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Fri 8th Feb 2019 - Premium Opinion: Are you sitting comfortably?

Are you sitting comfortably? by insights editor Mark Wingett

In my first Friday Premium Opinion piece I take a quick look at the state of the current market, some thoughts on the two words – transparency and realism – that will be important for operators this year, and look at some of the bigger beasts in the restaurant sector.

The past 12 months have seen businesses strain every sinew to continue their growth and, in too many cases sadly, to continue their very existence. The hospitality sector has again proved its resilience and ability to adapt and evolve but the fear is it will have to do so all over again. The industry is going through a seismic change and some key strategic decisions will have to be made in the coming year across all corners of the market. Some will roll the dice, stick or twist. There will be more pain, some surprises and hopefully some success stories too.

In January 2018, Scottish brewer and retailer BrewDog acquired the Ape & Bird in the capital’s Cambridge Circus from former darlings of the central London dining scene Polpo, in what now seems the perfect example of how the next 12 months would play out – in simple terms, wet-led trumped food led… or so the narrative went. The fact the James Watt-led business would later acquire the Jamie’s Italian unit in Canary Wharf further underlined this shift.

While pub and bar operators could fall back on their drink sales – and the growing trend for premium drinks (craft beer and cocktails) – food-led operators, and in particular mid-market casual dining businesses, found themselves in the eye of a rising cost maelstrom and against a consumer that had reached tipping point when it came to what they expected from an eating-out experience. Businesses that had rested on their laurels or become arrogant on previous or even fleeting success were found out. A swathe of restructuring cases ensued – the majority caused by wider market issues but many by their own shortcomings.

According to the Centre for Retail Research, 10,413 jobs were lost across the casual dining sector in 2018. The centre warned it expected a further 10,950 jobs to be lost across the casual dining sector in 2019, with independents being hard hit. Many of the large chains have already made cuts and – whether voluntary or through the necessity of a CVA – the argument is whether some of them cut deep enough. The days of the 150-strong brand, even a 100-strong one, seem over. Prezzo cut a third of its circa 300-strong estate on the back of its own CVA but you would have to question whether the UK restaurant sector or consumer still needs or wants 200 Prezzo units in the mix. I fear one of the businesses that has already undergone a restructure could come under pressure to cut its numbers again – such is the speed of the correction/recalibration the sector is currently undergoing.

Size matters, or so they say, but the past 18 months have been a wake-up call for companies in the 100 to 300-strong estate range. Too big to evolve quick enough and stay relevant, this trend has seeped further down the chain and I would argue has become a concern for anyone with 30 sites upwards. Have you got a strong enough point of difference? Can you stretch your brand? If the key staging points for a business were seven, 17 and 70, I would argue 37 needs to be added to that list. When an investment suitor asks whether you can double your estate, the answer might not be so simple any more.

Since the start of the year, a number of companies, led by Oakman Inns and Carluccio’s, have said they will help their non-British EU employees apply for “settled-status” in the UK following Brexit, placing pressure on their peers to follow suit. Fuller’s has been supporting its EU staff to get UK residency and, by the middle of last year, had funded applications for 20% of its eligible workforce. Sadly, what a post Brexit deal/no deal will look like remains elusive, but being proactive can provide much-needed reassurance to staff. It has always been important to hire and retain great people but now it’s unbelievably important in an environment where everything is getting harder and you can’t just pay more. The question is what levers can you pull to make people feel great about working for you so they stick around for a meaningful period of time, seemingly with one hand tied behind your back.

Without telling you how to suck eggs, the good news is many of the main issues that make staff less happy at work can be fixed with changes in thinking or behaviour rather than significant new investment. Feeling valued and respected, being recognised for a job well done, availability/accessibility of managers and senior leaders, chances to learn and do new things, mentoring schemes, encouraging outside interests/charity work – these are all achievable and already being carried out by those exceptional companies.

This year for me will be one where transparency and realism play key roles across all society – the hospitality sector will be no different. Operators will need to be even more transparent with their staff, investors, consumers and suppliers, being open with their strategies and how each one of those groups will play a part. You’ll need to be whiter than white on your back story, clear on your ethos, laser-like focused on your processes (allergen laws are currently front and centre of consumers’ minds), and deeply ingrained in your company’s culture. Operators will also need to be realistic on growth targets but they should expect that transparency and realism in return, especially from investors and landlords/property agents. One of the worst things I saw last year was a CVA document attached to CAU. It gave a rundown of why each site needed to be closed, only to be followed a month later by another document proclaiming what wonderful opportunities these sites would be for a new buyer. Thankfully, some landlords have woken up to the new world we operate in. Not enough, but some. It’s interesting that talks have moved away, especially outside London, from how big a premium will be paid to how much of a capex incentive they can provide to secure the best operators for their sites.

Two years ago it was suggested businesses in the sector would have to run at +4% like-for-like sales just to absorb all the costs the market faced. How many in the sector have come anywhere near that? Underlying like-for-like growth for the Peach Coffer Tracker, which represents large and small groups, was running at 0.8% for the 12 months to the end of November 2018, virtually the same as at the end of October, showing the eating and drinking out market remains essentially flat. It’s not going to get any easier – the fear I’ve expressed before is the current climate will take down even some good businesses. The need now is to be exceptional – day in, day out. It takes a special operation to be able to do that. A handful have but others need to step up to the plate – and quickly.

The Big Beasts

Much of the focus at the end of last year was on whether The Restaurant Group’s (TRG) deal for Wagamama would go through, which it did with a greater majority than speculated. The next 12 months will now shift that focus on how TRG uses its new acquisition and whether the change of ownership has an impact on Wagamama’s impressive performance. There may be some natural slowing, such are the levels the group is currently operating at. Already, the majority of analysts have pointed to Wagamama’s recent second-quarter results to validate TRG’s view about strength of brand and should, in time, give comfort on the acquisition multiple paid. Its second-quarter top-line growth of 15.4% to £81.5m in the quarter consisting of 12% like-for-like growth in the UK, 7% in the US and new openings is outstanding. The UK like-for-like figure is the strongest quarterly growth rate since FY15/16 and is impressive considering it is lapping a 7.1% comparative. The pressure is on TRG not to drop the ball, distract Wagamama’s management team or allow a talent drain. There has been no drop-off in innovation so far, with the recent launch of a vegan full-English breakfast offer, highlighting once more how the brand continues to stay ahead of the curve.

It will be interesting to see if TRG returns to the pub acquisition trail or looks at other bolt-on deals. Speculation suggests it has already started looking for a further acquisition. In the meantime, away from the already stated conversions from TRG’s existing estate, there will hopefully be a first trial site of the much-anticipated smaller grab-and-go format from Wagamama. Working titles for this concept have included Kuzu, with Mamago the latest name put forward. With YO! Sushi already stating its intention to focus on the food-to-go market, this sector is set to become a key battleground in the coming years as a number of established players diversify their offers and move further away from traditional big-box units.

Casual Dining Group
I wrote late last year that TRG’s deal for Wagamama placed some pressure on Casual Dining Group (CDG) to come back to the mergers and acquisitions table. With global private equity group KKR’s full backing and the out-of-the-blue appointment of outgoing Greene King chief executive Rooney Anand, who is fond of a deal, as its new chairman, the signs are it will take part in some form of transaction during the next 12 to 18 months. In some respects it’s quite a courageous move for Anand, with people pointing out his last move into the casual dining sector was to acquire Loch Fyne for circa £70m in 2007 – a deal impacted by unfortunate bad timing and one that never played out as he and Greene King expected. CDG still has to find a sustainable answer to what to do with Café Rouge and continues to generate returns from Bella Italia. Will Anand’s appointment put pressure on CDG chief executive Steve Richards, who has steered the company through the choppiest sector waters during the past five years and certainly put it in a better position than when he came on board? I would say yes in one respect that Anand is KKR’s appointment and they will expect him to bring some impetus to proceedings – to freshen things up. However, Richards should also welcome having a fresh pair of eyes on market opportunities and a new sounding board.

The immediate reaction was CDG, with Anand on board, would start looking at pub portfolio deal opportunities. I can’t see this being an immediate priority, especially as this is already a highly competitive market, although the company has previously mooted exploring some conversion opportunities from its existing estate for its Ale & Coffee House concept. It will also surely look to bolster the portfolio of brands it works with through its concessions arm. However, does KKR have the appetite for a similar transformational deal that TRG hopes Wagamama will be? Does acquiring a small pub or bar company, Giggling Squid, Turtle Bay, another Italian brand or Franco Manca turn the dial quickly enough? Perhaps there is another hail mary out there? What about a merger with or acquisition of the UK arm of PizzaExpress? Talking of which...

PizzaExpress reported a “resilient performance” in the UK and Ireland for the 26 weeks ending 1 July 2018, while its international business continued to expand. Underlying like-for-like sales in the UK and Ireland grew 0.9% excluding impact from adverse weather (down 0.7% unadjusted). The question is whether that resilience continued into the second half of the year? With circa 470 restaurants across the UK and Ireland, the company has got to the stage where expansion opportunities are becoming limited. Keeping a 50-year-old brand relevant is always high on the agenda but how you make more of your existing estate will also be a key question for the management team this year. Managing director Zoe Bowley intimated last year the company was looking at different models, while Chinese private equity firm Hony Capital, which owns PizzaExpress, has previously talked about bringing other international brands into the UK. The first part of that strategy will kick off earlier this year with the company trialling Za, a grab-and-go model at its PizzaExpress branch near Fenchurch Street Station. Similar in feel to Azzurri Group’s successful Coco di Mama brand but based on pizzas rather than pasta, the concept focuses on pizza by the slice, wraps and salads. It will hope to be more Coco di Mama than Carluccio’s Via.

The company has also set out a five-year plan – entitled Future Express – to refresh its core brand and estate, with a raft of initiatives to be trialled in the coming year including a new look, logo and investment in training. Last month, the company launched its 300th live delivery site in its exclusive partnership with Deliveroo. The company said the partnership would remain an “important element” of the PizzaExpress growth strategy. It is thought like-for-like sales remain flat and delivery now makes up 20% of the brand’s sales. Talk at the start of the year was of concerns raised around its circa £1bn debt pile and of vulture funds circling the business, buying up the company’s debt on the cheap in an attempt to seize control. The company’s bonds, which are trading at 47p in the pound compared with 90p a year ago, saw a surge in trading in January, suggesting opportunists view the chain as vulnerable. They will also be interested in a business that still holds strong appeal to the family market, a strong management team, and a pizza concept believed to generate a gross profit margin of circa 82%.

While the brand’s growth in China has been slower than Hony would have wanted, it is taking action to improve performance and continues to look at how it operates in tier two cities. Hony strongly believes China offers a significant long-term structural growth opportunity and, in that respect, you wonder what the long-term plans for its UK arm are? Could a suitor propose acquiring the UK franchise and look to make the brand a franchise opportunity, keeping a core base of company-owned sites but allowing franchisee groups to take swathes of the business, in turn bringing in new investment, energy and ideas? Hony and the current management team may baulk at that idea but we are in a climate where all avenues need to be explored.

Next week’s opinion slot will, among other things, take a look at big players in the pub sector

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