Langton Capital – 2015-11-11 – Daily Wrap: Franchising, costs & inflation, Premier Foods & other:
Leisure Wrap & Other:
So the trading day is grinding to a close. We’re another day older but are we any wiser? After a day of intensive head-scratching, pen flipping and gossip, we have been considering the following. As always, contact us if you’d like further details:
Franchise versus company operated units:
• McDonald’s has increased its re-franchising target from 3,500 restaurants to 4,000 as part of its target to become 95% franchised.
• Intercontinental Hotels and more recently a number of US restaurateurs have pushed the ‘capital-light’ model hard & have returned cash to shareholders
• Looking at the pros and cons re the franchised model, we see that it 1) allows for a capital-light structure and 2) it can therefore allow faster expansion or the return of capital to investors as units are transferred from company-owned to franchise.
• In addition 3) it involves less company risk. One may see a group owning its assets (say Whitbread with Premier Inn in Germany) in some territories but franchising them in others (for example Whitbread in India or the Gulf).
• Franchising 4) may also allow a company to expand rapidly (say KFC in China) in a territory where there may be some restrictions on foreign-ownership or assets or companies.
• But the franchised model a) can be less profitable on a unit-by-unit basis. In addition b) it involves a certain lack of or loss of control. The brand owner may ‘scrub’ its franchise list from time to time but it still runs a reputational risk that is beyond its day-to-day control.
• Hence you pays your money & you takes your choice. Many established companies have a 2/3 v 1/3 (franchised v company-owned) model in developed economies with a franchised model in developing markets.
• Others have virtually 100% franchised models – such as Dominos in the UK or Subway – with many other operators never even considering the franchised route to market – Restaurant Group, JD Wetherspoon etc.
Costs and likely future inflation:
• Tesco Dave tells us we are (or rather he is) facing a ‘lethal cocktail’ of high business rate tax and costs at a time of declining profits.
• He points to an estimated £14bn of extra costs to be paid by the retail industry over the next five years as a result of national living wage increases and other costs.
• And this at a time when the industry (and leisure retailing, licensed & otherwise) has little pricing power of its own.
• So how will this end?
• Well the costs are baked in, so they’re going to happen.
• And, longer term, we can’t as a country allow all businesses to see their margins fall to such a point that they go bust hence inflation is being added as a 3yr to 5yr ingredient.
• And that serves a number of purposes.
• Politicians are rightly concerned that deflation could or would be potentially more dangerous than would rising prices and hence they would be quietly pleased if crowd-pleasing moves such as the National Living Wage were to kill off deflation before it can take a hold.
• However, if you were to stand in the Square Mile and say that inflation was a latent problem, you would be dismissed as a crank.
• Nonetheless, this may ultimately be an issue and, in that environment, heavily-indebted companies such as Punch Taverns & Premier Foods (and indeed all operators with a preponderance of freehold units) would find themselves handily positioned to prosper as their incomes would rise whilst their debt wouldn’t.
Langton deserves a drink…
Langton went out after work for some much-needed ‘field research’ at a couple of city centre bars the other night and was struck by the difference between the two.
Random information, hopefully not all of it useless (re most leisure operators etc.):
• Commodity prices. Precious metals weak, non-ferrous metals weak, softs weak except for El Nino plays, sugar, cocoa and OJ.
• Sterling up v US$ and Euro. Happy days for importers of commodities, holiday makers, holiday companies etc. Not such good news for exporters.
• Premier Foods says H2 will be better than H1. And yesterday’s reported H1 was the best reported trading for a number of years.
• With the weather still a balmy 18 degrees or so outside and winter still seemingly a remote prospect, MKS is moving still further ahead of itself as it will preview its summer 2016 ranges today.
We’re so 21st Century, this morning’s Tweets (diff. font size denotes importance):
1. Singles Day spending breaks records in China, Alibaba hits $10bn (no typo) in sales by 2pm. Last year was at $9.3bn.
2. ALMR has suggested that ‘wholesale tipping changes may undermine stability’. It adds HMG should proceed cautiously.
3. Diageo is holding an investor conference today focusing on its N American business + performance of its brands, says trading in line
4. Reports from China are claiming that orders of Greene King beers have exploded in the wake of president Xi Jinping’s visit to UK
5. The libertarian inclined IEA has argued that ‘end to 24hr licensing would not be in the public interest’
6. McDonalds has increased its re-franchising target from 3,500 restaurants to 4,000 as part of its target to become 95% franchised
7. Sainsbury’s underlying group sales for the 28 weeks to 26 September fell 2% to £13.64bn as underlying PBT dropped 17.9% to £308m
a. SBRY. CEO Mike Coup commented: ‘We are making good progress against the strategy we outlined last November’
8. ASDA is to pour cold water on the Black Friday buzz in the UK this year. The US-owned chain was ‘credited’ with much of it in 2014.
9. Tesco Dave (Lewis), has warned that retailers face a ‘lethal cocktail’ of high business rate tax and costs at time of declining profits
10. Alton Towers is preparing to cut 190 jobs as it looks to provide a ‘reactive and customer focused approach’ following reduced visitors
11. EasyJet says that passengers left in Sharm el-Sheikh can expect to be airlifted out by the end of next weekend
12. Sportech updates on Q3 trading, says ‘revenues across our Racing and Digital business are slightly above prior year’
13. Premier Foods. Well so much for perfect markets, shares worth 20% more within minutes as it delivers the expected.
a. PFD. In a better position than for many years. H2 margins to rise, debt to fall ‘significantly’. Forecasts more likely to rise than fall, PER c5x is too low