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Tue 29th Aug 2017 - Douglas Jack – Restaurant Group recovery will take longer than expected
Douglas Jack – Restaurant Group recovery will take longer than expected: Peel Hunt leisure analyst Douglas Jack has argued that the Restaurant Group’s recovery cold take longer than expected, downgrading his recommendation on its shares to ‘Reduce’ from ‘Hold’. He said: “For Thursday’s H1 results, we forecast PBT being down 29% to £26.1m (down 21% excluding last year’s extra week), despite some favourable footfall trends and cost savings, and before the full impact of significant price reductions. In our view, the risk to 2018E forecasts is on the downside and the recovery period will be longer than expected. We move from ‘Hold’ to ‘Reduce’. Restaurants are the weakest sector in leisure, in our view, needing 2.5- 3.5% like-for-like sales to hold profits, against a backdrop of oversupply and, in many cases, overpricing (and therefore lacklustre like-for-like sales), and limited scope to mitigate site costs and diversify revenue. This year, Restaurant Group can offset its £16m-19m of incremental costs through closures (£10m saving), £5m worth of central cost savings (to be recycled into extra marketing) and £4m from openings. Excluding the £3m impact of one fewer week, it therefore needs like-for-like sales to be flat in 2017E to hold profits, a scenario that is not going to be helped by needing to cut prices. Like-for-like sales fell by 1.8% over the first 20 weeks despite being assisted by a 13.2% increase in cinema attendance and a 7.3% increase in airport passenger volumes in January-April. We expect like-for-like sales to have weakened in May-June due to a circa 10% cut in Frankie & Benny’s (F&B) pricing, cinema attendance falling by 9.8% and airport passenger volume growth slowing to 3.9% over those two months. Half the estate is next to cinemas, which helps to drive footfall. However, the long-term trend here favours cinemas (which are adding their own food and beverages) rather than their co-located restaurants. Over the last seven years, average cinema ticket prices have risen by 36% (taking an increasing share of consumer spend), with attendance falling by 3%. The pubs should be trading well, but they represent just 12% of the estate. With Chiquito and Coast to Coast also cutting prices in H2, profits are likely to fall further over the next 12 months. Where prices fall by 10%, volumes need to rise by a minimum of 12% to offset. Volume recovery takes time, but cost pressures are ongoing and cost mitigation opportunities are finite. Our forecasts, which are 3% below consensus, assume like-for-like sales fall by just 2.7% this year, and rise by 1.4% in 2018E. Profits are highly operationally geared (7%:1% like-for-like sales) to any change in like-for-like sales in either direction. In our view, management has done a good job with recruitment, changing the menus (although F&B’s menu is still far too big, in our view), and sourcing cost savings. Some commentators claim the market will write 2017E off as a transitional year, but with price cuts weighted to Q2 and Q3 2017, there is a clear risk that 2018E will also be a transitional year, with profits falling again and requiring a cut in the dividend (which is currently only 1.2x covered). On 16x P/E, we would take some profits; we are cutting our target price from 350p to 300p.”


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