UK consumers haven’t had it so good for at least 10 years. Unemployment continues to fall, underpinning job security, while wages continue to rise, both in nominal and real terms, given inflation remains around zero. House prices continue to rise, utility bills are falling and the pound is strong against the euro, making holidays in Europe all the more attractive. Furthermore recent falls in the oil price have begun to make their way through to the petrol pumps suggesting 2016 should get off to a reasonable start, despite the traditional post Christmas retrenchment. In similar pieces in recent years, I would have mentioned the inevitability of interest rates rising during the next 12 months but such an increase seems further away than ever and, with more people owning a house outright than having a mortgage (source PWC) and the increasing popularity of renting, we see little impact on demand when rates do start to rise.
Recent trading data suggests that enriched customers are not increasing spending in pubs, bars and restaurants by more than 3% to 4% per annum or c1% on a like-for-like (lfl) basis. This has recently been exacerbated in certain parts of the UK following the terrorist attacks in Paris with central London and certain major shopping destinations suffering from reduced footfall and shorter dwell time. There is also an undoubted impact of ongoing additional supply that is curtailing lfl sales growth among the more established operators; UK consumers have never had so much choice.
The performance of listed companies in 2015 (to 22 December) has been polarised with relatively new entrants such as Patisserie Holdings (+52%) significantly outperforming more established operators such as Mitchells & Butlers (-17%), Wetherspoon (-10%) and The Restaurant Group (+3%). However, the sector’s one IPO, Revolution Bars Group, performed disappointingly with the stock declining c12%, posing further questions over companies that generate most of their sales later in the trading day.
Weighing up equity investments
The postponement of the rumoured D&D Restaurants IPO signals that, for equity investors, valuations need to accurately reflect returns on existing restaurants, plus the growth potential from a pipeline. The lack of obviously scalable brands is also likely to have posed question marks as to how to accurately value the growth potential of D&D.
Private equity has also reduced the multiples it is prepared to pay since the high watermark set by BC Partners with its acquisition of Côte in the summer. Both YO! Sushi and Gaucho have had to substantially reduce their expectations in order to get deals over or close to the finishing line.
There have been successful IPOs in other areas of the leisure industry with Elegant Hotels Group, Hostelworld, On the Beach and Gym Group all coming to the market, albeit the latter two had to reduce their valuation expectations to get the float away.
Conversely the acquisition of Spirit Pub Company by Greene King marked an excellent return for investors who more than doubled their money (pre dividend payments) since the demerger from Punch Taverns in August 2011. The acquisition has helped drive a very satisfactory performance from Greene King with the share price rising 24%.
Influential factors of 2016
So what does this tell us about expectations for 2016. Economic growth of c2% and sub 2% inflation with consumer confidence at close to record levels and subdued cost inflation suggest the sector remains attractive. However, on the ground it is a crowded marketplace with low barriers to entry, easy access to capital and a battle to get the best sites and attract and retain the best people. Add in the difficulties of retaining customers and it is clear that there are benefits of operating in either product or geographic niches.
The major external event that is likely to shape the trading calendar is the European Football Championships with England’s Saturday night game against Russia likely to reduce restaurant trade significantly. With more home nation participation than usual in football tournaments, for sport-focused pubs the opportunity for a boost to trade is greater than usual, particularly given the 2pm, 5pm and 8pm kick-off times. The Olympic Games in Brazil are unlikely to have much of an impact, and with Christmas Day falling on a Sunday (2016 is a leap year), celebrations will start later than ever, with ‘Mad Friday’ likely to be madder than ever.
As ever, the stock market tries to discount the impact of future events into current valuations and we think that the national living wage (NLW) is now accurately reflected in company share prices, if not in all analyst forecasts. We also see rising pressure at rent reviews given the sharp increase in rents being paid by some operators with relatively low return on capital hurdles, but food cost inflation should remain close to zero. Hence margins should be broadly flat in the short-term but unless mid-single digit lfl sales growth can be achieved, they are likely to gently decline during the medium-term as the NLW ratchets up.
Expect M&A activities review
The stock market continues to place a premium on growth and high (40%-plus) returns on invested capital, as witnessed by the Patisserie Holdings EV/EBIDTA multiple of 18.6x, which could prove a useful barometer if Costa Coffee were to be demerged from Whitbread under new CEO Alison Brittain.
We also expect to see the major shareholders of both Stonegate Pub Company and Casual Dining Group take the opportunity to exit should public market conditions be favourable and valuation multiples remain resilient. Both companies have a good story to tell, with experienced management teams to deliver their business plans.
Should lfl profit continue to remain difficult to achieve, we expect shareholders to encourage management teams to review M&A activity with our favoured approach being a merger of equals between The Restaurant Group and Mitchells & Butlers. The enlarged c£3bn market cap company could find up to £60m of synergies we believe and, given the positive reaction of the stock market to Greene King’s acquisition of Spirit, should be seen as a viable route of creating sustainable shareholder value. Happy New Year, let’s hope it’s a good one.
■ Simon French is head of leisure research at Cenkos Securities, a leading UK small and mid cap stockbroker, and works in the group’s Liverpool office
