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Restaurants back on the menu

Created:

1 March 2010

Updated:

2 March 2010

Written by:

Algy Hall

The restaurant sector has coped with the recession a lot better than many industry-watchers had thought it would. It seems eating out has become more deeply ingrained in the consumer psyche, and less of a discretionary item, than it was during previous downturns. At the same time, many of the UK's biggest restaurant chains have used their scale to cut costs and their marketing nouse to attract customers. But does that mean that cylicality is off the menu for good? We doubt it.

Meal or no meal

One of the reasons for the resilience of big restaurant chains last year is that they were quick to enter into aggressive promotional activity. For most of 2009, the branded dining-out market was awash with meal deals, such as voucher code promotions, two-for-one deals and meals for a tenner, as restaurants battled it out with pub groups to get diners through the door. This has kept trading robust, although at some cost to profit margins.

"The reality of 2009 was better than feared for many in the leisure sector and particularly restaurant operators," says Greg Feehely, head of research at broker Altium Securities. "The industry starts 2010 in a much better position than it started 2009, but it's still pretty brutal in terms of getting people through the door."

Marketing strategies based on price promotions gave rise to fears in some quarters of brand damage - that diners would learn to associate certain chains with cut-price offers, and refuse to dine there without a discount. However, restaurant groups are proving themselves adept at rebuilding margins (just check out the drinks prices!) and that offers themselves, as part of a wider mix, in fact have the potential to boost profits.

Off the menu

The losers in the restaurant sector during the recession, and there have been many, have largely been independent operators. Large chains have used their buying power to create economies of scale and undercut independents. However, the resilience of chains also comes down to the fact that many have been good at giving customers what they want.

Peter Martin, founder of eating and drinking-out consultancy Peach Factory, believes that the recession has forced the managers of restaurant chains to stick to their knitting. They've focused on operational performance, rather than doing deals. "This has been a reality check for the industry,"says Mr Martin. "People are saying: we're in the business of looking after people. It's got the industry to focus on the core of what it's there for."

Many chains such as Restaurant Group and Carluccio's have also been taking advantage of the pain in the property market to open new restaurants, and have been reporting that trading at such establishments has been ahead of budget.

Hell's kitchen

While the restaurant industry may have shown its mettle during 2009, there are likely to be plenty of challenges ahead. VAT has already been bumped back up to 17.5 per cent and the odds on a 20 per cent VAT rate after the election are fairly short. New rules have banned the use of gratuities to top up restaurant workers' pay to the minimum wage, and this will add to costs for some operators. Meanwhile, a public-sector job cull is a distinct possibility, putting unemployment back on an upward trajectory.

These hurdles look all the more daunting given the anaemic nature of the recovery so far. Even the football World Cup is likely to be bad news for the industry as it is expected to entice would-be diners away from al fresco dining spots and into pubs at a time when the sun will, with any luck, be shining.

"It's likely to be another tough year," says Mr Martin. "But at least we know what toughness looks like. It was hard in 2009 but most companies came through it."

Take away

The ongoing economic uncertainty is weighing on share prices and one upshot of this could be that some much-anticipated consolidation finally takes place in 2010. A long-time 25 per cent shareholding by Nandos owner Capricorn Ventures in Clapham House, which runs the Gourmet Burger Kitchen, is one source of speculative interest. And if Capricorn does want to bid, recent share price falls makes this look like an opportune moment.

Prezzo is the other widely-touted bid candidate in the sector. A previous management buyout attempt is rumoured to have been thwarted by a lack of financing, but conditions in the credit market have eased, so a second approach is certainly possible.