"Be fearful when others are greedy, and greedy when others are fearful" | The Consumer Sector View
Nov 17, 2022 / Blog
At finnCap, Consumer Research Director Nigel Parson recently published his consumer note ‘Shopping Trolley’ which analyses six UK restaurant operators which include Tortilla Mexican Grill, Fulham Shore, Restaurant Group, Hostmore, Revolution Bars and Loungers. Despite some recent poor trading, current market conditions for the restaurant industry represent an interesting opportunity for investors seeking high operational gearing as we head into recovery but, accepting that, calling the timing of a trading recovery is difficult, perhaps even impossible. He draws inspiration from Warren Buffet’s quote “be fearful when others are greedy, and greedy when others are fearful”.
It is no surprise that the cost-of-living crisis has had an impact on the restaurant sector as people tighten their wallets and spend less. UK consumer confidence fell to an all-time low of -49 in September (from -44 in August) as households continued to struggle, according to GfK index.
The sector is facing the worst cost pressures since 2017 with costs rising sharply for labour, food and drink, servicing debt but particularly energy. These cost pressures have highlighted those companies with effective hedging strategies. Loungers is an excellent example as it is fully hedged for energy until September 2024 and is best positioned to combat this, while at the other end of the spectrum, Tortilla Mexican Grill has no hedges in place and instead has resorted to buying spot rates. In between these two, Fulham Shore, Hostmore, Restaurant Group and Revolution Bars have hedged most energy costs to minimise risk. Only Restaurant Group has an interest rate cap in place.
However, it is not all doom and gloom. Despite the challenges facing operators, the UK population consumes well over an estimated 1 billion meals a week, with total UK expenditure on food, drink and catering totaling over £240bn in 2021, according to the Office for National Statistics (ONS). Restaurants account for a quarter of the total eating and drinking out market by turnover, c.£10bn.
One of the upside opportunities for restaurant operators is that property conditions are excellent, for store rollouts and expansive growth strategies. Competition is reducing. Over the past three years, restaurant supply has shrunk by c.18%, as smaller and single restaurant operators struggled with the pandemic claiming many victims. The cost-of-living crisis is likely to clear out further under-performing and under-capitalised brands and companies, yielding significant market share opportunities for the best operators previously mentioned. As such, the availability of high-quality new sites, at sensible rents, is increasing. Some of these sites are so good that they have not historically been affordable for the hospitality industry in general and specially for restaurant operators.
Employment is another key metric to consider. A resilient jobs market will be important if we do sink into a recession, as many of those who lose work should be able to find alternative employment. The UK is almost at full employment, with job vacancies now equal to the numbers unemployed.
Forecasts are, at best, an informed best guess and now, with so many variables at play, predicting near-term sales trends is unusually difficult. But we do know what we are looking for when evaluating companies: proven management teams, strong brands, good margins, a sensible debt profile and plenty of financial headroom to cope with shocks
Our universe of PLC restaurant operators has seen their share prices decline between -29% to -86% year-to-date. We believe that the prices now fully discount the consumer cost-of-living crisis but fail to consider the buoyant property market conditions and their gearing into recovery. From an investor’s perspective, this is a very interesting time to go bargain hunting.