Cube Midcap Report (3 Sep 2019) – Acquisitions leave sour taste #RTN #NRR

Cube Midcap Report (3 Sep 2019) – Acquisitions leave sour taste #RTN #NRR

Good morning! The midcap report is back today for a quick look at:


Restaurant Group (RTN)

  • Share price: 133.3p (-14%)
  • Market cap: £655 million

Interim Results

This share has been a very unpleasant ride since 2015, dropping from over 500p down to current levels.

The owner of restaurant brands such as Frankie & Benny’s and Garfunkel’s added Wagamama to its portfolio late last year, for the hefty price tag of £357 million, plus the assumption of Wagamama’s substantial debts.

The Wagamama deal was narrowly approved by shareholders, with only 60% voting for the transaction.

To help pay for it, a discounted rights issue was needed to raise over £300 million. That was a bitter pill to swallow, and the momentum of RTN’s share price has been bearish since then.

Interim Results

The commentary published today begins in a very bullish fashion. Like-for-like sales are up 4%, and the company reports an adjusted profit of £28 million (up from £20.7 million a year ago). The company mentions a “strong pipeline” of growth opportunities for Wagamama and indeed for other parts of the business.

However, there is no hiding from a £100 million impairment charge and £10.7 million of onerous lease provisions, which together help to generate a very large statutory loss for the period of £88 million.

The goodwill impairment hits the “Leisure” business, i.e. the casual dining segment. Other segments include Airport concessions and pubs.

I have added the bolding:

We continue to make progress in our Leisure business, undertaking various initiatives to improve food offering, service standards and brand proposition.  However, we remain exposed to the well documented retail structural decline and a challenging cost environment, whilst competing in saturated local markets.  We have therefore taken a more cautious view on the medium-term outlook within our Leisure business which has been reflected in the impairment charge being recognised at the half-year.

Reading through the text, there is some further explanation:

In the Leisure business we have recognised an impairment charge across sites that were identified as structurally unattractive; and

In addition, given the well documented over capacity and continued like-for-like sales decline in the casual dining market, and ongoing cost headwinds we have taken a more cautious medium term outlook when assessing the Leisure business for impairment

A horrible price to pay

I’ve gone back to the 2018 Annual Report, to remind myself of the goodwill picture immediately following the Wagamama purchase, and two other acquisitions made by RTN in 2018.

In total, RTN took on nearly £600 million of intangible assets from its three acquisitions.

As far as RTN’s balance sheet was concerned, the deal was devastating.

The net asset value of the acquired group of companies was just £38 million. That’s including a value of nearly £260 million for Wagamama’s intangible assets.

In other words, the net tangible asset value of the acquired companies was deeply negative.

So RTN’s balance sheet become full of Wagamama’s intangible assets. And because RTN paid so much for these assets, it also took on £326 million of goodwill, representing the premium that it paid for these assets. NTAV went from £154 million, before the deals, to minus £155 million, after the deals.

It is this goodwill which is being written down today, as RTN acknowledges that the outlook is not as rosy as it had hoped.

The balance sheet at RTN today shows £372 million of net assets, but this includes £617 million of intangible assets – the goodwill that it has not yet written down, plus the notional value of trademarks and franchise agreements at Wagamama.

If trading gets worse, I would expect this £617 million to be scrutinised again.

Long-term borrowings of almost £350 million are another reason for flashing red lights. While the company is not currently in financial distress, this is a large debt pile which reduces RTN’s flexibility.

Outlook

This critical section of the report offers some reasons for concern.

The most recent six-week period is much weaker than H1, as the casual dining segment reverts back to like-for-like decline.

Trading is “broadly” in line with full-year expectations, i.e. investors can pencil in a small miss.

FY 2019 guidance is for the development of more Pubs and Airport concessions, and more conversions of existing sites to the Wagamama format.

My view

This is a share (and a sector) which I have been vigorously avoiding. Nothing in today’s report makes me want to change stance on this.

According to today’s full-year guidance, the company is planning for £50 million – £55 million of development spending in the current financial year. Interest expense will be £15 million to £16 million.

With adjusted operating profit of £28 million in H1, we can see that a significant bite of full-year operating profit is likely to be eaten up by interest costs.

The development capex will then put further short-term pressure on cash flow and the balance sheet.

The company reported over £160 million of headroom on its borrowing facilities at year-end, so this shouldn’t be an immediate problem, but I think it’s going to take a significant amount of time for RTN to work through this period of challenge. Scrolling ahead a year or two, its subsequent success will depend on whether the sector overcapacity has finally been taken out of the market. That’s certainly not something that I would like to bet my own funds on.

Am I being too cautious? Let me know!


NewRiver REIT

  • Share price: 166.4p (-1%)
  • Market cap: £509 million

Asset disposal update

This was covered on Cube with a brilliant report on its investor presentation in January of this year.

It owns retail shopping centres, retail warehouses, pubs and high street stores.

For FY March 2019, it reported year-end EPRA NAV  (i.e. using the most recent market value of properties) of 261p per share, after reducing the value of its portfolio by 6.4%.

Traditional shopping locations continue to struggle in the face of weak consumer sentiment and the secular shift online, and this is reflected in NRR’s very weak share price, at a substantial discount to EPRA NAV.

NRR is attempting to prove that its portfolio doesn’t deserve to trade at a discount, and is having an investor day in a few weeks which will “demonstrate the alternative use value inherent within its portfolio”. That’s one of the big controversies – what do we do with all of these shopping locations, when nearly everybody is purchasing online? Turn them into restaurants? I don’t think so!

One key indicator for investors is the premium or discount at which REITs such as NRR can dispose of parts of their existing portfolios.

My investing buddy Lewis has tweeted today that NRR is “selling the good stuff, keeping the bad, moving down the quality curve”. That’s one rather bearish interpretation of the news that NRR’s disposals so far in FY20 (including exchanged and under offer) are at a 1.2% premium to book value.

This is part of NRR’s policy to recycle assets: the disposal proceeds from these deals will be ploughed back into high-yielding assets, which can hopefully be improved.

I don’t have a strong view on this, but I do expect that valuations will continue to be under pressure, and I don’t know when this trend ends. Much like RTN, this is another stock where I find it easier to stay away. There must be easier ways to make some money in the stock market?

 


That’s it for today. Thanks for dropping by!

Cheers,

Graham

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COMMENTS

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  • comment-avatar

    Defo agree on RTN ……the headwinds are strong and its full of disgruntled bulls who want to get out . Pick battles you can win easily I say . Why take the risk ?

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  • comment-avatar

    Graham – totally agree with your view on RTN

    Philip

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  • comment-avatar

    RTN is well and truly worthy of the bargepole.
    I suppose that with Waga’s travel location and international operation, it is an opportunity a la WH Smith, except WH Smith legacy generates cash and they have few competitors in airports versus wagamama who have several (speaking as a regular Traveller who spends most of his time in the lounge having tasted the whiskey en route to the lounge).

    NRR, I am a little more bullish, (not on the company but the sector). I don’t think the deep discounts to NAV are justifiable. For income, I think they are sound investments, albeit I am at the more defensive end. That said I do hold regional reit and British land is a very recent addition. Regional is highly diversified (although given the commentary, I will need to look again at whether recent disposals have sold the jewels in the crown).
    Was looking into London b2l and decided BLND would give me the same exposure with more diversification at a fraction of the transaction cost (especially if my size was aligned with a London deposit!).

    Great article Graham (again) and congratulations to you and your wife to be on your engagement.

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    Graham
    NRR has a policy of recycling assets out of lower yielding assets into higher yielding assets. They are not under balance sheet pressure to sell assets, ie no debt due so the comment that they are selling the jewels  does not stack up.

    Valuations are under pressure in the UK retail sector due to negative Brexit sentiment and the structural changes in retail. Valuations matter most for landlords that have to sell due to debt service or covenant pressure such as Intu and Hammersons.  These landlords hold stock tights is most affected by the structural shifts to online retailing such as department stores, fashion and casual dining.  Many of these like a house of Fraser or Debenhams have lost their customer proposition and failed to develop a multi-channel presence.  NRR does not have exposure to these names. It is positioned in the discount and value sector that is less exposed to online. It provides very affordable rents. Hence occupancy in its portfolio remains high and there is a very small amount of loss of r3 t from administrations and CVAs. 

    The price discounts a lot of downside  on valuation which can be a fiction if th3 landlord does not have to sell assets. Also, valuations on the property market are difficult right now since comparable transactions are no5 happening. Valuers are operating in a vacuum and in this state they will tend to build margins of safety into the cap rates they use to value the property. 

    Eventually, we hope for a return of value to fundamentals from mark to market.

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    • comment-avatar

      Yusuf, thanks so much for the comment. Yes, there is plenty of downside built into the NRR share price. I hope the valution trend bottoms out soon.

      Graham

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