If you can find a Zoom shareholder who is willing to talk about the trauma of the past 18 months, that haggard investor will acknowledge that most consumers have tried hard to go back to their normal, pre-pandemic lives.
Despite what the Zoom share price tried to tell us during the pandemic, nobody thinks that being locked up at home and experiencing everything online is the best way to live.
Consumers are spending on experiences, with travel and social gatherings high on the list. Delta Air Lines reported its highest bookings in history in March, as people finally felt confident enough to book holidays for the northern hemisphere summer.
Leaving aside ongoing travel restrictions in Asia, people are out and about again and restaurant owners are celebrating the return of consumer demand. The question is: will it remain strong enough to counter the significant inflationary pressures being felt by the industry?
According to research by Advertising Week Europe that Bloomberg reported on in May 2022, 69% of UK consumers plan to save money through fewer trips to restaurants. About 60% plan to reduce spending on clothing. Only 46% said they would cut back on travel. In Maslow’s lesser-known Hierarchy of Wants, inflation looks set to hurt restaurant demand before it affects travel.
This is logical if you remember that travel requires a much wealthier consumer than restaurants do. Everyone in a developed market can afford a hamburger. Not everyone can afford to hop over the ocean for breakfast in Paris. Wealthier consumers are held back by Covid restrictions, not by affordability (even in a time of inflation).
Speaking of inflation, restaurant owners seem to constantly run the gauntlet for survival. Just as demand has returned, inflation has picked up in input costs for these businesses. Energy costs sit front and centre here, particularly for European businesses that run on gas.
In SA, the cost of energy seems to be less of a problem than the availability of energy. There’s nothing like load-shedding on a Friday night to destroy the already-challenging economics of a restaurant.
This has put a damper on the recovery in this sector. There was an opportunity for businesses to adapt during the pandemic and implement digital channels as a differentiator. When it comes to widespread inflation and consumer pressures, there’s only so much that can be done.
Despite all this, Famous Brands recently released results for the year ended February 2022 and the trajectory of the recovery is clear to see. Revenue increased from R4.7bn to R6.5bn, which was enough to return the group to an operating profit. Headline earnings per share (HEPS) from continuing operations was 356c a share.
There’s even a dividend of 200c a share, which sends a clear message about the confidence management has in the sector. A meaty dividend also confirms that the balance sheet has stabilised after such a tough period, with net debt to earnings before interest, tax, depreciation and amortisation improving from 3.04 times to a far more palatable 1.32 times.
There’s no justification for Spur and Famous Brands to be trading at pre-pandemic levels
It’s worth looking one level deeper at Famous Brands, as the recovery looks different in the “Signature Brands” vs the “Leading Brands” segments — the full-service restaurants vs the quick-service restaurants. The restaurants that suffered the most in Covid were those that depend on dinners that are lubricated with wine. Alcohol bans and curfews were a disaster.
The takeaway burger joints did OK in the end, as people could use delivery services to bring some calorific happiness to the household. Leading Brands revenue was up 58% in this period and Signature Brands was up a whopping 91%, reflecting the relative base effect.
In FY2020, Famous Brands’ HEPS was 417c, 17% higher than the latest result. There’s still a road to recovery ahead. The share price was trading at about R62.70 at time of writing, well below the R80 a share seen at the start of 2020. Interestingly, the share price briefly reached that “full recovery” level in January 2020, before dropping more than 18% in the recent bear market.
The latest Spur results are for the six months to December 2021, so the timing isn’t directly comparable to Famous Brands. It does help that the company reported restaurant sales growth both year on year and vs the preceding six months. Those growth rates were 28.3% and 18% respectively. Spur group’s revenue increased 40.3% year on year and HEPS was 119.3% higher at 70.10c a share. A dividend of 49c a share was declared, a payout ratio of 70% vs 55% at Famous Brands.
In the six months ended December 2019, headline earnings was 125.81c a share. This was 80% higher than the latest result, so Spur took a much harder knock from the pandemic than Famous Brands. Trading at about R19.50 at the time of writing, the share price would need to increase by nearly 30% to return to the levels seen at the start of 2020. Much like Famous Brands, the share price briefly reached that level at the start of 2022, before dropping nearly 22% this year.
With the SA consumer under a great deal of pressure from fuel costs and basic food inflation, investors need to tread carefully in this space. The share price recovery earlier this year to pre-pandemic levels was clearly premature, as confirmed by price action in subsequent months. Just based on earnings, and especially given the inflationary environment we are in with rising yields, there’s no justification for Spur and Famous Brands to be trading at pre-pandemic levels.
The five years leading up to the pandemic weren’t appealing either, with Spur having lost 15% of its value over that period and Famous Brands having shed more than 30% of its value based on a disastrous foray into the UK market.
With neither of these companies making a compelling investment case, there is another JSE-listed company that you may find interesting. Bidcorp is a global food service business, with exposure to hotels and office catering in addition to restaurants. In a trading update in May, the company noted a record third quarter and strong performance in all markets outside Asia.
Bidcorp says operating leverage (the opportunity to expand margins through revenue growth off a partially fixed cost base) has been offset by cost-push inflation. As a logistics business with wholesale margins (much like Famous Brands), Bidcorp and is exposed to supply chain disruptions, higher energy costs and wage demands of warehouse workers and drivers. Unlike Famous Brands, Bidcorp doesn’t earn franchise fees from restaurants or profit from selling branded restaurant sauces in the supermarkets.
Bidcorp’s share price is down 4.4% since the start of the pandemic and has lost 2% this year. This puts the performance far ahead of Famous Brands and Spur. Still, it hasn’t been a happy place for investors to put their money.
In the search for interesting investments in this sector, we need to look abroad to the US market, where everything is supersized. There’s no shortage of restaurant brands to choose from, representing everything from takeaway tacos through to premium coffee and sit-down steakhouses.
Since the beginning of 2020, performances have varied considerably. The top performer is Chipotle Mexican Grill, up more than 53% in that period. Restaurant Brands International, owner of Burger King among other brands, has lost more than 20% in that period.
Looking at the five years before the pandemic tells a different story. Chipotle was the laggard with a compound annual growth rate (CAGR) of just 4.4%. Domino’s was great over that period, achieving a CAGR of 24.9%. Wendy’s with 19.9% and McDonald’s with 16.2% both deserve a mention.
Any of these companies would’ve been a better choice than the JSE-listed players. Americans are unbeatable at creating and exporting great consumer brands. The restaurant industry is no exception, with the golden arches of McDonald’s and the smiling face of Colonel Sanders recognisable across the world.
Clearly, investing in this sector on the global market has been more rewarding than investing locally. The more difficult analysis is around whether any exposure to this sector is advisable in this environment.
We’ve seen substantial sell-offs in the sector and the leading companies haven’t been spared. Chipotle and Domino’s have both lost a third of their value since the peaks in 2021. Apart from a general cooling off in valuation multiples, something smells off in the fridge.
In the US in particular, staff wages are a major pressure point. Starbucks may refer to its employees as “partners” in an attempt to make them feel like they are part of the wealth-creating class, but we know that the situation on the ground is different. Starbucks is dealing with the threat of staff forming a labour union. There’s an entire website dedicated to “educating” staff about the unions, reminiscent of Sibanye’s recent labour dispute. You would be forgiven for forgetting that you’re reading about a business in the US.
When combined with energy costs and inflation in food input costs (in the latest earnings call, Domino’s noted double-digit increases in food), margins are under pressure in these businesses. In the first half of this fiscal year, margins at Starbucks have compressed by more than 200 basis points.
At Chipotle, prices have been raised by about 10% and margins have still gone in the wrong direction. Restaurant operating margin is down from 22.3% to 20.7%, attributed to higher wages and food costs.
With inflation still raging, consumers will cut down somewhere. Restaurants seem like a soft target. Having survived the pandemic, these businesses are now facing significant margin compression. Overall, it probably makes the most sense to let the dust settle before investing in this sector.
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