Ratings Score Snapshot

Credit Highlights

Flynn Restaurant Group L.P.’s operating performance remains stable, with positive same-store sales growth throughout all six concepts it operates. However, operating conditions within the restaurant industry remain challenging as commodity and wage inflation continue to pressure restaurant operators and consumers with less discretionary income. Systemwide sales could become challenged if pricing actions remain aggressive and impair the brands’ relative value proposition, which is particularly important to preserve in a weakening macroeconomic environment. During past periods of economic weakness, the quick service restaurant (QSR) industry has benefited as consumers trade down, seeking more affordable dining options. We believe Flynn is well situated to manage these challenges in a mild recessionary environment given some of the value-oriented QSR concepts it operates such as Taco Bell, Wendy’s, and Pizza Hut.

We forecast Flynn’s S&P Global Ratings’ adjusted leverage to be in the high-4x area and EBITDA interest coverage to be in the high-2x area over the next 12 months. We expect operating results to improve in 2023 as commodity inflation eases and wage pressures lessen, with adjusted EBITDA margins improving toward the mid-teen percentage area, from the low teens in 2022. We continue to view the macroeconomic environment as highly uncertain and expect the QSR and casual dining sectors to remain highly competitive, particularly among value players. We expect Flynn's adjusted debt to EBITDA to improve modestly toward the high-4x area in fiscal2023, reflecting a modest improvement from the low-5x area in fiscal 2022, primarily because of improving EBITDA and relatively unchanged debt levels. However, we continue to view Flynn's financial policy as aggressive given its previous debt-financed acquisitions and majority ownership by the private-equity investing arm of the Ontario Teacher's Pension Plan and Main Post Partners.

We expect adequate liquidity and good covenant headroom over the next 12 months and believe free operating cash flow (FOCF) will remain modestly positive despite elevated capital expenditures (capex). Our projections incorporate modest EBITDA growth as commodity pressures continue to ease and price initiatives taken by Flynn continue to materialize. However, our base case also incorporates the possibility of a mild recessionary environment in 2023. We forecast modestly positive FOCF over the next 12 months given elevated capex levels as the company continues to implement its growth strategy via new unit developments, unit remodels, and maintenance. We expect Flynn to invest about 6%-8% of sales annually in capex. Our view incorporates the risk that additional capex invested toward remodeling stores in the long term may not necessarily result in sustained higher revenue within every unit.

Outlook

The stable outlook reflects our expectation for mid-single-digit percent revenue growth in 2023, driven by consistent same-store sales growth and restaurant unit expansion. We expect Flynn will fund its growth initiatives with internally generated cash flow and believe it has the flexibility to pull back on its new unit growth plans if performance deteriorates. We forecast S&P Global Ratings’ adjusted leverage to improve modestly toward the high-4x area in 2023 amid easing cost pressures.

Downside scenario

We could lower the rating on Flynn over the next year if:

• Flynn’s operating performance were challenged due to slower same-store sales growth and profits declined amid heightened competition, leading S&P Global Ratings’ adjusted leverage to climb to and remain above 6.5x on a sustained basis; and
• We expected the company to generate less than $50 million of annual FOCF.

Upside scenario

We could raise the rating on Flynn over the next year if:

• Operating performance were significantly stronger than expected from continued positive sales trends across all concepts, leading to margin improvement above our base case; and
• We believed the company would maintain a less aggressive financial policy such that S&P Global Ratings’ adjusted leverage were sustained below 5x.

Our Base-Case Scenario

Company Description

Flynn is the largest franchise operator in the U.S., with 2,354 restaurants as of Sept. 30, 2022, and one of the 20-largest food service companies in the country. Flynn’s portfolio extends across 44 states and generates roughly $3.9 billion in sales. The company is majority-owned by financial sponsors Ontario Teachers' Pension Plan (35% ownership interest) and Main Post Partners (39% ownership interest), with Flynn management retaining the remaining minority ownership stake. As of September 2022, the company owned and operated:

• 944 Pizza Hut restaurants (QSR);
• 441 Applebee's Neighborhood Grill & Bar restaurants (a casual dining restaurant chain);
• 367 Arby's restaurants (QSR);
• 283 Taco Bell and related Yum! Brands restaurants (QSR);
• 190 Wendy restaurants (QSR); and
• 129 Panera Bread bakery-cafes (fast-casual chain).

Business Risk

Our rating on Flynn reflects its participation in the intensely competitive restaurant industry, exposure to fluctuations in commodity prices, and rising labor costs as a restaurant operator. The company has sizable operating scale and a strong portfolio of multiple nationally recognized restaurant brands. It also operates in multiple segments (casual dining, QSR, and fast casual) that diversify its revenue streams and commodity cost exposure. However, the company is susceptible to missteps by franchisors, depending heavily on their product innovation strategies, menu, and marketing initiatives to drive traffic.

Flynn generates lower margins relative to peers with similar restaurant concepts amid labor and inflationary pressures. The company also modestly underperforms most other restaurant operators due to historical franchisor missteps at the Applebee's brand and its portfolio of Arby's units. We expect Flynn's profitability to continue to remain below most of its restaurant peers but expect operating performance to improve as commodity pressures ease. Our base case also incorporates a mild recession in 2023.

Financial Risk

Our highly leveraged financial risk assessment reflects the company’s financial sponsor ownership, relatively high debt balance, and modestly positive FOCF projections over the near term. However, we expect Flynn to generate about $250 million of operating cash flow in 2023 as its scale expands from its recent acquisitions and as pricing initiatives taken drive better cash generation.

While we do not foresee debt-financed dividend transactions in the near term, we continue to view the company’s ownership by a financial sponsor as a risk. This reflects private-equity sponsors' generally finite holding periods and a focus on maximizing shareholder returns. The potential for future debt-financed dividends or major acquisitions could raise leverage above our base case assumptions over the long term.

Debt maturities

As of Sept. 30, 2022:

• $114 million existing first-lien term loan due June 2025
• $35.5 million FRG Properties first-lien term loan due December 2025
• $25 million Wendy’s revolving credit facility and $117 million first-lien term loan due March 2026
• $25 million Pizza Hut revolving credit facility and $170 million first-lien term loan due March 2026
• $80 million revolving credit facility due December 2026
• $936 million amended and extended first-lien term loan due December 2028

Liquidity

We view Flynn's liquidity as adequate. While its liquidity position would qualify for a stronger liquidity assessment based on quantitative factors, it does not meet certain qualitative characteristics. Specifically, we do not believe that it could absorb a high-impact, low-probability event without needing to refinance because of its heavy debt load. On a quantitative basis, we project that the company's liquidity sources will exceed its liquidity uses by more than 1.2x over the next 12 months. We also believe that Flynn's net sources will remain positive even if its EBITDA declines 15%.

Covenant Analysis

Requirements

The term loan facilities at the restricted credit group are not subject to any financial maintenance covenants. The cash flow revolver facility is subject to a springing net leverage ratio when usage exceeds 35%.

Compliance expectations

Based on our projections, we do not expect the springing covenant to be applicable over the next 12 months.

Environmental, Social, And Governance

Governance is a moderately negative consideration, as is the case for most rated entities owned by private-equity sponsors. We believe Flynn Restaurant Group L.P.’s highly leveraged financial risk profile points to corporate decision-making that prioritizes the interests of the controlling owners. This also reflects the generally finite holding periods and a focus on maximizing shareholder returns.

Group Influence

The rated debt facilities are guaranteed by Flynn's Taco Bell, Panera Bread, and Arby's operations through a restricted credit group structure that excludes Wendy's (Wend American Group), and Pizza Hut (Hut American Group) operations. Flynn Restaurant Group L.P. is the ultimate parent company as well as the borrower of the debt facilities for the restricted credit group. Our rating on the company incorporates our consolidated view of the group, including its unrestricted subsidiaries' operations. As part of the November 2021 transaction, the company folded its Applebee's (Apple American Group) operations into the existing borrowing group, which includes Bell American, Pan American, and RB American.

Issue Ratings--Recovery Analysis

Key analytical factors

• We rate Flynn's first-lien debt, consisting of an $80 million cash flow revolver due in 2026, a $114 million first-lien facility due in 2025, and a $936 million amended and extended first-lien term loan due in 2028. The '3' recovery rating indicates our expectation for meaningful (50%-70%; rounded estimate: 60%) recovery in the event of a payment default.
• Our recovery analysis considers a hypothetical bankruptcy scenario in which the first-lien lenders benefit from the first lien on substantially all tangible and intangible assets of the restricted credit group.
• Our simulated default scenario contemplates a default occurring in 2026 because of a steep decline in EBITDA stemming from several factors. These include a protracted decline in consumer spending, intensified competition from other local and branded restaurants, higher commodity prices and payroll costs, and an inability to pass increased costs through to its customers.
• We have considered the recovery prospects from the restricted credit group of subsidiary group guarantors and the residual value from the non-restricted group subsidiaries, which would flow indirectly to the primary borrower and parent in a default scenario.
• Our simulated default scenario assumes that Flynn would emerge from a bankruptcy event to maximize its lenders' recovery prospects given its market position as the largest Applebee's, Arby's, and Pizza Hut franchisee and one of the largest Taco Bell, Wendy's, and Panera Bread franchisees in the U.S. Therefore, we valued the company on a going-concern basis by applying a 5x multiple, which is in line with the multiples we use for other restaurant operators to our projected emergence-level EBITDA.
• In the restricted credit group, our recovery analysis assumes that by the time the company defaults, about $43 million of borrowings would be outstanding on the first-lien cash flow revolver (excluding outstanding letters of credit) and about $997 million would be outstanding under the first-lien term loans.

Simulated default assumptions

• Simulated year of default: 2026
• EBITDA at emergence: About $208 million
• Implied enterprise value (EV) multiple: 5x
• Estimated gross EV at emergence: About $1.04 billion

Simplified waterfall

• Net EV after 5% administrative costs: About $987 million
• Aggregate subsidiary debt at unrestricted groups: About $354 million
• First-lien credit facility claims at restricted group: $1.13 billion
• Recovery expectations: 50%-70% (rounded estimate: 60%)

*Debt claims include six months of prepetition interest.

Related Criteria

• General Criteria: Environmental, Social, And Governance Principles In Credit Ratings, Oct. 10, 2021
• General Criteria: Group Rating Methodology, July 1, 2019
• General Criteria: Hybrid Capital: Methodology And Assumptions, July 1, 2019
• Criteria | Corporates | General: Corporate Methodology: Ratios And Adjustments, April 1, 2019
• Criteria | Corporates | General: Recovery Rating Criteria For Speculative-Grade Corporate Issuers, Dec. 7, 2016
• Criteria | Corporates | General: Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Dec. 16, 2014
• General Criteria: Methodology: Industry Risk, Nov. 19, 2013
• General Criteria: Country Risk Assessment Methodology And Assumptions, Nov. 19, 2013
• Criteria | Corporates | General: Corporate Methodology, Nov. 19, 2013
• General Criteria: Methodology: Management And Governance Credit Factors For Corporate Entities, Nov. 13, 2012
• General Criteria: Principles Of Credit Ratings, Feb. 16, 2011