Sector analyst Simon French looks at the key trends affecting the eating and drinking-out sector in 2018, including the increasing importance of convenience and effective use of technology. He also discusses the differing approaches of some of the industry’s most notable investors, and why argues that now is not the time for operators to ease up on innovation.
Consumers are cooking less. However, restaurant visitation is in decline and the place of consumption appears to be moving away from in-store and tilting towards the home, car or workplace. Growth is from delivery and drive-thrus. After a raft of mostly CVA-enforced closures, net new openings of restaurants are at best stagnant.
Usage is polarising between convenience and occasion. In the past convenience may have meant fast food or quick service restaurants. However, consumers’ expectations have never been higher and convenience should not be a byword for cheap.
It is instructive to look at the stalwarts of the high streets. PizzaExpress, Nando’s, Five Guys and Wagamama are the mainstay of many towns and cities. One striking feature is the long-term ownership structure of all of those. Whilst PizzaExpress is owned by private equity, it’s backer Hony Capital has only made four exits in 15 years, whilst Wagamama has benefitted from an over seven year holding period from its majority owner Duke Street Capital.
Delivery continues to be the single biggest influence on the market
Furthermore, traditional QSR operations such as McDonald’s and KFC have evolved into highly desirable choices for consumers looking for convenience and quality. In addition, both have embraced delivery and drive thru.
Indeed delivery continues to be the single biggest influence on the market (over and above weather and the travails of the England football team). The appeal of Just Eat to customer and restaurant alike is obvious. Whilst the stock market has fretted over its move into delivery its real success has been driving improvement in the quality of its partners with PizzaExpress, KFC and Domino’s Pizza all available in certain locations.
However, the willingness of investors to fund loss-making activities will profligate services that consumers could come to regard as indispensable. In China this has reached coffee deliveries to your desk, an innovation which is eating into Starbucks’s traditional dominant position. The question is how the customer will react when faced with additional cost to make the service profitable.
There is a symbiotic relationship between the premium end of the market and occasion-led (date nights, birthdays, business lunches, graduations etc) dining. There continues to be notable successes including San Carlo Group, Individual Restaurant Company and Hawksmoor. The ability of Individual Restaurant Group to reinvent itself through the evolution of Piccolino and the creation and rapid rollout of Gino di Campo is particularly eye catching.
After many years of under investment, pubs and bars are becoming a credible alternative to staying in
The wet-led trade is fighting back and occupying the middle ground with innovative drinks offers around craft products, cocktails and focus on community. After many years of under investment, pubs and bars are becoming a credible alternative to staying in.
The back-drop for investment though remains less than compelling. Disposable income is set to be squeezed again through rising interest rates, petrol prices and utility bills. Cost increases due to weakening Sterling from an uncertain Brexit outcome and labour cost rises due to unnecessary government intervention are a given.
Thus it’s not hard to see why serial sector investor Luke Johnson wrote that 19 out of 20 PE firms are no longer interested in the space. If like-for-like sales need to grow at twice the rate of inflation to maintain profitability and new site opening potential is limited, then it is hard to see how sufficient earnings growth and thus returns can be generated to warrant investment.
The notably successful PE exit of 2018 has come from Bridgepoint which recently sold its 10-year investment in Pret. Intriguingly, it has also created a complementary set of Italian casual dining offers under the Azzuri Group, across the Ask, Zizzi and Coco di Mama brands, suggesting it has developed a successful framework for investing in the sector. Principals at Equistone, TPG, Apollo and BC Partners must look on wistfully.
At the same time, a large number of small operators continue to scale attractively. There is an increasing northern bias to these successes: Mowgli, Arc Inspirations, The Alchemist and Mission Mars all have strong credentials rooted in highly targeted brand offerings which are difficult to replicate in a home environment. All have attracted different styles of capital through Foresight, Santander, Palatine and Business Growth Fund respectively.
In uncertain times there is the temptation to go back to basics
The end of September and quarter rent day is likely to see a further round of operations fail due to weak takings across the summer compounded by hot weather. We think the brands that continue to anticipate and shape what the consumer wants will continue to successfully and profitably grow market share. In uncertain times there is the temptation to go back to basics, reduce innovation and eliminate cost. Whilst this may improve short term cash flow the risk is that longer-term growth potential is delayed or at worst destroyed.
Traditionally large companies are inferior at innovation but add value through the ability to scale fledgling concepts through the introduction of commercially effective systems and processes not to mention the financial benefits of superior buying power. Both The Restaurant Group and Casual Dining Group are ideally placed to capitalise on this opportunity with relatively strong balance sheets and excess capacity in central functions.
Innovation can also be stimulated from further afield. A recent visit to Vancouver highlighted strong all-day offerings, a focus on craft beers and spirits, plug points (including USB) everywhere and the ubiquity of sports coverage across all trading formats. Perhaps most eye-catching was the efficiency and effectiveness of the staff with a well regarded busy pub serviced by just one bar tender, including making cocktails. In an era of rising labour costs the ability to find and retain staff of such calibre will be a key differential. Of course when the entry level tip suggestion on the card machine is 18%, the burden of high labour costs is nearly shifted in a transparent way directly onto the consumer. The alternative approach was in evidence on the other side of Canada, at Toronto airport where the food and beverage outlets provided iPads and card machines at each table to order and pay (tip suggestion 18%!).
Of course removing the human element from the eating-out experience arguably makes it no different an occasion to eating delivery food at a desk or kitchen table. It will ultimately be up to the consumer to decide if restaurant staff warrants their hard earned cash.
Simon French has spent 24 years working in and around the leisure industry as an operator, investment analyst and advisor. He recently co-founded Bixteth Partners, which specialises in management advice and capital introduction. He is a director and shareholder of Chop’d. He can be contacted via simon@bixtethpartners.com
