Description

At less than 6 times EV-EBITDA, 4.5% dividend yield, The Restaurant Group currently represents a good price to buy into a stable business that more than likely will be around 10 years from now and if the company's margins normalize back to its normal range by end of 2017, you can get a predictable 27% upside to the current stock price.

The Restaurant Group plc operates 488 restaurants and pub restaurants throughout the UK.  Its principal trading brands are Frankie & Benny's, Chiquito, Coast to Coast and Brunning & Price.  It also operates a multi-brand Concessions business which trades principally in UK airports.

Brands
1) Frankie & Benny's (258 units)
Classic New York and Italian 50s- and 60s-style restaurants specialising in pizzas, pastas and burgers. A New York- Italian family welcome awaits all guests from all walks of life.   First opened in 1995 in Leicester, now they span across leisure and retail parks as well as standalone sites and airports throughout the UK.
The brand had a difficult 2016 year, with declining like-for-like sales and operating margins, substantially underperforming the market.  Operational leadership was changed in June and following the strategic review of the brands at the end of the summer, a series of price and menu trials were launched to test and learn the most effective way to arrest trading performance.  10 sites were opened and 15 sites closed during the year.
2)Chiquito (79 units)
Chiquito is famous for the best fajitas and margaritas in a vibrant restaurant with passionate service
The Chiquito menu delivers tex-mex dishes ranging from fajitas, enchiladas, burritos and nachos to burgers, steaks, southern fried chicken and ribs. The décor draws inspiration from Mexican architecture and Latin style. Serving guests in the UK for over 25 years, Chiquito appeals to young adults, couples, teenagers and students.
Chiquito traded poorly in 2016, with declining like-for-like sales and operating margins.  While a drop in cinema attendances contributed to some of this decline, the main drivers were poor proposition changes, and operational issues affecting speed of service.  Five sites were opened and 12 sites closed during the year.
3) Coast to Coast (21 units)
America is home to some mind-blowing food. And we’re not just talking burgers, steaks and subs (hunger-bustingly good as they are). We’re talking about the gastronomic wonders from the lengths of the great states. Now to find it, you can travel the 3,142 miles of Lincoln Highway or you could save yourself a few bucks and come on in to see what we found. If it’s smoky, crispy, sticky or spicy, we discovered it and we’re serving it with a giant helping of hospitality and a glass of barrel-aged bourbon on the side too.
Coast to Coast had a difficult 2016.  The brand is relatively young and while lower sales are to be expected from new units after their opening year, sales have continued to decline thereafter.  A radical change to the menu in January was received poorly and progressive price changes in recent years have also contributed to significant declines in like-for-like sales.  Two sites were opened and two sites closed during the year.
4)Garfunkel’s (13 units)
Founded in London in 1979, Garfunkel’s is proud to be the original British café restaurant serving breakfast, lunch and dinner all day every day. Garfunkel’s London restaurants offer guests a place to relax, and they have a loyal following: local residents and workers who have been eating at Garfunkel’s for years.
5) Joe’s Kitchen (3 units)
Joe’s Kitchen is fun, welcoming, casual, down to earth and wonderfully simple. Taking inspiration from Borough Market, London, Joe’s offers great tasting fresh food, cooked by people who care.
The atmosphere at Joe’s is relaxed and inviting, with a playlist of great British classics, both old and new.
6)Pub restaurants (57 units) Brunning & PriceMostly set in rural locations, each of our pubs are unique, preserving their varied characters. We serve cask ales, decent wines, and British dishes complemented by influences from other parts of the world. We believe that classic pubs will never go out of fashion – our owner-operator approach, with the focus firmly on quality and consistency, provides a solid base for expansion.
The Pub business traded well during 2016, growing like-for-like sales and profits.  The strong and stable team continued to develop the business, improving the menus and successfully trialling new booking technology to accommodate more covers. Four sites were opened and one closed during the year.
7)Concessions (59 units)
TRG Concessions: over 25 years’ experience of providing exceptional hospitality to the travelling public. Our brand portfolio includes table service, counter service, sandwich shops, pubs and bars. We deliver existing TRG brands, create bespoke concepts and establish partnerships to franchise third-party brands. Our record of innovation, partnership, and performance ahead of sector growth will ensure we remain a market leader in this sector.
The Concessions business had another strong year in 2016.  While benefitting from strong passenger growth across our UK airport sites, we added to this by successfully driving incremental covers and spend per head.  We opened one site during the year, a new pub in Gatwick North terminal which has its own gin distillery and closed two due to airport configuration changes.

Almost taken over by Private Equity in 2016

The company kept warning and missing estimates in 2016 that it was in danger of getting taken over by private equity. Partially because of this, management team made drastic measures to hire new CEO and new CFO.

New CEO and New CFO

The first half of 2017 should be difficult and transitional as the company addresses problems of multi-year brand deterioration. The company has hired a new CEO in Andy McCue, ex-CEO of Paddy Power and has substantial turnaound experience in multi-site consumer business through rigorous approach to customer insight.  The company also brought in a new CFO in Barry Nightingale, who has extensive turanround experience.  Nightingale spearheaded an 18-month cost-cutting exercise at Monarch, the budget airline that at one time was on the brink of collapse. Under Monarch’s private equity owner Greybull Capital, Mr Nightingale helped launch a £200m cost-cutting programme at the airline, which had posted a £94m loss when it was taken over in 2014.

It is thought that Mr Nightingale could now mirror the complete cost overhaul he undertook at Monarch, which more recently posted £40m of underlying profits before interest and taxes in the year to October 31.

New Incentives for CEO and CFO

The following options were awarded to the CEO and CFO

Andy McCue Chief Executive Officer 236,424

Barry Nightingale Chief Financial Officer 116,507

The Awards will, subject to performance conditions, vest three years from the date of grant. A two year, post-vesting holding period applies. The Company's employee benefit trust will hold the shares necessary to fulfil any obligation arising from the vesting of the Awards.

Closures and Impairments

The company closed 33 locations in 2016 and will close 8 more locations in 2017

66 locations were impaired in 2016

FY17 incremental profit benefit associated with the closures in 1st and 2nd half of 2016 will result in 10 Million Pounds.

Cost Savings

The new CEO and CFO have identified $10 million in annual savings.  Full benefit should be seen in 2019.

New Sites

The new CEO and CFO have put an investment allocation discipline with their new sites.  The planned 7 new Frankie & Benny’s and 7 new Chiquito sites are expected to generate  >25% Return on Capital

Rent Costs

In 2016, Rent Costs as a percent of sales was up to 11.7%. Contrast that to 10.8% and 10.6% in 2015 and 2014. After the closures in 2016 and 2017, I expect this to go back down to the 10.5% range.

Back to Basics Customer Insights

Company brought a new team to become lean and mean. It also is going to be more responsive to customer insights. It is testing several menus with different prices and some of the early data are encouraging. To put in perspective, their flagship brand, Franke and Benny's was allowed to slide for 4 years by the previous management team. This new management team does not plan to allow that to happen again.

Insider Buying at Prices Higher than Here

On 30 August 2016 Mike Tye, Non-executive Director, bought 7,284 shares in the Company on the London Stock Exchange at a price of 409.76p per share and consequently has a shareholding in the Company of 7,284 shares, representing 0.003% of issued share capital.

On 26 August 2016 Debbie Hewitt, Non-executive Chairman, bought 17,325 shares in the Company on the London Stock Exchange at a price of 432.90p per share and consequently has increased her shareholding in the Company to 28,630 shares, representing 0.014% of issued share capital.

10 Year Record

The company has demonstrated an ability to generate free cash flow, pay dividends, and repurchase shares for the past 10 years as seen by the tables below. The jewel is the concessions business at the UK airports.

Valuation

Over the next 10 years, if the company pursues the discipline of requiring 25% return on capital on new sites, it is quite achievable that the company can double its revenues to 1.5 Billion with EBT margin much higher than the historical 12.5%. Assuming it uses the free cash flow generated to buy back shares and pay dividends. Maintenance capex is about $26M (2016 full year report). 2016 EBITDA was 121MM. Ebitda minus Mtc Capex is about $95M. Using a 10 times EBITDA-Mtc Capex multiple yields 950 Million EV or a 460 pence stock price for a 27% upside by the end of the year. Should the company miss that goal of $95M Ebitda minus capex, you have the dividend yield to wait for another year in which case your IRR can still be 15% per year. And if the company really misses by several years, I think your 10 year IRR in this stock, can still be a decent 11-12% per year.

Catalyst

Insider Buying

Closing of unprofitable locations

New CEO and new CFO with good turn around track records