Propel Morning Briefing

Goodbody – up to 22% of smaller operators at risk of financial distress in 2018

Goodbody leisure analyst Gavin Kelleher has argued up to 22% of smaller operators are at risk of financial distress in 2018 as it shapes up to be a “very difficult year”, particularly for food-led operators.

Kelleher said: “We see a number of challenges for 2018 including lacklustre market growth, a softer consumer environment, growing competition, and substantial cost pressures in the region of 300 basis points of a margin headwind.”

“We expect most of these issues to be more painful for food-led operators. To assess the degree of financial vulnerability across the industry, we have analysed the financial statements of a mixture of smaller public and private UK operators.”

“These operators had estate sizes ranging from five to 650 sites, with the median number of sites per operator being 50. These operators were predominantly managed and a mixture of dry and wet-led. Our sample covers a total of circa 7,000 sites, which is circa 6% of the estimated 119,000 pubs, restaurants and fast food outlets in the UK.”

“If we were to exclude independents from the market population we believe our sample would cover a considerably higher proportion. We have found that at present five operators (8% of total) had a fixed-charge cover (using Ebitdar as the numerator) of fewer than one times. However, this doubled to ten (16%) when we simulated a 300 basis points margin decline and to 14 (22%) for a 400 basis points margin decline. However, we believe our analysis could actually underestimate the percentage of operators. Our choice of Ebitdar as a numerator in fixed-charge cover is likely to overestimate the capacity to fund fixed charges given the minimum reinvestment requirements in the estate.”

“Competitive discounting has clearly been a growing theme across the sector in 2017 and is unlikely to recede any time soon. The potential impact on gross margins is difficult to estimate but in the absence of market growth it is likely to become more prevalent. Furthermore, distressed smaller operators may not always act rationally in a challenging period. Naturally, many of our data subjects’ most recent financial accounts cover reporting periods that are almost two years old and therefore their financial performance is likely to have worsened since because of cost headwinds.”

“In the medium term, we believe the result of this is likely to be consolidation (as scale provides efficiencies around purchasing power, labour and central functions) and closures. Both would provide a small mitigation in the form of cost synergies and reduced competition, and may create an opportunity for larger operators to acquire smaller chains with strong brands for distressed valuation multiples.”

“However, in the near term its effect on sector competition could be quite negative as distressed operators may not always act rationally.”


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