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Thu 10th Mar 2016 - Analyst – The Restaurant Group needs bold approach
Analyst – The Restaurant Group needs bold approach: Leisure analyst Simon French, of Cenkos Securities, has advocated a bold approach at The Restaurant Group, including culling the tail of Frankie & Benny’s and improving food quality, to reverse the current decline in like-for-like sales. Issuing a ‘Buy’ note, he said: “Yesterday’s (Wednesday, 9 March) 23% share price fall reflected yet another disappointing update from the group who seem reluctant to address the core issue which is the increasing marginalisation of Frankie & Benny’s. Since the beginning of 2016 we have downgraded our current year earnings per share forecasts by 6.6% yet the shares have fallen 38.7% resulting in the price-earnings ratio compressing from 17.5x to 12.2x, its lowest since 2009. We also highlight that the EV/Ebitda multiple of 6.7x would appear particularly appealing to private equity who have been happy to pay 8-9x (or more) for inferior businesses such as Gaucho, YO! Sushi, Las Iguanas and Cote in recent months. Combined with the group’s under geared balance sheet we think a would be suitor could pay c600p/share and raise net debt/Ebitda to 3.0x whilst maintaining fixed charge cover above 2.0x. At 600p/share the EV/Ebitda multiple would be 9.4x. 2015 results were in-line with expectations despite an unforeseen circa 14% increase in central costs which meant that trading profit and margins were ahead of our forecasts. However, the 1.5% like-for-like sales decline which began in November has continued through to the beginning of March. Management thinks that like-for-like sales increases will be difficult to come by this year – we are more cautious and assume that this level of decline continues. Similarly management expects a 30-50bps decline in the Ebit margin, we forecast 70bps. Incoming chairman, Debbie Hewitt will need to act swiftly to decide whether management change is needed – having been a non-exec for over nine months she will already hold strong views – but we think an injection of outside talent is long overdue. Our assessment of the group is that Concessions and Pub Restaurants are performing strongly with Chiquito and Coast to Coast performing well but Frankie & Benny’s underperforming. Some of this reflects competition issues – in some cases from the group’s own brands – but we believe the issue is more internal, the menu change reduced choice limiting the broad appeal of the brand, one of its key attributes. Similarly key items such as a burger appear out of kilter with the competition on price, quality and thus value; anecdotally, execution appears less consistent. We think the group needs to consider disposing of some of the brand’s tail and/or convert underperforming sites to other group brands. For the remaining sites we would advocate a bold approach which we doubt will be implemented: pricing needs to be tweaked down rather than edged up, the menu needs broadening and more fresh produce introduced. This will impact margins in the short-term but provide a more sustainable foundation from which to grow. However, we would caution reading too much into like-for-like sales growth. Whilst we agree that it is a leading indicator of group profit performance, the measure that it needs to be reconciled with is Return on Invested Capital (ROIC). In recent days both Whitbread and Restaurant Group have been penalised by the market for weaker than expected like-for-like sales growth performances over a ten-11 week period. Both companies have aggressive rollout programmes that sometimes cannibalise existing site sales but improve overall group ROIC which in the case of The Restaurant Group improved by a further 20bps to an industry-leading 14.0% in 2015. That said we struggle to reconcile the group’s cautious outlook and like-for-like sales underperformance versus the market and its peers with its desire to continue opening 40-plus sites per annum particularly when some of these compete directly with its existing brands. In an era of rising supply, using its strong balance sheet to acquire competitors would seem a more pragmatic approach to gaining market share. We assume group like-for-like sales remain at -1.5% for the remainder of the year and that Ebit margins decline 70bps resulting in a 6.8% downgrade to £87.7m profit before tax, modest growth driven by the opening of 38 net new restaurants. In 2017E we assume flat like-for-like sales growth, 38 net new restaurant openings and flat margins. This results in a 7.4% downgrade to earnings per share. We also introduce our 2018E where we forecast 2.0% like-for-like sales growth, 38 net new restaurants and a 20bps improvement in the Ebit margin. The group’s financial outlook is not unattractive, profits should grow this year, on every metric, and on a three-year view, earnings should grow at circa 7% per annum compound with debt reducing at more than 10% per annum with dividend cover maintained at 2.0x. Since the beginning of 2016 we have downgraded our current year earnings per share forecasts by 6.6% yet the shares have fallen 38.7% resulting in the price-earnings ratio compressing from 17.5x to 12.2x, its lowest since 2009. On an adjusted EV/Ebitdar basis the stock trades on 7.2x 2016, substantially below its peers in a range of 7.4-8.6x.”


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