Those who run restaurant or pub companies are likely to be breathing a sigh of relief that 2017 is over. The year brought with it a wave of added costs from the new national living wage, higher business rates and inflation prompted by a weak pound. In order to make up for these added costs many companies are trying to become more efficient and deciding where in the market they feel best placed. But costs aren’t forecast to fall anytime soon, so investors are faced with the question of which businesses look best prepared.
One of the most significant burdens so far, and one that is likely to get worse this year, is the cost of labour. Analysts at Numis expect costs on pub companies and restaurants to increase by an average range of 3.7 per cent to 4.6 per cent in 2017-18, and by a similar amount in 2018-19. The first round of increases to the national minimum wage has already gone through, and the next round – a 4.4 per cent increase to £7.83 due in April – will capture even more of the workforce. Another increase could come in April 2019, with the Office for National Statistics (ONS) stating it’s “on course” for an increase to £8.20 by that date. The average impact on margins across pub companies is expected to come in at a 130 basis point contraction. These pressures should begin to fade in the next two to three years as the affected companies adjust to the new normal, although ways to mitigate these costs may become harder to find.
The weak pound has been another headache altogether. A number of drinks and raw ingredients are often sourced from outside the UK, and denominated in foreign currencies. Given the protracted weakness in sterling, many suppliers have enforced price rises for customers – namely restaurants and pubs. Depending on how much downward pressure sterling has yet to take, there’s an argument to say that these price hikes should start to annualise out. But inflation is also constricting consumer spending power, and limits how much disposable income Britons have to spend on going out to eat and drink.
The Peach Tracker, which looks at the food and drink industry, has found that venues that focus more on drinks have outperformed those that serve food. This is in direct contrast with the last recession, where food took over as customers’ main vice.
Such drastic conditions have forced pubs and restaurants to focus on efficiency improvements and cost savings. Greene King (GNK) wants to claw back £40m-£45m via its acquisition of Spirit, while Aim-traded group Fuller, Smith & Turner (FSTA) is aiming to suppress costs by investing in a “comprehensive, far-reaching enterprise resource planning system” and going digital – its larger rivals will need to keep a watchful eye on smaller rivals.
All this uncertainty has also forced pub and restaurant companies to categorise themselves as either ‘budget’ or ‘premium’. Greene King is spending £10m on promotions and events that should help to push up sales volumes by encouraging customers through the doors. The first results saw drink volumes increase by 2.6 percentage points and the number of meals sold up 1.3 percentage points. If this strategy continues to pay off, other pub and restaurant companies may follow suit. Restaurant Group (RTN) is pursuing a similar strategy. Chief executive Andy McCue said the previous management team’s insistence on keeping prices up had been a deterrent to customers.
The flip side of the promotional drive is the emphasis on premium products. Fuller’s is one company that does this well. Chief executive Simon Emeny was confident that the group’s higher-end position in the market would keep customers coming, as should new openings in prime locations such as Liverpool Street and Euston stations. Marstons (MARS) is taking a similar approach. The pub business has spent the past 10 years focusing on destination and premium locations, and although these types of venues only account for about a quarter of the estate, they deliver nearly half of the group’s sales and profits.
| Company | Price (p) | Market value (£m) | PE ratio | Yield (%) | 1-year change (%) | Last IC view |
| Compass Group | 1,526 | 24,162 | 20.5 | 2.2 | 6.9 | Hold, 1,540p, 22 Nov 2017 |
| Domino's Pizza Group | 343 | 1,664 | 23.9 | 2.4 | -9.1 | Sell, 272p, 16 Aug 2017 |
| Greene King | 520 | 1,611 | 8.3 | 6.4 | -26.1 | Buy, 530p, 07 Dec 2017 |
| Marston's | 114 | 723 | 8.2 | 6.6 | -15.0 | Buy, 119p, 04 Jan 2018 |
| Mitchells & Butlers | 262 | 1,108 | 7.5 | 2.9 | -1.8 | Sell, 239.9p, 27 Nov 2017 |
| Restaurant Group | 4,365 | 1,956 | 3,267.1 | 0.0 | NA | Buy, 339p, 31 Aug 2017 |
| SSP Group | 644 | 3,058 | 41.5 | 1.3 | 62.3 | Hold, 640p, 22 Nov 2017 |
| Wetherspoon (JD) | 1,278 | 1,348 | 18.7 | 0.9 | 41.7 | Hold, 1,181p, 18 Sep 2017 |
| Whitbread | 3,855 | 7,071 | 16.2 | 2.5 | -4.7 | Buy, 3,752p, 24 Oct 2017 |
Favourites
Marstons looks as though it has a good year ahead of it. So much so that we made it one of our Tips of the Year. Shareholders can enjoy a near-7 per cent dividend yield at a price tag of just eight times forward earnings – a discount to its historical valuation and to many of its London-listed pub peers. Its push for premium should help support pricing power and attract those customers whose earnings will not be so squeezed that they can’t spring for a pint. Its acquisition of Charles Wells Brewing Company has helped increase its presence in London and the south-east, and opens the opportunity to expand into Scotland.
Outsiders
Mitchells & Butlers (MAB) recently scrapped its interim dividend – a prudent yet deeply unpopular decision with shareholders. We don’t see much reason to be optimistic on the stock at the moment. Price rises and a push to promote premium options failed to salvage margins, down 80 basis points over the first half. At 266p, the shares are trading at eight times forward earnings. We think its shares are cheap for a reason.
