Description

We view The Restaurant Group PLC (“RTN”) as a compelling, timely, and liquid long position.  Importantly, there is an offsides "stale" short in the shares that may need to cover should our thesis play out as anticipated.

The Restaurant Group owns and operates nearly 500 pubs, restaurants, and concessions (food and beverage locations in airports and train stations) in the UK.  The company’s ~200M shares trade on the London Stock Exchange for roughly £2.50 per share, implying a market cap of £500M (or $690M in USD).  The balance sheet is strong with de minimis net debt.  Average daily trading volume over the last four weeks is close to $5M per day.

Two Gems

We think two of RTN’s business segments are gems.  The pubs business, an on-trend collection of more than sixty British gastropubs, grew revenues by +14% and EBITDA by +15% in the most recent annual reporting period, with designs on similar growth rates in years to come.  This segment has healthy margins (mid-teens EBITDA margins), strong like-for-like sales (consistently upper-single-digits), and many of the properties are freehold (i.e. owned by RTN - we estimate close to £200M of real estate value).  Even better, cap-ex requirements are low as many of RTN’s gastropubs have customer loyalty built up over generations with a clientele that prefers the gastropubs stay the same, rather than change.  RTN adds value by bringing its scale to bear behind-the-scenes via purchasing, systems, and operational best practices.

The concessions business is even more attractive, as RTN’s operation is a duopoly player in the UK (peer SSP Group PLC’s shares trade for 32x earnings) with strong growth prospects driven by expansion opportunities and the tailwind of steadily rising passenger counts on both planes and trains.  To compete in concessions, an operator must offer a portfolio of brands such that it can manage an entire airport terminal or railway station – a meaningful barrier-to-entry.  RTN seems poised to grow this high-margin business with a slew of recently-announced brand partnerships that position the company well for continued transportation hub wins.

We believe these two high-quality segments make up the bulk of RTN’s value.  Importantly, RTN management seems to agree as these businesses are receiving heavy attention and investment for the future.

The Problem Child

The problem child has been RTN’s restaurants division.  A prior management team failed to invest in data, leading to poor business decisions including an ill-advised attempt to raise prices that alienated customers.  A new team, led by Chairman Debbie Hewitt and CEO Andy McCue, has built a sophisticated operation that we believe can reverse the mistakes of the past and take the company to new heights of profitability.

Our due diligence indicates that Mr. McCue has attracted top-end industry talent to RTN that is now permeating through the organization and changing the culture.  The contrast between the prior team’s data-blind approach and the new team’s data-led approach is evident in substantial recent and ongoing upgrades to RTN’s marketing, branding, pricing, menu, and the consumer proposition in its restaurants business.

Investment Thesis

We are bullish on RTN’s prospects.  The market, however, has yet to reach the same conclusion.  RTN’s shares trade at a 12% free cash flow yield.  Consensus expectations are for continued low-single-digit declines in like-for-like sales and annual per-share earnings of 25p.  We disagree.  As RTN’s volume-led recovery gathers steam and the company laps price decreases from April/May 2017 that reset the company’s value proposition, we think RTN’s like-for-like sales may soon turn positive.  The inflection could receive extra rocket fuel as RTN rolls out a new brand identity, reimagined stores, and increased marketing spend for its largest brand by the end of H1 2018.

As the consensus view shifts from backward-looking pessimism to forward-looking optimism around revitalized like-for-like sales, we think there is ample upside in RTN’s shares.  Should RTN’s margins and multiple return to historical levels, we see a company with 40p+ of earnings and a share price approaching 750p.  This represents upside of close to +200% to fair value with the key inflection in the business set to occur in the next 3-6 months.

Our Favorite Set-Up

The bear thesis on RTN’s shares (~10% are sold short) has nothing to do with The Restaurant Group and everything to do with the British consumer.  Following Brexit, the UK economy has ground to a standstill and the British consumer has come under pressure beset by stagnant wages and rising inflation.  British restaurant firms that took on too much debt are feeling the pressure, and the headlines are ominous: debt-laden competitors Prezzo, Strada, and Jamie’s Italian are each shuttering one-third of their locations (100, 11, and 12 respectively).  Investors have responded by shorting baskets of stocks tied to the British consumer.  Even the sell-side has gotten into the game, with UBS and HSBC both stamping “sell” ratings on RTN.

This is our favorite set-up.  As heavy short-sellers ourselves, we find the best longs are where short-sellers have a stale thesis and have missed the inflection in the underlying business.  The rush to get back on-sides (from both buy side and sell side) can be fast and furious.  In this case, we think the turn in RTN’s business is at hand.  The high-growth pubs and concessions businesses today make up a larger portion of sales and profits.  Volumes have been steadily trending up from negative mid-single-digits to nearly flat, with a step-change for the better in the Net Promoter Score of RTN’s largest restaurant brand over the last six months.  The restaurants business (referred to as the “leisure” segment by RTN) faces much easier comparisons starting in April/May due to lapping the prior-year price drop.  Paired with the launch of a new marketing campaign and the roll-out of refreshed locations, we think the inflection in like-for-like sales from negative to positive is imminent.  The strengthening British pound (which should help ease inflation fears) and the exit of so many competitors can only help accelerate the turn.

With almost no debt, a 12% free cash flow yield, an A+ management team, some great assets, a bearish buy-side and sell-side, a stale short position in the shares, and an inflection in like-for-like sales at hand, we view The Restaurant Group PLC as a cheap, timely, and attractive long opportunity.

Disclaimer

The author of this posting and related persons or entities ("Author") currently holds a long position in this security.  Author may purchase additional shares, or sell some or all of Author's shares, at any time.  Author has no obligation to inform anyone of any changes to Author's view of RTN LN.  Please consult your financial, legal, and/or tax advisors before making any investment decisions.  While the Author has tried to present facts it believes are accurate, the Author makes no representation as to the accuracy or completeness of any information contained in this note.  The reader agrees not to invest based on this note, and to perform his or her own due diligence and research before taking a position in RTN LN.  READER AGREES TO HOLD AUTHOR HARMLESS AND HEREBY WAIVES ANY CAUSES OF ACTION AGAINST AUTHOR RELATED TO THE NOTE ABOVE.  As with all investments, caveat emptor.

Catalyst

-Like-for-like sales flip from negative to positive as RTN laps last year's price drop and launches a new marketing campaign for its largest brand

-Short-sellers are forced to cover a "stale" short thesis and bulge bracket sell-side shops reverse their "sell" ratings

-The turn is amplified as inflation pressures ease and competition exits the space

-An A+ management team pushes the pedal to the floor in pubs and concessions while re-energizing the RTN growth story