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Morning Briefing for pub, restaurant and food wervice operators

Wed 25th Oct 2017 - Update: Sector dynamics, Whitbread, Heineken
Douglas Jack – the demand and supply dynamics now more attractive for pubs than restaurants: Peel Hunt leisure analyst Douglas Jack has argued that the quoted pub sector is a more attractive investment proposition than the restaurant sector. 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.”

Heineken reports UK Third Quarter volume drop, growth elsewhere: Heineken has reported volumes in the UK were down double digit in it Third Quarter , continuing to be impacted by a partial de-listing at a large customer. Overall, consolidated beer volume was up 2.5% organically, with growth in Asia Pacific, Americas and Africa, Middle East and Eastern Europe offsetting lower volume in Europe against tough comparatives. Heineken volume was up 3.4% driven by Brazil, South Africa, Russia and Mexico. Jean-François van Boxmeer, chairman of the executive board and chief executive, said: “Performance in the third quarter was solid, with an acceleration of organic volume growth in Asia Pacific and Africa, Middle East and Eastern Europe. Growth in Asia Pacific continued to be driven by Vietnam and Cambodia whilst in Africa, Middle East and Eastern Europe, the main contributors were Russia, Ethiopia and South Africa. In the Americas, Mexico continued to deliver, and weaker volumes in the US were offset by growth coming from Brazil. Europe had to face tough comparatives, partly due to less favourable weather in some key markets. During the period we completed the acquisition of Punch Securitisation A. Our full year expectations remain unchanged.”

Morgan Stanley downgrades Whitbread after share price drop: Morgan Stanley leisure analysts have downgraded Whitbread’s after yesterday’s half year results. A note stated: “Premier Inn’s single brand, single market, owned/leased structure is not in vogue, but this structure has created arguably the “best” listed hotel chain globally, with an occupancy rate exceeding 80%, TripAdvisor score of 4.4, an OTA mix of just 5%, a unit growth rate of 7%, and a 65% freehold mix. Costa is by far the largest coffee chain in the UK and the second largest globally, offers upside from its new product and technology improvements, and is seeing rapid expansion not just in the UK but also overseas. Overall, we forecast Whitbread will generate a FY17-20e CAGR of 8% for both sales and EPS (nearly all from expansion rather than like-for-like growth), leading to a company trading on a cal 2020 P/E of 11.5x and EV/Ebitda of 7.5x. Our sum-of-the-parts values the shares at £45, 20% above the current share price. The company devoted more time (yesterday) to discussing its International divisions, and although profits improved sharply (£1m to £4m for Costa, £(3)m to £(2)m for Hotels), these are unlikely to move the dial much, in our view, even if the company does achieve its £25-30m Costa International Ebit target by 2020. Similarly, although there has been more investor chatter about the group structure recently, management sounded very committed to it, noting group synergies in achieving efficiencies for Costa which is only mid way into a multi-year turnaround, and that Premier Inn’s real estate backing creates capital gains that can be recycled as well as relatively high margins. With concerns over the UK economy and Brexit likely to linger for some time, and trading likely to remain dull (Costa faces a tough Q3 comp at +2.9%), which will be reported late January, just being “cheap” or a “good company” do not appear to be sufficient for outperformance. We have no doubt that Whitbread’s brands will emerge stronger than the competition, but until investors know how long this period of dull trading will last, we would not be surprised to see the “buyer’s strike” remaining. We are cognisant our positive rating has not worked, and disappointed to be downgrading after yesterday’s share price drop, particularly with 20% upside to our new £45 price target. However, we think the significant uncertainties over the UK economy could hang over the shares for an extended period.”

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