In a note on The Restaurant Group (TRG/RTN), leading analyst Douglas Jack at Numis look at how the UK’s economic outlook is favourable for consumers; why eating out growth has slowed, whereas the pace of restaurant supply growth has accelerated; questions whether the addition of more town/city centre restaurants is going to encourage custom to switch away from suburban and rural locations and suspects many recent opening by independent operators could close as business rates, rents, labour costs and interest rates rise.
Jacks: “The UK’s economic outlook is favourable for consumers. Economic growth has helped to drive up employment, with average earnings now starting to follow. With cost inflation (RPI) at 1% and mortgage costs at an historical low, the outlook for disposable income is good.
“We believe The Restaurant Group should be a beneficiary of these trends, particularly when customers have completed the current phase of capex catch-up.
“The UK economy is now generating real growth, with GDP exceeding inflation against a backdrop of rising employment and disposable income. The key to controlling it is productivity. Improving productivity is required to protect corporate margins, thereby limiting price increases and limiting increases in inflation and interest rates. Higher employment, rising wage inflation and benign cost inflation are increasing consumer disposable income.
“Longview Economics expects average earnings growth to strengthen further in 2016E, but the benefit of this trend is forecast to be offset by higher inflation in non-discretionary products. This recovery in household disposable income is reflected in the latest ASDA Household Income Tracker, which argues that a further pick up in retail spending is ‘likely to continue over the second half of 2015’.
“Overall, the licensed retailers outperformed the retail sector between 2009 and 2014, but the retail sector has outperformed since March 2015. In our view, many consumers were unwilling to forego eating out during the recession. At that time, they curtailed on big ticket (capex expenditure), which is now accounting for a higher share of consumer expenditure now that consumer cash flow has started to recover.
“In our view, licensed retailers should enjoy the full benefit of this improving cash flow when consumers have completed the current phase of catch up.
“Eating out growth has slowed, whereas the pace of restaurant supply growth has accelerated. However, the latter has largely occurred in high street locations, which The Restaurant Group has avoided. Thus, the market dynamics are not as bad for the company as some commentators have indicated, hence the company’s ongoing outperformance against the market.
“For restaurants and food-led pubs combined, supply growth has accelerated to match the pace of eating out growth. All this supply growth is being driven by restaurants. In our view, their supply growth rate, at 8.1% in the year to March 2015, is too high. Some commentators have suggested that this is a risk to RTN, however, most of this growth is occurring in high street locations, away from where RTN trades.
“High street locations account for 56% of both restaurant supply and expansion. Given customers’ preference for convenience, one has to question whether the addition of more town/city centre restaurants is going to encourage custom to switch away from suburban and rural locations. In small towns, new restaurants can grow the market, creating demand. In large towns and cities, incremental supply is more likely to cannibalise existing restaurant trade unless it results in the provision of a new type of offer.
“In our view, customers’ decisions tend to be influenced by location and cuisine. If they prefer the convenience of driving to a leisure/retail park with free parking in comparison to catching public transport to a city centre, they are unlikely to choose the latter just because it now has 30 rather than 25 restaurants, in our view.
“Another consideration is that expansion is being dominated by London, in which 728 restaurants (a 9.1% increase) opened in the year to March 2015. Under 3% of RTN’s sites are in central London, and this ratio is falling. Amongst the greatest risks for London restaurateurs is supply growth, which has already started to undermine restaurant LFL sales within the M25.
“Also, independents, which account for 81% of restaurant supply, contributed: two-thirds of restaurant sector expansion over the last four years, and 81% of restaurant sector expansion over the last year (to March 2015). We suspect many of these openings could close as business rates, rents, labour costs and interest rates rise.”
