The Restaurant Group owns various UK food chains and their biggest division is Frankie and Benny. But like most restaurants, they are feeling the pressure with like for like sales fell 3.9% in 2016 and another 1.8% in the first-half of 2017.
But, the industry is facing the perfect storm when you have a slowdown in consumer spending, spending habits, food inflation and the devaluation of the British Pound, also wage pressure. The conclusion drawn is high input costs with little room to raise prices.
So, why am I bullish?
Despite the headline, I am cautious but happens to be bullish in the future. That’s not because it is projecting like-for-like sales growth to return from H2 2017. But, the write down on their assets offer new shareholders a clean slate.
On a whole, the sector is struggling and just recently another restaurant owner, Fulham Shore has said trading is tough despite rapidly growing.
Okay, back to The Restaurant Group.
Reason one: No pension deficits
The company has no pension deficits because there aren’t any pension schemes. This saves them from future expenses, but it also means labour turnover is high, due to the lack of security offered to long-term staff. Therefore, it has to retrain new staff more frequently and sometimes this can lead to inconsistent performances in their various chains.
So, you save on pensions but spend more on training expenses for new staff.
Despite this, administrative expenses haven’t blown out of proportion. So far, it is under control.
Reason two: Manageable debt level
Despite rising sales, the company’s debt remains low at £40m or equivalent to 6% of market capitalisation. That is down to the reliance of operating lease, where annual net rental expenses rose from £32m in 2004 to £83.2m.
However, sales have risen from £200m to over £700m in that period, the increase in rent expenses are manageable.
Reason three: It has freehold properties
Not only does this business has low debt, it owns £110m worth of property values.
That covers 17% of market cap. of £678.2m @ £3.37 per share. Now, the shares @ £3.16 or 19% of market cap.
Reason four: £140m credit facility
This facility will help the business through tough times, that’s a luxury some don’t have. The worry of issuing new shares is very unlikely, but any debt intake from the facility will increase the financial risk, especially when the business can’t make a profit.
Reason five: The £116m exceptional charge
That big write down of their assets (minus cash) is equivalent to 23% of total assets. The decline in after-tax adjusted profit is 10%. Minus any exceptional charges for chain closure, it is likely their last big write down, unless something unexpected happens.
Reason six: The depreciation rate isn’t distorted to boast profits
Despite the large exceptional charges, it has maintained depreciation rate of 5.86% slightly below their 12-year average of 6.18%.
Separately, the company’s asset net book value is below 50% of their original cost at 48%. Their average is 60%.
Reason seven: The £116m write downs bolster capital and asset turnover
Although, this is an artificial boost it could also be interpreted as a way of undervaluing The Restaurant Group’s assets, so if they decide to sell a division off, it could record a profit.
Reason eight: It has consistently produced free cash flow
Despite the super competitiveness of the food business, the company manage to turn over positive free cash flow.
Since 2004, it has accumulated free cash flow of £250m when post-tax normalised totalled £534.3m. That is £234.3m of surplus cash returned to shareholders.
BTW, that how the company paid accumulative dividends of £290m without raising too much in external financing.
On the flip-side, some of these features like low debt and zero pensions are prevalent in other restaurant businesses. I also notice the rise of receivables from £8m to £18m in two years, a thing we should keep an eye on.
Overall, the company is well-managed and has proven to stand the test of time by making adjustments. But, I do think the share price is priced at fair value when the sector as a whole is coming under severe stress.
Putting Restaurant Group’s market value into perspective
Using normalised operating earnings, it has an EBIT yield of 8.55%, but that yield at one point reached 17%.
It’s free cash flow yield 5.28% looks tempting.
Now, looking at earnings power value, the shares are trading in-line with fundamentals.
Given the 12-year historical data, The Restaurant Group’s valuation doesn’t go overboard in terms of valuation and managed a 40% premium to fundamentals when it peaked at £7.50 per share. Their most undervalued point back in 2009, it traded at a discount of over 250%.
Personally, I would invest in The Restaurant Group, if:
EBIT yield: 10%;
FCF yield: 7%;
EPV, as % of share price: 150%.
These look unlikely because adjusted EPS will fall in 2017. (see below)
Share Price Forecast
15 analysts following this company is projecting the stock to trade between £2.75 and £4.30 in the next 12 months, an average of £3.70.
That is despite adjusted EPS of 22 pence and 23 pence for 2017 and 2018, giving it a perspective PE of 15 times and well below 30 pence in 2016.
Despite this, I see this as an initial turnaround, which will gather some momentum next year. Therefore, the shares will come under pressure and could breach £2.50. If you take into account of their technical (see below), then it could breach £2.20 which was their initial trough. So, a divergence convergence scenario could signal a buy, if the turnaround story gathers pace.
Unfortunately, an adjusted EPS of 22 pence = £45m. Given that normalised earnings are declining rather than rising, the perspective earning multiple should be no more than 10 times.
So, a £2.20 is my forecast in the next 12 months.
Some conservative analysts would attach eight times multiples meaning they are forecasting the shares to fall to £1.90.
Putting this together, I think the shares have 65% chance of falling to £2.20 and 50% of reaching £1.90.
Remember, if recovery gathers pace, it would be a good entry point for new shareholders.
Thanks for reading.
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The opinions expressed by the writer is for entertainment and research purposes. It does not constitute professional investment advice. Data is correct on available information at the time.
Finally, the writer does not own the company’s stock, unless stated otherwise.