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Buy recovering Restaurant Group

Following a torrid 2016, Restaurant Group's new boss has set out a turnaround plan that could result in considerable upside for shareholders and has maintained the generous dividend
March 23, 2017

We believe there is a good chance stricken Restaurant Group (RTN) will turn a corner this year, as its new management works to reinvigorate its well-known eating-out brands. While like-for-like sales and margins are expected to continue to fall in 2017, we think the shares will benefit as early signs emerge of the turnaround strategy bearing fruit. And, in the meantime, shareholders have the prospect of a 5 per cent dividend yield to tide them over.

IC TIP: Buy at 359p
Tip style
Speculative
Risk rating
High
Timescale
Medium Term
Bull points
  • Clear turnaround plan
  • Attractive dividend yield
  • Falling capital expenditure
  • Low multiple of sale valuation
Bear points
  • Cost pressures
  • Short-term margin pressure

While much of the hard work is yet to be done, new boss Andy McHue - formerly of Irish betting group Paddy Power - has already managed to instil some confidence among investors with a better-than-expected set of 2016 results. Crucially, though, Mr McHue has identified a number of problems and laid out clear plans to address them. Central to his view about what has gone wrong is that the group has lost customers by focusing too much on keeping prices up.

 

 

The company has already launched a number of promotions to win over new and lapsed customers. In the future, Mr McCue wants to harness analytic tools to make better decisions, including promotions, based on hard customer data. This should help in his aim to restore the 'value credentials' of Restaurant Group's brands, which include Frankie & Benny's, Chiquito and Coast to Coast, so its restaurants are not permanently reliant on offering deals. To this end, work is being done to revamp menus with set prices aimed at families.

Frankie & Benny's, the group's biggest and best-known brand, will come under particular scrutiny. Changes will include raising the number of menu items under £10 from five to 22 by the end of this month and launching a weekday menu with two courses for £9.95, down from £11.95. Typically, Frankie & Benny's has not been heavy on promotions, but management claims targeted discounts have proved effective in recent weeks. Less about price, Restaurant Group's American bar brand Coast to Coast will undergo a "fundamental repositioning" towards a burger and steak concept. While this is a competitive market in London and the south-east, it has good potential in regional retail and leisure parks up and down the country.

The work to reinvigorate brands is expected to weigh on operating margins, which fell last year from 13 per cent to 11.1 per cent. Broker Peel Hunt expects this measure of profitability to drop to about 8.5 per cent both this year and next, before heading back up to 10 per cent come 2019. The job of stabilising then raising profitability will be made harder by rising costs, including food prices, wages, the apprenticeship levy and business rates. However, the new boss has a range of initiatives under way to more than compensate for this.

A cost-cutting programme aims to make £10m of annual savings by 2019 at a one-off cost of £6m. Furthermore, last year 33 underperforming sites were closed and a further eight will be shut this year, and the balance sheet value of 66 other sites was reduced. As well as eliminating uneconomical sites, the £117m exceptional charge related to this restructuring will help with attempts to revive margins by reducing future depreciation and amortisation charges and by creating a £44m provision to shield the income statement from cash costs associated with rental agreements that are judged to have turned sour. All in all, management expects 2017 profits to benefit to the tune of £10m.

The flipside of the benefit to future profits from the exceptional charge is the reverse effects on future cash flow statements making it harder for the company to keep up its track record of excellent cash conversion. Nevertheless, the strong balance sheet (net debt of £28.3m and undrawn borrowing facilities of £112m) and faith in the potential to reinvigorate the brands has given management confidence to hold the dividend, despite the earnings cover now being below the target of two times.

Cash flows will be helped by the fact that the group is drastically scaling back new openings from 44 at the peak in 2015 to 16-20 this year. New openings fell to 24 last year as trouble set in. Broker Liberum expects this to mean 2017 capital expenditure will come in at £45m (£20m on new openings and £25m on site maintenance), compared with £55m last year and £75m in 2015.

RESTAURANT GROUP (RTN)

ORD PRICE:359pMARKET VALUE:£723m
TOUCH:358-359p12-MONTHHIGH:438pLOW: 230p
FWD DIVIDEND YIELD:5.3%FWD PE RATIO:15
NET ASSET VALUE:104pNET DEBT:14%

Year to 31 DecTurnover (£m)Pre-tax profit (£m)*Earnings per share (p)*Dividend per share (p)
201463578.129.915.4
201568586.833.517.4
201671177.129.817.4
2017*69857.922.517.4
2018*73760.923.919.2
% change+5+5+6+10

Normal market size: 3,000

Matched bargain trading

Beta: 0.48

*Peel Hunt forecasts, adjusted PTP and EPS