Multi-bag or bust? RTN, MAB, RBG, and OTB

My usual targets are high quality companies that are aligned with shareholders, because these can be compounding investments. This is the best kind of long term portfolio to build but right now I feel like there could be some pretty exceptional investment opportunities out there that justify a widening of the remit...

There is a long way to go in this lockdown, with a great deal of uncertainty remaining even though we are seeing early signs of peaking curves. The stock markets have rallied, but there is still plenty to play for. The Government must balance the length of the lockdown against its economic impact.

Amid the daily news flow of dividend cuts, equity placings, and administrations, it is possible to pick a profitable path. This lockdown isn’t happening in a vacuum. Companies are pulling out all the stops to survive and I feel that the majority of those that were good operators before the lockdown will remain good operators after the lockdown.

The downside risks to investors in this market are clear, however: the really big opportunities right now carry with them the risk of permanent capital loss. So pick wisely and understand your risk exposure. The shares I look at below pretty much all carry the risk of permanent loss of capital… But if they pull through they could be extremely lucrative investments.

Last week Restaurant Group’s shares jumped by more than 40% in a single day. Revolution’s shares are up 20% today. When all is said and done and we look back with the benefit of hindsight, the big winners will have come from the areas most at risk. I think it is worth covering these opportunities.

How long does a lockdown last? And how long is a piece of string?

Wuhan is tentatively coming back to life, with a lockdown period of 76 days. Italy’s lockdown began on 09 March, meaning it has been in effect for a month so far. France’s lockdown began on 17 March. The UK’s started on 23 March.

Bear, base and best cases

Assuming a ten-week lockdown seems like a pretty reasonable base case if we take Wuhan as the precedent.

Given the body language and rhetoric of various experts, I do not think the best case will be significantly better. We will be in lockdown for at least another month or so, on top of the three weeks we have already sat through. Call it seven weeks total as the best case.

The bear case, on the other hand, could be significantly worse. We just don’t know. For now, let’s assume the worst case scenario is six months (c180 days) of this lockdown we have all come to know and love so well.

A couple of weeks ago we talked about the increasing likelihood of significant equity placings at lower share prices. It looks like that is now what is happening. I’ll explore this theme more in another article, but suffice to say companies are wise to raise capital and deepen liquidity buffers - and to do it early, while there is appetite.

If, in three months’ time, we are still in a position where companies must plan for a sustained lockdown, then share prices will most likely be lower than they are now.

Given the lockdown assumptions above, how do some of the hardest-hit companies fare?

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Restaurant Group

FY19 share price: 166p

Today’s share price: 58p (-65%)

Market cap: £295m

Monthly costs: c£3m - c£5m

Liquidity headroom: £219m

Back on the 19th of March, Restaurant (LON:RTN) said it was “consider[ing] its funding options, both equity and debt, on an ongoing basis.” Last week the group got away a significant placing after market hours. The whole thing must have leaked like a sieve because the group’s share price jumped by some 41% before the RNS. Funny that.

Say what you like about the fundamental quality of Restaurant Group’s dining brands but, placing aside, I have been impressed with the group’s decisive actions and informative communications over the past few weeks.

In fact, this lockdown has sparked RTN into action and has accelerated a number of key long term strategic decisions. RTN has raised £57m of cash and is ditching two struggling brands (Chiquito’s and Food and Fuel), with a third of its bloated 600-strong estate earmarked for closure.

Perhaps the group really can emerge from this period as a better business?

On 08.04.2020 RTN further updated the market post-placing, saying: “In light of the rapidly changing developments regarding Covid-19, we have modelled a pessimistic scenario for the current financial year…”

The assumptions:

• All units closed until end of June (99 day lockdown)
• phased reopening of through July to December 2020
• Around 400 of its 600 restaurants and pubs open by the end of 2020
• An overall decline in Group total sales of c. 50% in FY2020 (assumed down 60% in the first half and c. 45% in the second half (with Q3 down 60% and Q4 down 30%).

The company is also working on preserving cash:

• capital expenditure has been reduced to no more than £30m for FY2020,
• costs have been reduced to a minimum and ongoing cash expenditure is now only c. £3m per month,
• Staff have been furloughed and included the business rates holiday for three quarters of 2020,
• Food and Fuel and Chiquito have been placed into administration, and
• the Group continues to work with landlords.

The group adds:

Under this scenario, we forecast a minimum of £60m of cash liquidity throughout the remainder of the 2020 financial year. The Group believes that in the event that all our restaurants and pubs are shut down for a period in excess of that assumed in this scenario, then the adverse impact on cash would be no more than £5m for each further month of complete closure plus the cost of furloughing employees.

Here’s a stab how this all plays out using RTN’s assumptions:

This very rough take, which essentially consists of halving FY19 revenue and then applying a mix of FY18 and FY19 margins, seems to come out at roughly RTN’s own estimates. It’s probably a bit generous as it doesn’t include the cash costs of the zero-revenue period.

Nevertheless, this does show that a group like RTN can survive the base case assumption of a Wuhan-level lockdown.

What’s more, the RTN of today is looking like a different proposition to the RTN of just a month ago. It has an extra c£50m of cash and the lockdown is sparking a dramatic improvement in the quality of the group’s estate, with 200 of the group’s 600 sites set to be closed.

The remaining 400 units will be led by Wagamama (c145), pubs (c75) and Concessions (c45), with the remainder being Frankie & Benny’s and some leftover Chiquito’s and Food and Fuel. This is a high risk : high reward proposition, but everything has its price. I would want to do quite a lot more digging before I decided to jump in here, though.

Mitchells & Butlers

FY19 share price: 457p

Today’s share price: 205p (-55%)

Market cap: £955m

Mitchells & Butlers (LON:MAB) has updated on the covid-19 situation saying ‘all sites have now been closed for over three weeks, and a number of actions have been taken to reduce our cost base.’

Some 99% of its workforce has been put on furlough ‘with basic pay for all employees including the Board reduced to between 60% and 80%, depending on seniority’. Operating costs have been cut and discretionary capital expenditure projects have been stopped.

MAB’s ‘cessation of trade’ covenants - whereby a company (and most companies that have securitisations) will be in technical breach if they do not trade for 30 days or more - are a concern. The group has agreed a temporary waiver until 15th May on this front, though, which sets a precedent for other pub, bar and restaurant companies with similar debt structures.

M&B concludes ‘the group has material cash resources which we believe should be sufficient to fund obligations well into the second half of the year.’

The group has c£4.5bn of freehold property against c£1.7bn of total debt. It has been operating for more than a century. I would back it to pull through, although this is certainly going to be a bumpy ride.

One key point to investigate further is who are this group’s bondholders? In times like these, the latter always trumps equity. Shareholders can quickly realise certain bondholders are absolute sharks - they might not particularly care about looking charitable if they can smell a profit.

Revolution Bars

FY19 share price: 81p

Today’s share price: 18.3p (-77%)

Market cap: £7.7m

Monthly costs: c£1.5m

Liquidity headroom: c£12m

Revolution Bars (LON:RBG) is the highest risk : reward company in this set. It looks like, even accounting for today’s announcement, the group is just about hanging on.

It has updated saying that it has furloughed 98% of its workforce. The company says the board has taken 50% pay cuts and negotiations with landlords regarding rent relief is ongoing. All capital expenditure has been cut.

RBG says ‘these measures have significantly reduced the Group's weekly running costs to approximately £0.4m per week and management continues to seek further cost reduction opportunities.’

Regarding debt, RBG says it is ‘pleased to announce that, subject to final documentation, Natwest has agreed to increase the Facility to £30.0m until 31 August 2020, following which it will step down to £24.0m as the Group begins to benefit from its normal positive working capital cycle following an assumed recommencement of trade in July 2020.’

With about £12m of headroom (RBG has net bank debt of c£18m and a £30m limit) and monthly running costs of c£1.5m, I think it’s possible that more needs to be done at RBG to ensure it has enough liquidity to navigate this lockdown. It might just about have enough, but it will be close.

At today’s extremely depressed prices, it is worth monitoring as there is a chance of this happening. Lenders have already shown goodwill in extending facilities and waiving covenants so far. This is only for those with a very high risk tolerance, though.

On the Beach

FY19 share price: 487p

Today’s share price: 259p (-47%)

Monthly cash costs: £2m

Liquidity headroom: c£50m

On The Beach is best positioned to survive this lockdown. It has an asset light, flexible, no inventory risk model and has no fixed commitments on hotel rooms or airplane seats. The group elaborates:

A tour operator or airline will generally have an almost immovable committed inventory cost (aircraft and/or hotels) and infrastructure cost of 60-70% of its aspirational total sales (transaction value) with or without any demand. An online travel agent like OTB without any inventory commitment only incurs inventory costs on each sale made and under normal conditions will have an underlying operating cost of approximately 8% of sales of which almost 70% is flexible marketing spend. If demand falls away completely then the fixed cost base will drop to c.3% of aspirational sales (or one twentieth of the costs of a similar sized asset heavy operator).

OTB is also the only listed UK travel business that operates a fully ringfenced customer trust account. Unlike the majority of online travel agents, tour operators and airlines, OTB does not rely on cash received for forward bookings to trade.

Monthly cash costs are now less than £2m across the entire Group and OTB has renewed its bank RCF to provide up to £50m of liquidity. At the last balance sheet date (September 30th 2019), the group had a net cash position of £55m.

Stress Test

OTB runs a helpful theoretical stress tests in its recent COVID update. The assumptions are prudent:

• No bookings until the end of September 2020 across the travel industry for travel on any dates in the future;
• All flight programmes would be cancelled until the end of September 2020;
  • All forward bookings until the end of September 2020 would therefore have to be cancelled and all customers refunded;
• Although bookings would return slowly once airspace reopens, bookings would remain at a significantly reduced level YOY until at least the end of March 2021 (H1 FY21).

In this event, OTB would end H1 FY21 “with only a limited drawdown of its facilities and significant headroom” which would “allow the Group to take advantage of the multitude of opportunities that these market conditions would present.”

Given OTB’s asset-light model, clear communication, and prudent modelling assumptions, I am minded to think this is one company well-placed to wait out the storm. With fixed costs of less than £2m per month and ringfenced cash, there is a fair chance of OTB’s share price reverting to historic levels over the next three years.

Conclusion

Spending time trying to figure out how certain Leisure companies might weather this almighty storm is time well spent.

Some will survive, and who knows where their share prices might end up in the coming months? There is certainly an argument for the more risk tolerant among us to be bold in these exceptional conditions.

Of the stocks listed above, OTB strikes me as best placed to survive. Not only that, management appears to have one eye on capitalising on conditions. It also models the longest lockdown (or at least, grounded flights) up until the end of September, which would be some 191 days - longer than my bear case scenario mentioned above.

Restaurant Group is changing quickly as an investment proposition. I have typically been bearish on this company but I am ready to revise my opinion should further research warrant it. It models a 99-day lockdown until the end of June, as does Revolution.

As for Revolution - this strikes me as the highest risk : reward of the bunch. With a market cap of just £7.7m, it is priced at a fraction of historic annual sales. If it can survive and recover, it could tenbag and then some. For now, it remains extremely high risk even with today’s new measures.

For both Mitchells & Butlers and Marston's (not included in this article, but with similar operations and debt structure), further investigation into just how supportive bondholders will be for the inevitable upcoming waivers is a key point.

The option of not going anywhere near this sector for the foreseeable future is, of course, valid. For those with a higher risk tolerance, though, taking a dispassionate and clear-headed look at some of the companies listed above could lead to some promising contrarian recovery opportunities.