Propel Newsletter Archive Page

Analyst – pubs and restaurants: beware the margin squeeze: Numis leisure analyst Tim Barratt has warned that pubs an restaurants face a margin squeeze. He stated: “Recent trends in the Peach Tracker suggest that even pre-referendum like-for-likes in casual dining were gently decelerating. We take a cautious view for 2016-17 (like-for-like sales growth in 0-1% range), which, combined with cost pressures of c.3% (wages +5%, FX-related food inflation), should lead to a squeeze on margins. We believe those best placed to deal with this have pricing power (Fuller’s) or other cost savings (Greene King) to protect earnings. In contrast, in price-elastic segments operators such as JD Wetherspoon may struggle to pass this on. More positively, we detect a pull back in new supply as operators adjust to the glut of openings from the last two years. The quoted players now generally favour reinvestment over new openings, evident in Mitchells & Butlers’ £80m remodel programme and Restaurant Group increased maintenance capex. Only niche operators such as Revolution Bars Group and Marston’s will see material contribution from new space in the next two years we believe. The risk is that defensive capex is returns dilutive: ranking the operators in terms of ROIC, returns at RTN remain industry leading but we expect over 100bp of dilution at managed operators RTN, M&B and JDW in the next two years. Recent underperformance means that the sector trades on an average EV/Ebitda of 8.7x compared to a cross-cycle range of 6.6-11.7x. We believe that value is starting to emerge and that some of the negatives we identify in this note are starting to be priced in. Nonetheless we do not expect sentiment to improve imminently and remain selective, favouring RTN for turnaround potential and MARS and GNK for their resilient business models, with multiple earnings levers. We are more cautious on the managed operators such as MAB (pension deficit, NLW exposure) and JDW (low margin, price- elastic consumer) as operational gearing gives these the lowest earnings growth potential in the peer group. In recent quarters, several companies have demonstrated a mild improvement in Ebit margins, reflecting benign input costs and modest like-for-like growth eg MAB +50bp (1H16), RTN +30bp in FY15. For other companies the impact of complying with wage legislation has had a more immediate impact on margins: GNK Pub Company (ex Spirit) -30bp (FY15/16) and JDW -110bp (1H16). Note that JDW raised its starting wage in August 2015, well ahead of the NLW’s introduction in April 2016, bringing forward the hit to margins.” On the impact of the National Living Wage, he stated: “We now expect a fundamental deterioration in margin outlook after several years of benign cost conditions, largely owing to the introduction of the National Living Wage and the possible impact of currency depreciation on imported food/drinks. It is possible that tighter controls on EU workers could tighten labour availability (in some pubcos non-UK nationals are 50% of front of house staff) but we have not adjusted for this yet. Conversely inflation in rent costs and utilities is likely to be less material. The introduction of the NLW in April 2016 created a new category of wage regulation, applicable to over 25 year olds and equivalent to a 10.7% uplift over the NMW that applied to the same workers in April 2015 (650p per hour). Similarly, it is 7.5% above the NMW from Oct 2015. Operators have given conflicting views on the likely coverage of the NLW in their estates, whether they expect to maintain differentials across the workforce (extending the reach) and whether they will offer the higher rate to employees under 25, irrespective of the legislation. Given these uncertainties, we try to make two simplifying assumptions- that on average wage costs will increase by c.5% and that in the short term this cannot be recovered through higher prices. The medium term outlook for wages is also likely to be challenging. Currently the NMW and NLW are set on different timetables (although this may change). The Low Pay Commission has proposed an increase in the NMW (applicable for 21-24 year olds) to 695p from October 2016, equivalent to another 3.7% increase. The government had previously announced its intention to increase the NLW such that it reaches 60% of median wages (see fig 10) by 2020, presented in shorthand as at least 900p (although in reality this will be a function of the growth in average wages across the economy). We therefore expect a c.6% pa increase in the NLW for the foreseeable future. While recent political changes could mean that such a policy is sidelined, it seems prudent to model mid-single-digit wage growth in FY17 and FY18 too.”

Conviviality hires David Robinson as managing director: Conviviality, the UK wholesaler and distributor of alcohol and impulse serving consumers through its franchised retail outlets and through hospitality and food service, has hired David Robinson as managing director. He joined the Group on 1 July 2016 having worked in the retail sector for over 20 years, holding senior positions with a range of large organisations. His retail career started at Dixons Stores Group where he held roles within commercial and product marketing before joining Homebase as a category manager. In 2003 he moved to Argos and worked in a number of marketing and commercial roles before joining the Homebase executive board as commercial director in 2009. Robinson joined the Argos executive board as commercial director in 2011 and was most recently Argos’ chief operating officer. Conviviality chairman David Adams said: “I am delighted to welcome David to our board as managing director of Conviviality Retail. During his time with Argos, David was instrumental in the implementation of its strategic, operational and financial transformational plan and we look forward to benefiting from his significant retail experience.”