As the retail leisure sector comes under increased scrutiny from investors, Richard Kleiner, CEO of Gerald Edelman and non-executive chairman of newly-floated Comptoir Group, spoke to the BDLN about his concerns that management teams are sometimes being backed into a corner…
Businesses in the retail leisure sector are spending far too much time keeping tabs on what investors want and not enough time cooking up a business success story. Retail companies need to start focusing more on opening up new units in order to grow the business and the brand and ‘The Management’ should spend less time worrying about forecasts and ‘like-for-like’ equations. All involved should remember that if the business wins, everyone wins (including the company’s shareholders.)
What’s the growth story?
There are two things that concern me most about companies in the retail leisure sector. The first is how assumptions made about a business growth story are affecting the behaviour of that business.
When it comes to investment in the catering and restaurant market it’s always about the growth story. What’s your background? What’s your history? Where are you now and where are you going? Investors often base this story on a roll-up play – we’ve got a great management team and we’re going to make some acquisitions – or we’ve got a great brand – and now we’re going to roll it out.
The market – whether that’s for an IPO or an existing listed company – often measures growth by the increase in the number of profit centres. So on an IPO, for example, the broker who sponsors the flotation will create a piece of research based on a future profit projection.
The broker bases their projection on the information provided by the management team. They then supplement this with their own analysis. Let’s say that the growth story on this IPO is that a retailer is going to increase their existing number of units from 20 to 40 in the next three years. Then that is the assumption that the broker will build into his three-year projection.
Good business reasons v bad assumptions
The problem with this approach is that quite often (in fact—on every single occasion!) reality is very different from projection and forecast.
A good management team will always try to follow good business practice. They’ll want to make sure that any new potential retail site ticks almost all of the ‘ten’ boxes needed to give a deal the green light. Those ticked boxes would normally include: location, demographics, footfall, local competition, and category of customer. If potential sites don’t meet these criteria, then a business would ordinarily decide not to proceed with the deal. But now, of course, they may fail to hit the market’s projections.
And because they’re not going to hit their profit projections, they may find themselves in a situation where they’re forced to perhaps make compromises and, as a result, four outcomes are possible. They look at sites that aren’t fit for purpose. They pay excessive premiums to get into certain sites. They negotiate over-the-market rent levels with landlords. Or they spend insufficient time planning for the important opening of a new unit.
Furthermore, if they don’t find the extra profits from somewhere else (as a result of slower rate of openings,) they can also find themselves having to make a profit warning. The result of that profit warning can be that their share price will be slashed. Slaughtered, in some cases – sometimes by as much as 50%.
We can do more to enable management teams to believe that the share price is not going to drop. We can give them the confidence to come to the right business decisions for the sake of the medium and long-term future of the business and to encourage them not to chase dubious deals just to meet market expectations.
I think that building such confidence is worthy of consultation and discussion. Get the brokers, institutional investors, people within the industry, the management teams and their advisers in a room to accept that this is an issue and to explore what the alternatives might be.
Is it just about educating? Or is it about better communication between management teams and investors? Would it not be better if companies were to announce profit warnings sooner and with a sensible explanation? There have to be some better methods and I suggest we should find them!
The second thing that concerns me about companies in the retail leisure sector is the issue of ‘like-for-like’ sales comparisons.
I’ll give you an example. The Restaurant Group (TRG) announced their results in April. Total sales were up by 4.7%. But the like-for-like sales—a measure which reflects trading at outlets open for a year or more—were 2.7% lower.
I empathised with their CEO Danny Breithaupt when he said – and I paraphrase here – ‘we’re a quality business who have grown our sales yet again. But like-for-likes sometimes have to take a back seat.’ This comment, in effect, confirms that the market uses the like-for-like measure as a significant indicator about how a business is growing.
TRG shares dropped by 26% on the day of the announcement, despite their underlying sales growth.
The problem with like-for-like is that, as far as I’m aware, there’s no accounting standard and no guidance about how you determine the measure. So, with my somewhat simplistic example given earlier, if a company increases its units from 20 to just 23. Then that’s a straightforward comparison.
But what if of the 20 sites in 2015 the company earmarks three of them for refurbishment? Companies can drop those three out of the like- for-like equation! You’re comparing 17 with 17. Firms take the three earmarked for refurbishment (which often coincides with poor performing sites) out of the equation. Furthermore, a site that’s taken out of the equation can take a year – or even two – to be re-included.
So the like-for-like measure can be open to manipulation, which isn’t good for the market. It’s also possible that this hides deeper issues. Some sites don’t need refurbishment; they actually need increased management time instead in order to understand why the particular trading issues exist.
Yet again, this appears to lead to decisions that are potentially damaging for a business – just to satisfy the market. My purist approach is to let management teams continue to do the right thing for the good of the business, irrespective of whether they meet the market’s forecasts or whether they satisfy a like-for-like expectation.
It’s the politicians’ analogy. Their decisions tend to be short term as they think only about policies which will win them votes. And I really don’t want businesses to follow that principle. I don’t think that they should be doing things just to satisfy market expectations; they should decide what’s good for the business in the medium to long term.
So what does the retail leisure sector need? More transparency. More open and timely communication. And more support for quality management teams. Investors and shareholders alike should ask themselves the question: do we want to slaughter a share price or a company value because management teams are forced to do the wrong things for short-term gains?
Remember — if the business wins, everyone wins.
All articles written and edited by the BDLN