Leading analysts Douglas Jack and Ivor Jones, at Peel Hunt, says the story of investing in the leisure sector is “survival of the fittest”.
He stresses that investors will be looking for the right sub-sectors – the ones which can grow and embrace technology with attracting over-supply.
He backs Domino’s as one of the company’s with the greatest scope to exceed like-for-like sales expectations, while The Restaurant Group’s forecasts carry the greatest downgrade risk. He backs Fuller’s and Shepherd Neame as having the greatest scope to exceed expansion expectations.
He said: “The supply/demand dynamics of the pub market are more attractive than that of the restaurant sector. With drinking out recovering, the managed pub sector is now more active at repositioning assets away from value towards premium brands than from drink to food. Overall, the quoted operators have above-average exposure to premium venues and to London.
“Pub drink price increases are correlated to the current price level, implying that premium priced venues have less price-sensitive customers. In both pubs and restaurants, the premium segment is outperforming in relation to pricing and volumes.
“Tenanted pubs are performing at least as well as managed pubs. Managed pub like-for-like sales rose by 0.9% on average (1.8% in London; 0.6% outside London) in the year to September 2017 (Coffer Peach Tracker). In comparison, the quoted tenanted operators generated average like-for-like net income growth of 2.3% during the last year.
“Restaurant demand and supply growth is slowing, with large operators cutting back on expansion and independents likely to contract in size. As with pubs, premium venues are outperforming in the restaurant sector. However, for the sector as a whole, like-for-like sales are minimal versus c3% being needed to offset costs, with limited scope to mitigate costs and diversify revenue.
“Overall, managed restaurant like-for-like sales rose 0.3% (0.1% in London; 0.4% outside London) in the year to September 2017 (Coffer Peach Tracker). Somehow, independent restaurant numbers rose in H1 2017; we view this as being unsustainable.
“Traditional pizza market demand slowed from 8% to 4% in H1 2017, but with Domino’s growing by 7% vs 1% for the rest of the market. This largely reflected tough comps, unfavourable weather and increased competition.
“Domino’s dominates the sub-sector in relation to profitability, advertising fund, and has controls and profits that aggregator deliverers can only dream of. We expect Domino’s, with 46% share, to drive stronger growth in H2 2017. Domino’s Pizza, Fuller Smith & Turner and Shepherd Neame have the strongest balance sheets in the sector, and Ei Group and Restaurant Group have the weakest, in our view. Even though trading conditions are tough for many companies, we believe the sector’s cash flow should rise steadily over the next two years.
“Corporate activity is being dominated by the pub sector, with national brewers re-entering/extending their ownership. Recent restaurant sector corporate activity has involved companies being bought out of administration. The largest quoted pub and restaurant operators are focused on rebranding and repositioning their outlets. Pressure to acquire should increase in 2019E if cost pressure does not abate, and cost mitigation opportunities start to wane.
“We believe Revolution Bars Group’s (RBG) shareholders turned down a 203p/share cash offer as a result of Deltic’s equity merger proposal, which we estimate was worth 280p/share at a 10% equity FCF yield if £22m of shareholder loan notes convert to equity (314p/share if they do not). We do not believe shareholders voted for the company to remain independent. The failure to engage with Deltic, combined with Takeover Panel rules, forced Deltic to withdraw its offer, however Deltic has stated that restrictions on it bidding for RBG do not apply if the board of directors of Revolution agrees to engage. We believe RBG shareholders want the Deltic merger to proceed. This would resolve stewardship issues and create significant shareholder value. Thus, we believe management should now engage with Deltic.
“Our forecasts are slightly below consensus. We believe Hollywood Bowl, Ten Entertainment and Domino’s Pizza have the greatest scope to exceed like-for-like sales expectations, whereas Restaurant Group’s forecasts carry the greatest downgrade risk in our view. We believe Fuller Smith & Turner and Shepherd Neame have the greatest scope to exceed expansion expectations.”
