Leading analyst Mark Irvine-Fortescue at Panmure Gordon has said that although the management change at The Restaurant Group (TRG) should be a positive catalyst for growth, the competitive environment remains unyielding and the backdrop of consumer uncertainty and cost inflation arguably puts additional pressure on the ‘transformation programme’ being successful.
He puts forward eight important issues that the new management team led by Andy McCue should focus on including cutting the estate’s tail, menu initiatives and operational discipline.
On menu initiatives, he said: “TRG’s LFL performance started to decouple from peers shortly after the new F&B menu was rolled out in August 2015 (price drift, 70 item changes). Management acknowledges that ‘substantial price and proposition changes are required’ across all Leisure brands, i.e. Chiquito and Coast to Coast as well as F&B. We assume 10% pricing investment in F&B, 7% in other Leisure, plus more customer-driven menu content drives modest volume offset towards the end of the year, equating to LFL declines of -8% and -5% respectively in 2017.
“Cutting the estate tail. At the interims in August 2016 33 underperforming sites were earmarked for exit (including 14 F&B, 11 Chiquito) with impairments made to a further 29 sites. We would not be surprised if a lot of the latter were exited too: we model a further 15 closures in 2017 and 8 thereafter.
“Rollout commitments. TRG will be pre-committed to certain leases for new restaurants, presenting a dilemma for management trying to address format underperformance. We model 10 new openings in 2017 and 7 p.a. thereafter. Investing capital in new sites will be difficult to justify before judgement can be passed on strategic initiatives. But TRG’s options will depend on individual lease terms and landlord negotiations.
“Operational discipline. Management has alluded to the need for better, more efficient service levels and operating processes, which chimes with anecdotal customer feedback we have seen. Finding sustainable cost savings would bring welcome relief with inflationary headwinds afoot, but may be difficult to push through without damaging staff morale, which presumably is already low, and with some reinvestment into brand/marketing arguably required.
“Capex investment. Allied to the brand/marketing point above, we expect TRG to switch capex away from expansionary investment into maintenance capex, in order to refresh restaurants at a time of menu/brand relaunch. We model 4.5% capex as a % of sales going forward, versus 2.9%/3.1%/3.6% in 2015/14/13.
“Leverage. We forecast net debt of £44m at December 2016 and lowly ND/EBITDA leverage of 0.4x which should afford RTN some welcome flexibility as it embraces the transformation programme. Capitalising rental leases as debt, we estimate adjusted leverage moves north of 3x, which is less comfortable – although subject to the outcome of estate decisions.
“Dividend. We assume a flat DPS of 17.4p yielding a generous 6%. We expect some sort of update on capital structure and dividend policy on 9 March.
“Exceptional charges. We expect further exceptional charges in 2017 beyond those already called out for 2016, namely £39m for impairments and onerous leases and £18m further write downs. We expect most of said charges to be noncash, but there are likely to be some modest cash restructuring items.
“Remain at HOLD, TP lowered to 310p. We base our TP on 7x 2017 EBITDA, in-line with Mitchells & Butlers and a justified discount to Greene King (8.4x), Marston’s (9.3x) and JD Wetherspoon (9.0x). The current valuation is not optically ‘cheap’, although should represent trough earnings. Given multiple uncertainties touched on above, we feel it difficult to have investment conviction at this stage, and await the strategy reveal on 9 March for further management disclosure. We therefore remain at HOLD for now.”
