1. Sector landscape and outlook

Restaurant or eateries are engaged in the business of preparing and serving food and beverages to customers. Over the last few decades, this sector has evolved very strongly on the face of increased disposable income of people and globalization of food. Globalization of food has an immense contribution to the development of this industry. Also, the length and width of this industry allow a large number of players to coexist profitability; however, it is not a significantly higher margin industry due to humongous competition, but volume is such a huge that can be buck on and sustain profitably. Restaurants are classified in many ways. Several broader classifications of restaurants include food itself (e.g. vegetarian, non-vegetarian, vegan, seafood), Cuisine (e.g. Italian, Chinese, Mexican, Indian, French, Offering Style (e.g. tapas bar, a sushi train, a tastet restaurant, a buffet restaurant).

COVID-19 Impact on the UK Restaurant Sector

The containment measures taken by the government to reduce the spread of the novel COVID-19 proved damaging for the UK restaurant industry. As part of the UK government televised statement on March 16, 2020, the British Prime Minister Boris Johnson advised the public to avoid venues such as bars and restaurants, though no ban was yet enforced. The year-over-year change in seated diners in UK restaurants went down by 52% that day, and by 82% on March 17, 2020. Only a few days later, from Friday evening on March 20, restaurants were forced to close. However, the British government's comments prompted fury from many in the industry who believe they will be unable to make insurance claims without a concrete ban from the government. But the Association of British Insurers said that even in the event of a forced closure the "vast majority of firms wouldn't have purchased a cover that would enable them to claim on their insurance to compensate for their business being closed by the COVID-19 pandemic.

Fig 1: Daily impact of COVID-19 on restaurant dining in the UK Feb-Aug 2020.

Source: Statista

After approximately three straight months of stringent lockdown due to the COVID-19 pandemic, restaurants in the United Kingdom was allowed to re-open on July 4, 2020, provided they follow strict hygiene conditions to prevent a second wave of the novel virus. A week later, on July 11, the number of seated diners in UK restaurants were still down by around 45% but began to gradually increase. As of August 29, 2020, the percentage of seated restaurants in the UK was around 9.44% higher than the last year's figures.

Food delivery services to witness increased demand

A few days prior to the UK government's lockdown due to the coronavirus outbreak, consumers were already beginning to use delivery services more frequently to order food and drinks. According to the snap poll on March 18, 2020, ~60% of 18-24-year age group had already increased the frequency they use delivery services. The 35 to 54-year-old age group had the biggest likelihood to increase frequency, with 40% saying they would do so.

Fig 2: Increase in food delivery usage due to COVID-19 in Great Britain 2020, by age group.

Source: Statista

UK Treasury "Eat Out to Help Out (EOHO)" scheme is likely to Support UK Restaurants sector

The EOHO Scheme is an economic recovery measure by the UK government to support hospitality businesses as they reopen after the COVID-19 lockdown in the country. The brainchild of Chancellor of the Exchequer Rishi Sunak, the scheme was announced on July 8 as part of the Plans for Jobs summer economic update. Under the EOHO Scheme, the government would subsidise meals (Food and non-alcoholic drinks only) at restaurants by 50%, from Monday to Wednesday every week, all through August.

The discount is capped at GBP 10 per head and does not apply to take-away or event catering. There is no minimum spend and no limit on the number of times customers can avail the offer, since the whole point of the scheme is to encourage a return to dining in restaurants. EOHO is only one of the schemes in the UK designed to help the food services sector.

How much will the scheme cost the British government?

When presenting the Plans for Jobs update, the Treasury estimated that EOHO would cost the government GBP 500 million. However, according to the House of Commons research briefing on the scheme, published on August 20, "the final figure will depend on take-up of the scheme and could be higher or lower. If take-up continues at the rate shown over the first two weeks of the scheme, the cost of the scheme would be around £388 million, less than the forecast.

Why was this scheme deemed necessary?

All over the world, the food services sector is one of the worst affected by the pandemic. In the UK, a survey of 300 UK food services operators, conducted in April by Opinium, a London-based market research and insight consultancy, revealed that the top two concerns why customers are avoiding restaurants: a) fear of contracting the virus (46 per cent) and b) customers having less disposable income for dining out (44 per cent).

It is the second of these concerns that Sunak's scheme addresses, because, instead of delivering a financial package to operators, it makes eating out more affordable for consumers directly and helps restore demand. Restoring consumer demand is being crucial to the UK's economic recovery.

Restaurant Sector, one of the hardest Hit Sectors by the pandemic gaining grounds on the LSE

According to the Refinitiv data, we found that the UK Restaurant stocks are among the laggards weighing on the market. The Universe of 21 stocks listed and traded on the London Stock Exchange have on an average plummeted more than 34% on a Year-to-date basis and significantly underperformed the broader market as FTSE 100 index, and FTSE 250 index slumped approximately 22% and 19% during the same time. Moreover, the portfolio of 21 restaurant stocks on an average basis is trading approximately 46% below their 52W high price levels, whereas broader indices of the LSE have recovered.

Fig 3: YTD Performance of the UK Restaurant Stocks Listed on the LSE

Source: Refinitiv (Thomson Reuters)

The governments announced some relief measures which include EOHO Scheme, furlough scheme for workers, cutting VAT to 5 per cent from the standard 20 per cent, a business rates holiday and small business grants, temporary changes to licensing laws and outdoor seating under Business and Planning Act 2020, which would make it easier for restaurants and pubs to seat and serve customers outdoors and to comply with social distancing guidelines. As a result of these measures, the restaurant's stocks are edging higher, and in the last one month on an average, the basket of 21 restaurant stocks added 12%, with 13 out of 21 stocks delivering a positive price with Fulham Shore PLC (up 61.6%), Heavitree Brewery PLC (up 38.5%) and Marston's PLC (up 31.8%) are among the top gainers, DP Poland PLC and Daniel Thwaites PLC are only two traded flat in the period under consideration, and Tasty PLC (down 14.8%) and Fuller Smith & Turner PLC ( down 10.2%) are among the laggards in the period under consideration. However, 13 stocks which traded in the positive territory are delivering an average price return of 22.8% and significantly outperforming the benchmark indexes, FTSE 100 and FTSE 250 by 23% and 18.5% respectively. This shows the relative price strength in the restaurant sector stocks against the broader market.

Fig 4: 1-Month Price Performance of the UK Restaurant Stocks

 

Source: Kalkine, Refinitiv (Thomson Reuters)

Risk

The UK restaurant sector is currently exposed to a variety of risks ranging from distorted demand for their product on the face of social distancing measures, contracting economy, declining disposable income of the people of the country and also exposed to the next wave of outbreak.

Outlook

Given the recent price trend in the restaurant stocks and relative outperformance over the benchmark indices of the London Stock Exchange, show a relative strength in the sector. The various supports extended by the UK government, whether it was EOHO or other fiscal stimulus, tax holidays and other monetary reliefs, we believe that sector is reviving from its existential crisis and gradually will be back to normal in next one or two quarters. There are chances that full recovery could take some time, higher than other non-essential industries; but new avenues within the restaurants' space like delivery, takeout and other technological development could support their topline.

 

2. Investment theme and stocks under discussion (GRG, YNGA, LGRS and MAB)

After understanding the recent trends in the restaurant sector, let’s now look at the four players from the industry those are listed on the London Stock Exchange. To assess the same, companies’ stocks are evaluated based on Discounted Cash Flow (DCF).

 

1. LSE: GRG (GREGGS PLC)

(Recommendation: Buy, Potential Upside: Low Double Digit, Mcap: GBP 1.435 Billion)

Greggs plc is a bakery retail group based in Newcastle Upon Tyne, United Kingdom. The group specializes in bakery products like sausages rolls, sandwiches, doughnuts & bakery items.

 

 

Valuation

Our illustrative valuation model suggests that the stock has a potential upside of ~19% over the closing price of GBX 1,343 on 1 September 2020.

 

2. LSE: YNGA (YOUNG & CO'S BREWERY PLC)

(Recommendation: Buy, Potential Upside: Low Double Digit, Mcap: GBP 362.8 Million)

Young & Co's brewery plc is a London, UK-based company that owns and operates retail pub chain and hotels. The company currently has 276 pubs, 687 hotel rooms and employs close to 5,145 staff members.

 

 

Valuation

Our illustrative valuation model suggests that the stock has a potential upside of ~21% over the closing price of GBX 1,025 on 1 September 2020.

 

3. LSE: LGRS (LOUNGERS PLC)

(Recommendation: Speculative Buy, Potential Upside: Low Double Digit, Mcap: GBP 139.3 Million)

Loungers plc is in the business of having café/bar/restaurants across Wales and England. The group has 165 outlets currently.

 

 

Valuation

Our illustrative valuation model suggests that the stock has a potential upside of ~19% over the closing price of GBX 141.5 on 1 September 2020.

 

4. LSE: MAB (Mitchells & Butlers Plc)

(Recommendation: Hold, Potential Upside: Mid-Single Digit, Mcap: GBP 739.8 Million)

Mitchells & Butlers plc is engaged in operations of pubs and restraint based on Birmingham, UK. The company has 1,745 operational sites and employs close to 45,560. The company is included in the FTSE 250 index.

 

Valuation

Our illustrative valuation model suggests that the stock has a potential upside of ~6% over the closing price of GBX 166 on 1 September 2020.

Note: All the recommendations and the calculations are based on the closing price on 1 September 2020. The financial information has been retrieved from the respective company’s website and Refinitiv (Thomson Reuters).

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