A great unknown facing this sector is the introduction of the National Living Wage (NLW). Not necessarily the cost of it - many groups have already taken steps to tackle the burden on their balance sheets - but the knock-on effect is that those receiving extra pay will spend that additional cash at their establishments.
Pubs and restaurants already have a favourable trend buttressing their immediate fortunes. This is the strong and growing desire to do whatever we can to not have to cook our own dinner - the $70m raised by privately owned meal delivery firm Deliveroo in July is a case in point.
But to secure long-term growth, they will need some of this additional disposable income from improved wages to be spent in their venues rather than squirrelled away as fears about rising interest rates - read mortgage costs - continue to loom large.
Not only this, but however much is spent the competition for those pounds and pennies is increasingly fierce. Pubs are refining their food offerings as a way to battle against restaurants, food delivery services and increasingly popular fodder from fast-growing chains. Management at Mitchells & Butlers (MAB) recently acknowledged that more than half of its Harvester and Toby Carvery outlets had been "impacted by direct competitors opening in their immediate area". The business is now spending on developing what it sees as its more successful smaller brands.
Decisions about how to deal with increased competition will be key and successful innovation will be of utmost importance. Fuller, Smith & Turner (FSTA) - which sits outside the FTSE 350 - provides an example of this. Its 51 per cent stake in the budding premium pizza and cider chain The Stable provides the company with an element of growth distinctive from its core offering. Rival Marston's (MARS) has also engaged in the trend of 'premiumisation', with a key focus on its upmarket Revere brand of sites where its 'better burger and pizza' concept can be found. It is also growing its destination pub division, which numbers 360 now and where food is the main focus.
It's not only pub chains that are growing, though. Away from this part of the sector Restaurant Group (RTN), owner of chains including Frankie & Benny's and Chiquito, and Domino's Pizza (DOM) are expanding at a fair clip. Restaurant Group's chief executive, Danny Breithaupt, said he was aiming for 43-48 new sites this financial year, while Domino's is aiming for 1,200 pizza outlets in the UK & Ireland in the medium term from its 881 now.
The key consideration for investors will be the quality of any growth. You don't need to look too far back to see a range of pub groups that stretched themselves too thinly as the credit crisis hit and some businesses are still recovering from the hangover caused by this crunch.
On the flipside, 2016 will be a big year for companies dealing with the cutting of the beer tie - notably Punch Taverns (PUB) and Enterprise Inns (ETI). Hundreds of these companies' pubs will be able to buy their drinks from other sources in the coming years, but management will be hoping that the advantages of their large buying schemes - which stretch beyond booze into areas such as utility bills - will entice publicans to stay put. Both the aforementioned pub groups have been busy overhauling their strategies and ridding themselves of underperforming sites, meaning they start 2016 in better shape than they have been in for some time.
Overall, some positive trends have whipped up a bit of a storm in the sector, but if there is a slowdown in consumer confidence driven by weaker stock markets, China, or the uncertainty about the UK's future in the European Union, it will be preferable to back a management team that can either slow its expansion plans or maintain demand for its offering in a tight market.
RBS economist Ross Walker told the CGA Peach 2020 Conference that the consensus was for 2 per cent growth in the leisure sector, which he called "steady growth but not spectacular" meaning picking the right menu will be key.
Price (p) | Market cap (£m) | PE (x) | DY (%) | 1-year change (%) | Last IC view: | |
---|---|---|---|---|---|---|
COMPASS GROUP | 1,164 | 19,141 | 21.7 | 2.5 | 5.1 | Buy, 1,076p, 24 November 2015 |
DOMINO'S PIZZA GROUP | 961 | 1,598 | 31.7 | 2.0 | 39.5 | Hold, 835p, 28 July 2015 |
ENTERPRISE INNS | 95 | 482 | 4.9 | 0.0 | -15.0 | Hold, 100p, 17 November 2015 |
GREENE KING | 857 | 2,647 | 13.1 | 3.5 | 8.7 | Buy, 924p, 02 December 2015 |
MARSTON'S | 152 | 877 | 11.9 | 4.6 | 4.8 | Buy, 164p, 27 November 2015 |
MITCHELLS & BUTLERS | 272 | 1,125 | 7.6 | 1.8 | -37.6 | Hold, 353p, 24 November 2015 |
RESTAURANT GROUP | 505 | 1,015 | 16.0 | 3.2 | -27.1 | Buy, 526p, 15 January 2016 |
SSP GROUP | 287 | 1,362 | 23.3 | 1.7 | 6.1 | Buy, 305p, 27 November 2015 |
WETHERSPOON (JD) | 675 | 805 | 13.9 | 1.8 | -18.8 | Sell, 625p, 20 Jan 2016 |
WHITBREAD | 3,952 | 7,211 | 17.2 | 2.2 | -17.8 | Buy, 4,826p, 21 October 2015 |
Favourites
The clear focus of the Marston's 'F plan', which targets food and families, among other things, provides a solid strategy for the company to grow into and a 2.7 per cent dividend yield for under 12 times forward earnings is compelling. Restaurant Group is also a favoured stock thanks in part to its low debt and decent dividend. It also has good growth prospects and is being helped by low food price inflation and the fact that the NLW will only cost it about £2m a year.
Outsiders
We're least optimistic about J D Wetherspoon (JDW) as it is already facing a margin squeeze, even before the new pay levels are adopted. Many of its peers could potentially raise prices, but Wetherspoon's focus on being low-cost curtails this avenue of escape. Also, while it remains on 'hold' for now, a reinstatement of the dividend at Mitchells & Butlers has failed to defibrillate the share price.