack's sales were down 18% in the first half of 2020, ill-prepared to facilitate high off-premise sales volume. But as CEO Randy Garutti said, going forward, it's opening up drive-thrus "to increase the addressable market opportunity."
Prudent investors should monitor these developments in the restaurant space, because not all changes will necessarily reward shareholders long-term. For example, consumers might not be into the idea of virtual brands. Robert Byrne of food-service analytics company Technomic recently shared some insight on the podcast A Deeper Dive -- 78% of consumers say visiting a restaurant is one of their top social experiences.
The virtual brands created by Brinker and Bloomin' may help mitigate the effects of slumping sales right now, but it's fair to question how well these will perform when dining rooms are open and back to normal. I believe the moves made by Wingstop, Starbucks, and (particularly) Shake Shack are better as they're focused on supporting the existing brand with added convenience for diners. To me, that is the superior long-term strategy to capture consumer-discretionary restaurant spending.