Leading analysts Douglas Jack and Ivor Jones, of Peel Hunt, have given their view on themes likely to develop in H2 2018, and their thoughts on the development of a Modern Leisure Generation 2.0. They say that they expect JD Wetherspoon to trade the furthest ahead of expectations in the second half of the year, and The Restaurant Group to be the furthest behind. They also discuss the impact of weather on the eating and drinking out sector, suggesting that much of the recent de-rating of the pub sector is based on an assumption that like-for-like sales between July 2017 and March 2018 were more to do with consumer demand than cold, wet weather.

The note reads: “Recent trading has been heavily influenced by the hot weather and FIFA World Cup, which, in licensed retail, has largely exacerbated established trends in the sector. For example, Domino’s Pizza’s year-on-year web-hits rose by 26% in June vs 13% in July; LFL sales in wet-led pubs averaged +5% in MayJune, 7% ahead of the average in restaurants. Long-term investors should not be too concerned about budgeted events, such as the World Cup, unless they compound established trends to the point of forcing profit warnings (in either direction).

“In this note, we are more concerned with how investment should determine success or failure over the next decade, in what we call Modern Leisure Generation 2.0. The First Generation of Modern Leisure (1995-2006) aimed to replace the old and traditional with the modern. This often lacked the sophisticated segmentation model of the current technology-assisted disruptive phase, which, in the case of gyms and bars, has wiped out the undifferentiated middle-market that was built in the first phase.

“In this light, we review factors influencing historic changes in supply, and consider which assets are vulnerable to the next phase of disruption, and which assets have the potential to disrupt. The downside risks are greatest where there is oversupply, a lack of differentiation/convenience/events, as well as high exposure to labour cost inflation. On all measures, we believe restaurants are worst placed. Low-cost gyms are best placed, followed by bowling and wet-led pubs.

“In most areas of leisure, weather has a significantly greater influence on short-term demand than consumer confidence; the exception to this rule is restaurants, which are highly correlated to consumer confidence, albeit with LFL sales declines that have been exacerbated by oversupply. We believe the de-rating of the pub sector is due partially to previously weak LFL sales, which some have attributed to the consumer backdrop, whereas we believe it was mostly due to cold, wet weather between July 2017 and March 2018. We expect pubs and pub restaurants to be resilient to changes in consumer confidence, yet benefit from soft weather comparatives over the next nine months. Thus, we view recent weakness as an attractive buying opportunity.”

The note goes on the examine specific segments of the market:

Wet-led pubs benefit from supply reduction

• Wet-led pub supply has fallen by 38% since 2000, through a combination of price competition from supermarkets, bar expansion (in particular, that of JD Wetherspoon), conversions to food-led and conversion to alternative use (such as residential) to extract greater value from the assets. The smoking ban and regulatory interference in the leased pub sector have also contributed to supply reduction.

• In our view, the quality of the wet-led pub sector has never been higher, and these assets are more attractive than ever for brewers wishing to drive distribution and profitability. Attractions of the sub-sector include its repositioning to being more premium (competing on price does not work) and being less vulnerable to oversupply elsewhere in the on-trade.

• These factors, combined with a material slowdown in conversions from wet-led to food-led, have resulted in supply reduction starting to slow. We do not expect wet-led pubs to disrupt other sectors, but the less attractive and eventorientated outlets should remain vulnerable to demand switching to the off-trade, particularly if the Government starts raising alcohol duty to help pay for increased funding for the NHS.

Nightclubs took the medicine in 2006-11

• Nightclub supply fell by 34% between 2006 and 2011, and has been reasonably stable since. The dramatic fall was caused by regulation in the form of licence reform and the smoking ban as well as the financial crisis/recession. Despite these events, door money has not fallen for the best venues, which have also benefited from significantly reduced competition.

• Like wet-led pubs, reduced supply has increased the average quality of the remaining, more profitable clubs, which can benefit from a higher ratio of capex/outlet, the rocket fuel that powers LFL sales.

• The nightclub market benefits from minimal supply growth within the late-night market. We do not expect it to disrupt or be disrupted by other sectors over the next few years.

Bars: winners and losers

• The bar market over-expanded between 1997 and 2006, adding too much undifferentiated, mid-market product such as chameleon bars. All the chameleon bar formats have now closed, defeated by more specialist segments such as nightclubs, entertainment bars (for example, Walkabout), premium bars (for example, Slug & Lettuce or Revolution) and mainstream discounters (for example, Wetherspoon).

• During the worst phase of over-supply, too many operators resorted to discounting, which contributed to disorder in the areas surrounding these venues. Supply has rebalanced and operators are cognisant that trading is often strongest in the more premium products and venues.

• Reduced supply has increased the average quality of the remaining, more profitable outlets, which can benefit from a higher ratio of capex/outlet. We expect bar supply growth to be minimal, and for the event-driven wet-led outlets to outperform due to having less exposure to over-supply in the eating out market. JD Wetherspoon, Stonegate and Revolution Bars Group have emerged as winners, although the latter has suffered from company-specific problems in recent times.

Food-led pubs are stable overall, but with premium outlets outperforming

• The supply of food-led pubs has been relatively stable since 2006, with large new build pub restaurants and wet-led conversions adding to supply, offsetting tail-end sites converting to alternative use. In terms of square footage, supply has continued to grow until 2017, at which point the impact of over-supply in eating out became much clearer.

• Food-led pubs have a more balanced model than restaurants, benefiting from bar income and being better able to use events to drive footfall.

• The most premium outlets, with a more differentiated offer, are outperforming, similar to trends elsewhere in the sector. As a consequence, the premium segment (labelled “platinum” in the chart) is expanding at the highest rate through new sites and conversions.

Restaurants

• Restaurant supply growth was steady until 2012-15, when it accelerated at an unprecedented rate. Much of this expansion was undifferentiated, mid-market product (partly in retail/leisure parks), repeating the trend in gyms and bars in the previous two decades.

• Subsequent to this over-expansion, supply reduction has been delayed by small brands expanding (aided by younger customers’ desire to experiment and Deliveroo’s Editions reducing barriers to entry) as well as older private brands resorting to CVAs in order to share the pain with their landlords. We believe there are multiple sources of disruption:

• Delivery is exploiting customers’ desire for convenience, but it is disrupting the restaurant sector due to being relatively unprofitable and cannibalising more profitable in-store trading. The delivery phenomenon is more established in Indian and Chinese restaurants, due largely to the success of Just Eat. However, supply changes indicate that Chinese and Indian restaurants overall have not benefited from the growth in delivery, with supply in the former falling by net 15% over the last three years.

• Competition from branded food pubs, QSR (quick service restaurants), coffee shops, as well as more experiential leisure venues such as bowling centres.

• Too many of these mid-market restaurant brands do not have the product, amenity or location to raise prices to cover rising costs; and will likely have to reduce prices further to drive footfall, particularly with competitors passing CVAinduced rent reductions on to their customers.

• Following the trend in the gym and bar markets, we fear there is the potential for significant disruption in the midmarket of the casual dining sector, with undifferentiated destination sites being particularly badly affected.