From the wilderness of the last three companies I've looked at, I've jumped back into something I'm more familiar with. No more structural steel or horse-racing bookie services, here's one even I can understand at first glance - Prezzo (LON:PRZ) , the restaurant chain. If you live around the south of England, you've probably got a few near you and you might've even been to one. They do the sort of casual Italian-esque fare that's been rather a driving force of the restaurant industry (at least from my casual observation!) recently, and look like a genuine recent start-up to success story. They were admitted to the AIM in 2002, raising a rather humble £1.5m and valuing the business at £3.7m.
The history of its formation is interesting, too; one of the things that first catches your eye on the admission document is that the joint managing director (now CEO) was 22 when he co-founded the company. A little further digging - or a touch of knowledge on the Kaye family name if you're more worldy than I, I suspect - would dig up that the myriad connections. Golden Egg, Garfunkel's, Ask, Zizzi; all restaurant chains related to the family.
Back on Prezzo, though - their growth story is pretty obvious if you take a look at the graph to the right, where I've added a new line showing the number of restaurants they've opened. I suppose it shows a decent choice of premises, given how tightly operating profit and the number of restaurants are linked. Indeed, operating profit hovers between £80k and £90k per restaurant, though revenue does seem to be on an upward trend. Putting those two together leads to the obvious conclusion that margins are tightening. That is indeed the case; though perhaps there is a nod towards the direction of saying that we can expect restaurant margins to be squeezed in a recession. I'm not hugely swayed by that train of thought, but I suppose it could be worth the few percentage points that are in this.
There's no sign of a let up, either, with the last half-yearly anticipating another 25 restaurants this year (27 last). Full steam ahead; and it makes sense, given that it's working so far, and benefits usually come with scale. That seems particularly the case in the restaurant industry - plotting Prezzo's financial history or knowing the way the business works points investors to a benefit that is rather unusual outside of consumer facing businesses - you have a nice working capital cycle. When customers come in, they pay for the food. Most of the time, anyway! Your suppliers, on the other hand, increasingly become a free source of capital as you grow. The more clout you get and the better your bargaining power, the more you can exploit that discrepancy. Prezzo's last annual report shows this nicely - both the current assets and liabilities column are pretty light, to be fair, but with about £10m in current assets (and almost no cash) and £27m in current liabilities, the benefits are clear.
There's probably not a lot of room for this to grow further as a percentage - they have basically as much in payables % as Restaurant Group, their much larger listed competitor, but it still reduces the cost of opening new stores. Of course, given what they do, the balance sheet is made to look unusually streamlined by the amount of operating leases they have. Capitalising those lease payments gives us a better reflection of how returns have evolved over time, and makes comparisons more interesting; and they show a return on capital for Prezzo sitting more or less identical to that of Restaurant Group, at between 9 and 10%.
Returns like that set no hearts on fire, but there's two caveats to writing the investment off. Firstly, returns could conceivably improve. Prezzo was earning about 10% pre-crisis, and about 9% now. It's doubtful there's many more real scale efficiencies to exploit, given how decentralised restaurant chains are, but since it is double the size there might be ways of nudging towards the top end or slightly about those indicative figures. Far more important is the growth potential, though. Given the way they can grow - with very little cash up front - and with no sign of apparently letting up, both in word and in action (they pay a measly dividend) perhaps the wheels will keep spinning and it'll be onwards and upwards.
If I had to give an opinion; and this is something I often try and wring out of myself, given that I know my own propensity to profess (with reason!) ignorance and waft around in vagaries - I'd probably say that it looks cheap relative to The Restaurant Group (LON:RTN) . It seems to have a lot going for it, but its value hinges on that growth. I think the first sentence of this paragraph probably says more about my suspicion of Restaurant Group than my love of Prezzo. On a tangent, that has sparked thoughts of some sort of long/short around Restaurant Group and some of the listed pubs. Given the way pubs seem to be converging more more with restaurants, and the relative valuations, maybe there's something there...
Anyway: on the plus side for Prezzo, I suspect I will visit next time I see one, so they get a customer if not a ringing endorsement for the shares!
Filed Under: Value Investing,