Loungers tests demand for bar and restaurant shares #RBG #FUL

Loungers tests demand for bar and restaurant shares #RBG #FUL

Over-capacity in UK bars and restaurants is widely acknowledged.

Intense competition, declining footfall and rising costs (combined from time to time with failures of management) have all impacted on the results of listed entities.

This has left investor sentiment in the dumps. Consider the share price progression at Revolution Bars (RBG) (latest share price 68p, market cap £34 million).

(All charts from Stockopedia.)

Or we could consider Fulham Shore (FUL), whose share price is roughly half what it was two years ago (latest share price 11.3p, market cap £65 million).

Incidentally, I performed some research at both of these establishments during my stay in Clapham Junction over the past week.

Revolution was very quiet on a sunny Friday afternoon, providing me with a great environment in which to relax and read a book over some lemonade. I didn’t order food, nor did I witness how busy it might get when people left work for the evening, but it was a perfectly comfortable and pleasant environment.

I also had lunch at Franco Manco (operated by Fulham Shore) on two occasions. There’s a clue that I must have liked it, if I went back for a second helping!

Indeed, I thought it was superb value and the pizzas were delicious. Here’s the chorizo pizza I had on my first visit:

It didn’t change my perceptions of the brand too much. I previously visited it in King’s Cross and I liked it then, too. But I think the meals at Clapham Junction (including the starter) were possibly even better this time around. The waiting staff were excellent, too. I’d be a regular customer, if I could.

Despite my positive experience there, I must report that the restaurant was not overly full. I was there on Friday afternoon and again on Sunday afternoon, and my recollection is that there were plenty of spare seats, particularly on Sunday. The street is lined with food establishments and it must be difficult for any of them to stay far ahead of the others.

Ignoring competition – a fatal error

Losing sight of the realities of competition is a basic investment mistake, and is usually fatal.

At the end of the day, it doesn’t matter how wonderful a company’s product is, if there is an alternative that is better or cheaper (or both). If the product isn’t competitive, then the future of the business is questionable.

I do think that there is something special about the Franco Manca offering. Sourdough pizza tastes different to regular pizza – better, in my opinion.

Here’s an American chef talking about the difference:

Why sourdough? Well, there’s more flavor. It’s not neutral. And it’s far more easily digestible. That’s why a lot of people with gluten sensitivity can have sourdough. And I feel it’s good for you. I never really liked pizza with a lot of yeast. You have to drink a ton of water to get through it. Then you don’t feel good. And if people don’t feel good, they correlate that with something they ate. I’m not saying other pizzas are bad, but I think mine have more character. 

Another special feature of Franco Manca is the simplicity of menus. Seven pizzas to choose from for your main course, and a couple of salads, and that’s it.

These features help to define Franco Manca’s unique identity.

As an investment idea, however, I think you have to ask yourself how long these features can remain competitive. For example, what’s to stop other restaurant chains from offering sourdough pizza or simplifying their menus, if there is money to be made that way?

These question marks help to explain why I don’t own shares in any bar or restaurant chains. The only restaurant chain that I would feel confident to buy is McDonalds (MCD). The only coffee chain I would own is Starbucks (SBUX).

Given the share price movements at RBG and FUL over the past couple of years, I must not be alone in my caution as regards to the smaller players in this sector. The high-profile blow-up at Patisserie Holdings (CAKE) and the share price collapse at Restaurant Group (RTN) also come to mind.

Loungers Plc

All of this brings us to Loungers Plc. Today, it has announced an intention to float on AIM.

The company operates 146 cafe/bar/restaurants. 122 of these are Lounges offering “informal, unique interiors with an empasis on a warm, comfortable atmosphere”. No two sites are the same.

The other sites are Cosy Clubs, “more formal bars/restaurants offering reservations and table service”.

Loungers claims to be “the only growing all-day operator of scale in the UK”. It reports very strong like-for-like sales and total sales growth since FY 2017. Today’s announcement suggests that there is scope for portfolio growth to 500 sites, adding 25 sites p.a. in the medium-term.

The food menu offers meals for less than £10 and is designed “to fill the middle ground between value-pub and national restaurant brands/independents”.

Competition – Loungers Plc offers its customers a bit of everything, and therefore:

“The Group competes with every element of the trade of a pub chain, coffee shop, or restaurant, whereas each of those operators only competes for a part of Loungers’ sales.”

I’m not sure if this is a good or a bad thing, from a competitive point of view. Don’t we usually look for specialisation? Starbucks is synonymous with coffee, whereas McDonalds is synonymous with burgers, and this brand identification is what generates its pricing power.

Loungers sounds more like a sort of community centre, offering a generalised experience to its local residents. Perhaps it will be of little surprise to readers that it doesn’t operate in central London, and so far only has a few sites within Greater London.

The Numbers

Reassuringly, we learn “every mature site is profitable and the Group has only ever closed four sites.” The style of the venues is that they are supposed to look “lived in”, so there is little capex spend. No site has ever been fully refurbished.

That’s a cheap way to run a business and I wonder how it might limit the appeal of a Lounge versus, say, a JD Wetherspoon’s establishment (JDW). Any insights in the comments would be more than welcome!

As battle-hardened investors, I’m sure many of you will share my caution with respect to pre-IPO financial summaries.

Loungers reports an operating profit of £7 million in FY April 2018. It made a loss in the prior year due to heavy “exceptional items”.

For the 24 weeks to October 2018, it reports (unaudited) operating profits of £3.2 million, up considerably from £2 million for the corresponding period in the prior year.

Recent trading:

For the five-week period to 6 January 2019, the Group delivered record like-for-like sales growth of 11 per cent, building on a strong like-for-like performance over Christmas 2017 and maintaining the Group’s track record of consistently outperforming the wider hospitality sector.

So far in 2019, trading has continued in line with expectations.

The IPO

Loungers is seeking to achieve AIM admission by the end of this month.

Raising growth capital is not explicitly mentioned as the purpose of the IPO, whereas enabling the existing shareholders “to realise part of their investment” is mentioned. So I’m assuming that any transaction will be more oriented towards that purpose than towards raising new funds for the company.

Warren Buffett hasn’t bought an IPO since 1955. On the rare occasion that I’ve bought a newly-listed share, I’ve not done particularly well, either. So I will be watching Loungers from a safe distance, keen to see if it can shake up investor malaise with respect to the bar and restaurant sector.

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    We seem to have had different experiences for FUL! On Saturday night my wife and I tried two of them, only to be told we had to wait 15 mins+ both times.

    Tried again on Sunday and no room at the inn!

    Disappointing as it’s cheap and delicious.

    As for the shares, with NTAV at £11m, I personally don’t see the brand equity being worth over £50 million. It could halve, and that would be around fair value imo. But if it breaks 13p I’ll be a buyer for a trade.

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