FTSE 350: Casual dining sector will trade on intangibles

Take greasy pastry purveyor Greggs (GRG), whose shares almost doubled in 2019. Whether it was Piers Morgan’s confected scorn for its vegan products, or Jeremy Corbyn’s decision to raise its workers’ £300 bonus at Prime Minister Questions, the company has barely been out of the news. How much this suddenly-viral brand quality has contributed to free advertising and soaring sales – and how much credit is due to the bakery’s marketing department – is impossible to answer.

It’s unlikely to have hurt. Neither should we discount a refreshed store experience and canny product innovation, both of which have clearly contributed to last year’s 13.5 per cent increase in total sales, once new stores are factored in. But with costs rising, Greggs faces a tough test if it is to hit Peel Hunt’s adjusted earnings forecast of 93.2p per share in 2020. Even then, that equates to a forward-earnings multiple of around 25.

But for those investors wondering where the next Greggs is coming from, misdirection reigns. Even if veganism increasingly seems like a wave that can be surfed by any outlet, the location and size of most chains’ estates prevent the adoption of a Greggs-style 'food-on-the-go' model.

It is a truism that the best-placed brands have a keen sense of the budgets and habits of their customers. But this isn’t necessarily a differentiator. Although restaurants have never been better connected to customer living rooms, it’s questionable whether Domino’s Pizza (DOM) is still a net beneficiary of smartphone-based orders in 2020. A plan to exit international territories might lead to one-off cash windfalls and should boost operating cash flows, but it won’t solve the challenge of stiff domestic competition. Peel Hunt estimates Domino’s added just 28 stores in the UK in 2019, compared with a total of 234 in the previous three years. At that rate, it’ll be more than 15 years before the group hits its ambition for 1,600 stores.

Carefully done, there is of course merit – and capital appreciation – in an expansion strategy. Given its track record, JD Wetherspoon’s (JDW) recently announced plans to spend more than £200m on its pub estate over the next four years will give investors in the richly valued stock a much-needed sense of direction. A renewed focus on small- and medium-sized towns seems to us a sensible move.

Then again, the numerous casualties of casual dining in the last few years suggests the private equity-style roll-out strategy is in serious doubt. In 2019, it was consistency and reliability – in the shape of British drinking habits – which led the way for one of the strongest M&A trends in the stock market. Both Greene King and Ei Group (EIG) accepted premium bids for their companies last year, while Asahi paid a princely 24 times cash profit multiple for Fuller’s beer and brewing business.

This corporate action might also help to explain the strong re-rating in the shares of Mitchells & Butlers (MAB). Consistent increases in like-for-like sales above peers, and the self-perpetuating benefits of leverage reduction, have also helped.

As ever, there are enough consumer confidence surveys out there to doubt the possibility for sales price inflation in 2020. Other economic conditions could force publican and restaurateur hands. Indeed, as the year wears on, expect the frequency of the B-word to increase, as another cliff-edge for staff retention and product sourcing looms amid trade agreement negotiations. Catering services behemoth Compass (CPG) looks better placed than its peers on the high street, should it need to pass on the effects of higher costs.