Food still off in the dining sector

Food still off in the dining sector

Mention that you own shares in a restaurant stock and you’ll immediately be met with incredulous gazes and exclaims of horror. But is the restaurant sector the new defensive?

The retail sector has been taking a real hammering recently, with profit warnings due to hot weather, profit warnings due to cold weather, and a myriad of other reasons. What they mean is that footfall has declined and people aren’t buying like they used to. This has in turn had a knock-on effect on restaurants as the daytime trade has been affected by fewer shoppers.

Since the last crisis subsided high street offerings have exploded. Success breeds success, and many ‘me too’ competitors have joined the party, all offering gourmet, overpriced gunk that until recently had sold brilliantly. Consumers now have a choice, and with inflation hitting both the consumer (those who are above minimum wage have not experienced much real wage growth) and the operator (costs have risen and waiting staff have benefited from the living wage) the sector has reached saturation point after the euphoria of openings.

There are a few restaurant companies on the stock market, none of which currently seem appealing. But as competition disappears the choice narrows, meaning the survivors have a chance of a larger part of the market.

It’s unlikely that budding entrepreneurs find the sector mouth-watering anymore – bubbles like Dotcom and Bitcoin form because everyone is making money and going to retire millionaires. Previously, many were happy to overpay and grow at any cost, as indicated by David Fox whose rent bill for his restaurant was £75,000 and who was offered a staggering £650,000 to hand over the keys and move on, just so that they could bump the rent up to £130,000 (see here!)

Restaurants were stumbling over themselves in a mad rush to get the prime sites. Now that the reality is different, nobody is interested. Any remaining survivors will have a lengthy period to now get their houses in order before a fresh wave of competition joins. So who are the survivors?

Restaurant Group plc (RTN)

What’s to like about the restaurant sector? Not much, yet. Market leader The Restaurant Group recently released results, showing operating cash flow down from £46m to £25.6m. They will also struggle to wean their customers off the heroin of discounting, as they have created hordes of hungry addicts who may turn their noses up at full price.

The company remarked that Taco Tuesdays (all tacos £1) had been so successful that they’d launched Taco Thursday’s too – but who will now pay £11.99 for three tacos? They could say they’re “investing in margins”, but this isn’t margin investment. It’s margin destruction.

All of The Restaurant Groups’s free cash flow has been reinvested into the business, mostly on development capital expenditure, and so this may boost 2019’s numbers as one would hope that such large amounts aren’t required next year, too. New CEO Andy McCue has come to head up the business from Paddy Power and bought significant amounts of stock relative to his salary, but he has no restaurant experience. This isn’t a huge problem, but it is a dent in the narrative of the turnaround.

Restaurant Group remains on the list to be watched from afar for now, as the turnaround is in danger of entering loss-making territory – however, net debt is only around £22m compared to the market cap of circa £600m.

Tasty plc

Tasty plc (TAST) went on a screamer starting from 2010, shooting from 20p to 200p. It’s now back at 20p. The Kaye family are well known for their experience in restaurants; their dad Phillip (the ‘godfather’ of casual dining) founded Garfunkels (now owned by Restaurant Group), and together Tasty founders Sam and Adam Kaye (who still own 30%+ of TAST) also started Zizzi. Personally, I think only someone with either a lobotomy or no taste buds would go there, but people seem to go and if it makes money then that’s what matters. Their cousin Jonathon also founded Prezzo, so the Kayes are no strangers to catering.

Tasty reported recently that the sector is unlikely to see any improvements in 2018, though directors have recently bought and the company remains cash generative. They are not expecting to open any more sites and instead are focussing on the ones they have open by improving their structure and offering, which seems prudent. It is illiquid, and any material improvement would likely see a sharp re-rating of the shares.

Fulham Shore (FUL)

Another possible survivor is Fulham Shore which operates the Franco Manca and The Real Greek restaurants in the UK, with an additional single Bukowski site in Soho. Directors were heavily buying recently when the chips were down (always a good sign) and CEO David Page stated at the AGM that the company will fund new units largely through internally generated cash flow (perhaps the key word here is largely).

They are seeing a lot of opportunities come to the market as competitors go bust or through in the towel, and Fulham Shore’s management have the capabilities to leverage and capitalise on the situation. David started as a dish washer in Pizza Express, then became a franchisee branch manager, and the rest is history. There is seemingly a Pizza Express in every southern suburban area, and so a bet on Fulham Shore is a bet on management.

@vilage_idoit drinking his water

Fulham Shore moved into a loss this year as the company took an impairment hit, but still generated cash. They are far from out of the woods and there is a lot of work left to be done, but revenues have grown and importantly like for likes have gained ground.

Franco Manca is a competitively priced offering which relies on volume due to the low pricing. This is not discounting, it is everyday low pricing, and opportunities are there for a national rollout once the restaurant sector recovers. Requests for franchising outside the UK are also being explored.

Two pizzas and a salad was around £20 – a low cost base keeps the price down for punters

Once the storm has smashed competitors’ restaurants and dreams into the rocks, and sufficiently deterred new entrants into the arena, Fulham may have an opportunity to clean up shop. I’ll be watching.

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