Description

Overview

The Restaurant Group plc (RTN) is a UK hospitality sector operator with a diverse portfolio of businesses, spanning Pubs (Brunning & Price, 77 pubs), Leisure (casual restaurants including 108 site Italian American chain Frankie & Benny’s and 19-site Mexican chain Chiquito), Concessions (16 airport sites open as of September), and the Wagamama franchise of Asian-style fast-casual and to-go restaurants (146 sites, 4 to-go kitchens, 58 international franchisees).

After a decade-plus of fairly steady growth, RTN has been a disaster for shareholders over the past 5 years. The central problem has been overexpansion and deterioration of brand value in the company’s casual dining portfolio. This has led to two CEO changes, a desperate outsized acquisition of a growth property, growing debt burdens and dilutive equity raises.

What’s to like? For starters, the share price reset (RTN down ~80% from peak and ~60% YTD, though recovering sharply from lows post-vaccine news). Combine this with a drastic reshaping of the company’s business mix over the past 2 years, and the outlook in a post-vaccine environment looks appealing.

Over the past 2 years, the business mix has been radically repositioned in favor of more attractive and higher growth lines, due to two series of events:

1) Wagamama Acquisition:

RTN completed the acquisition of Wagamama in December 2018. Founded in 1992 by British-Chinese restauranteur Alan Yau (who subsequently developed Hakkasan), Wagamama succeed with a combination of a Japanese ramen bar style with communal long tables and a fast-casual feel, plus a broader pan-Asian menu. Wagamama had consistently achieved HSD-LDD same store sales growth over the prior 5 years (9.6% avg. annual LFL growth) and grown to 133 UK company-owned restaurants and 58 international franchised locations.

RTN paid £357 million in cash at a £559 million enterprise value, or ~13x LTM Adj. EBITDA of £42.5 million.  RTN marketed the transaction to shareholders as 8.7x after projected synergies of £22 million (£15 million cost, £7 million from existing site-conversions to Wagamama). The deal was funded by a massive shareholder rights offering that increased shares by 144% (13-for-9). Combined with the assumption of Wagamama debt the transaction resulted in initial pro forma leverage of ~2.5x.

The outsized deal was poorly received by shareholders, led to sharp share price decline, ultimately received only 60% approval, and shortly preceded the departure of CEO Andy McCue in February 2019.  

2) Large-Scale Covid-Era Estate Restructuring

RTN’s Leisure segment of casual restaurants contributed 24% of RTN’s property-level EBITDA in 2019 and had suffered from several years of declining SSS and profit. In 2Q 2019, RTN under new CEO Andy Hornby drew up a restructuring plan to rationalize the Leisure restaurant estate given the negative outlook. The planned reduction was from 368 sites at YE18 and 350 YE19 to 260-275 at YE21. Longer term, RTN targeted the exit of >50% of Leisure leases by expiry or break, with a median of 6 years remaining on its leases.

Covid-19 has provided the impetus (and necessity) to drastically accelerate the estate restructuring. Several restructuring steps have been completed:

-Chiquito Ltd. was placed into administration in April, eliminating 45 underperforming sites out of 63 total. Chiquito generated £65 million in revenue and £3 million EBIT in 2019.

-The principal remaining casual restaurant sub, The Restaurant Group (UK) Ltd, completed a Company Voluntary Arrangement (CVA) process with creditors in June, leading to the closure of 128 underperforming sites. This reduced the Leisure business to 160 sites, of which 83 have favorably restructured their lease terms in the CVA.

-RTN is exiting over half of its concession locations based on the weaker medium-term outlook. The majority of the remaining 30-35 leases have been renegotiated to waive minimum payments or link rent to passenger volume.

-RTN also exited 7 underperforming pubs, mostly in London inherited from the £15 million Food & Fuel acquisition in 2018.

Pro Forma Restructured Estate

With the recent actions, the repositioning plan that was likely to take 5-plus years has been completed, and then some, reducing the portfolio by ~40% and favorably renegotiating lease terms at some remaining sites (including turnover-linked rental payments).

While RTN’s limited disclosure makes it difficult to pin-point pro forma financials for the restructured portfolio, lost EBITDA from the casual restaurant closures should be modest. The Leisure group contributed <30% of EBITDA pre-covid, and in early 2019 RTN released rough data on the distribution of profits across the Leisure estate which suggests about half of the portfolio contributed ~80% of segment EBITDA. The pubs business has structurally higher margins due in part to ~50% freehold asset base (last valued at £153 million); last disclosed segment EBITDA margins were 20% in 2018 (£16 million Adj. EBITDA). Overall, RTN estimates it could generate £110-125 million in EBITDA off of 2019 revenue levels, versus £137 million in 2019.

Medium-Long Term Growth Outlook More Favorable

Critically, the medium-term earnings growth outlook of the remaining portfolio should also be greatly improved due to the improved sales mix as well as industry-wide capacity reduction. As RTN has noted, industry-wide, UK casual dining chains have already announced ~30% capacity reductions. More may be yet to come and small/independent exit rates will likely be higher.

With the recent restructuring, the growth franchise Wagamama now accounts for 37% of locations and upwards of ~45-50% of segment-level EBITDA. Wagamama is a unique growth asset in the UK, having grown from 31 sites in 2005 to 130 by FY18 and 148 currently, while consistently posting HSD SSS growth. RTN publicly targeted 200+ Wagamama UK locations over the long term prior to covid, representing 35%  growth.  Wagamama has achieved >40% restaurant-level ROI (EBITDA basis) on recent vintage new builds, averaging ~5 new sites per year. Looking beyond covid, Wagamama could well take advantage of the weakened competitive environment and empty retail space to both gain share at the existing estate and accelerate the rate of expansion, potentially even increasing the terminal footprint.

International expansion also remains a free call option of sorts at the current price. At the time of the acquisition, Wagamama had 58 international franchise sites in 23 countries, generating £3 million in high-margin revenue. Wagamama was showing strong progress pre-covid (franchise revenue up 24% TTM April 2019)

Wagamama also had 5 US sites generating £10 million at the time of the acquisition, but Wagamama to date had been unable to generate profitability in the US despite several efforts. In early 2020 RTN closed a JV with a US partner assuming 80% ownership, which eliminates upside here but also removes a cash-burning operation.

RTN Moderately Well-Positioned for Interim Pre-Vaccine Period

A second wave and renewed commercial restrictions have muddled the 4Q20 picture, but RTN looks relatively well positioned to handle the longer period between partial reopening and critical mass of vaccination. QSRs are clearly best positioned in this environment, but Wagamama is fairly well positioned within the fast casual or casual space. Wagamama already operated several to-go kitchens pre-covid and launched its first tailored to-go concept “Mamago” in late 2019. Wagamama gathered ~24% of total sales from takeaway and delivery in the 4 weeks ended Sep. 20, up from ~16% in 2019. With 39 of 149 Wagamama restaurants in greater London, the chain is not critically exposed there, while the Leisure portfolio has minimal exposure to central London. The Pubs (Brunning & Price) business is better placed with concentration in more rural areas with large outdoor spaces and limited competition.

RTN has disclosed SSS performance in the 11-week reopening period up to 20th September, which provides some insight. Wagamama reported +11% despite -24% in central London. The Pubs business was booming at +20%, while Leisure reported +4% (in line with industry) suggesting reduced competition and/or pent-up demand could help stabilize the remaining estate in the coming quarters/years. The Concessions business of course will take longer (-58% SSS on 16 open sites).  

Liquidity Situation

In April, RTN raised £55 million with a secondary offering that increased the share base by 20%. RTN finished 2Q20 with £311 million net debt (2.3x 2019 Adj. EBITDA) and £160 million in liquidity.  During the last lockdown RTN successfully reduced run-rate operating cash burn to ~£3.5 million/month but this will depend on further governmental assistance.  RTN  estimated it has 12 months of liquidity in a stress scenario including 3 months of lockdown and no additional government support.

Valuation

Not surprisingly, RTN shares have snapped back sharply in November after the positive vaccine trial news. But they remain depressed at 5x 2019 Adj. EBITDA, or ~6x EBITDA at the mid-point of the estimated range the restructured group would achieve on 2019 revenues. While not a no-brainer at these levels, RTN looks attractively valued versus peers and historical multiples given the superior growth outlook. On an EV basis shares are barely >20% above the (albeit excessive) price RTN paid for Wagamama two years ago. Wagamama earned £52 million in Adj. EBITDA in TTM April ’19 (last disclosed figures) and could easily generate upwards of £60 million post-vaccination based on SSS trends and estate growth.

Wagamama appears to have an easily achievable path to doubling EBITDA from there over a ~10 year period with far from heroic assumptions:  4-5 conversions/new builds per year, SSS slowdown to MSD (and ultimately LSD), flat margins, no meaningful international growth. This alone would likely justify RTN’s current market cap and the aforementioned assumptions leave some room for upside. Elsewhere, the Pubs business looks set up to outperform nicely in 2021. The restructuring of the remaining estate—including favorable lease renegotiations—as well as a massive competitive void could reverse the long term downtrend that has most affected RTN shares LT.  

It’s anyone’s guess how the next quarters evolve, but it’s not hard to see upside on a sum-of-the-parts basis and this should become clearer in ’21-’22 as RTN reports cleaner numbers on the restructured estate.

Catalyst

-Reopening environment crystallizes improved competitive position of restructured estate