Make a quick buck from fast food

In a downturn you might fear the worst for the country's pubs and restaurants. Yet recent figures from accountants at KPMG and market researcher, The Peach Factory, show that while restaurant and pub sales dipped in 2009 they are up 4.6% year-on-year in 2010. So what's going on, and are investors who dismiss the sector missing a trick?

KPMG's Helen Dickinson admits consumer spending may only continue "until the effects of government measures begin to hit people's pockets". But even allowing for that it seems eating out has become ingrained in our culture. What was a monthly treat for our grandparents has become something we expect. As Rose Jacobs notes in the FT: "Britons are going the way of Americans when it comes to dining out seeing it as a regular fixture in weekly life, not an occasional luxury." Food consumed outside of the home in Britain now accounts for 35% of total spending on food up from 25% in the 1960s. Analysts say there is plenty of room for that figure to grow. In America eating out makes up 50% of the total.

Another positive trend is the boom in childless young couples. Richard Harden, co-editor of Harden's Guide, says "the last 20 years has seen the growth of trendier restaurants aimed at those twenty- and thirty-somethings who in former eras would have been spending their money on nest-making". And according to Andrew Page, CEO of The Restaurant Group (see below), sales are also being boosted by an ageing but wealthy retired population and more working women with higher disposable incomes than ever before.

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That is not to say the credit crunch did not hit the sector. But it didn't hit all parts of it equally. In 2009 many consumers chose to sacrifice quality for quantity. Fast-food chains and mid-market sit-down restaurants actually did well as people, determined to keep their 'eating out experience', looked for value. KFC, Subway and McDonald's have all had 'good recessions' in Britain, and even announced expansion plans. Take-away firms such as Domino's Pizzas also saw profits rise. Meanwhile, mid-market chains such as Wagamama and Gourmet Burger Kitchen, which charge between £10 and £20 per head, thrived as consumers looked to eat out for less.

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Another effect of the recession is that restaurants have been forced into price wars as consumers gain a keen eye for a bargain. But the bigger players, who can deploy economies of scale to outperform independent operators, actually gained market share. As Peach Factory's Peter Martin acknowledges, competition "is having an undoubted impact on the topline (reduced margins) may well be the future for the market". However, low interest rates have been a boon. "In 1991, restaurants were closing left, right, and centre as due to soaring interest rates people with mortgages just couldn't afford to go out. It's been very different this time... eating out... is more affordable than ever," says Peter Harden, also of Harden's Guide.

Of course, when interest rates rise they will cut off some restaurant spending and punish chains that took on debt to expand. Further jumps in soft commodity prices will also squeeze margins if they are not passed on. Yet thanks to some big structural shifts, the most competitive restaurant chains should continue to make good profits. And with shares under pressure now is a good time to buy into the growing popularity of eating out. In the box below we look at one of the bigger bargains in the sector.

The best bet in the sector

Penny-pinching consumers seem happy to head for The Restaurant Group's (LSE: RTN) 360 branches spread across Britain. Three of its brands, Garfunkel's, Frankie and Benny's, and Chiquito are mid-market offerings whose meals cost between £10 and £16 per head. It also owns 42 pub restaurants dotted throughout the country and a chain of airport eateries.

The firm emerged from the depths of the recession last year with a £48.3m pre-tax profit and a 5% rise in sales. Unlike some peers, it "eschewed deep discounting" and maintained healthy profit margins. In 2009 operating profit margin only fell by 0.8% (from a robust 13%).

The group also paid off £12m of debt. Indeed, its rude financial health and relatively high margins mean that the company is well placed to cope with future rises in interest rates or soft commodity prices. And its size and balance-sheet strength position it to expand when any proper recovery arrives. But these qualities have been largely overlooked a share price of 243p puts it on a forecast price-to-earnings ratio for 2011 of 12. What's more, the shares yield 3.7%. This looks very good value compared to more expensive, smaller rivals, such as Carluccio's on a multiple 15.3 and Clapham House on a ratio of 18.5. They could be hit hard by a double dip.

This article was originally published in MoneyWeek magazine issue number 502 on 3 September 2010, and was available exclusively to magazine subscribers. To read more articles like this, ensure you don't miss a thing, and get instant access to all our premium content, subscribe to MoneyWeek magazine now and get your first three issues free.