TescoRestaurants: how does it sound?
Now you think I am completely out of my mind. Well, maybe I am but I havent lost the plot. New Tesco(LSE: TSCO)CEO Dave Lewis needs a brand-new strategy, so here is a bold plan for a man who knows well the dynamics of the supply chain. Thats precisely where value may reside if Tesco decided to snap up restaurant chains in the UK.
Look at the fundamentals of one possible target, Dominos Pizza (LSE: DOM). Like-for-like sales are growing fast. Its operating profit margin is forecast at 15% to 20% to the end of 2016, while the net income margin is expected to rise above 10%. At Tesco, divestments of unprofitable assets could easily fund bolt-on deals. Restaurant Group (LSE: RTN), Tasty (LSE: TAST) and Prezzo (LSE: PRZ) are also attractive.
Dominos Pizza: A Small Bite
Domino reported a trading update on Thursday that made for a good reading. Q3 like-for-like sales rose by 12.9%. Tesco could do with that.
Domino has been growing for several quarters now. Online orders are driving revenue growth, and are on their way up. The roll-out of store continues in the UK. Domino already has more than 570 stores in England, Wales, Scotland and Ireland and is expected to open more than 30 stores in the UK in the next three months. Results abroad were a mixed bag. Tesco could use its massive infrastructure to push the Dominos brand both domestically and internationally.
Dominos stock isnt cheap, based on trading multiples. It trades at a forward adjusted operating cash flow of 15x. Thats not ideal for Tesco, or for any other buyer in the retail sector, but then most assets along the food value chain trade higher than Tesco. With a price tag of 1.5 billion pounds, Dominos would be a small bite for the UKs largest retailer.
Prezzo Seeks Buyers
This relatively small chain of Italian restaurants is in talks with buyers. Prezzo has received preliminary proposals from Advent International and TPG Capital, two private equity firms, the company said on Thursday after rumours emerged in the marketplace. It operates 244 restaurants in the UK. As Prezzo said, any offer is unlikely to value the group above its current market value of about 310m. Why shouldnt Tesco consider an approach in the next few weeks?
Prezzo stock trades at a forward adjusted operating cash flow of 9x, so its much cheaper than that of Dominos. Its forward net income and operating margins are 9% and 12%, respectively. The Kaye family controls Prezzo, and also owns Tasty.
Tasty is a smaller target, with a market cap of about 60m, but it would cost much more than that to convince the owners to sell out. Finally, Restaurant Group, with a market cap of 1.2bn, is the biggest of the lot. Margins and growth prospects are enticing. Its valuation is not prohibitive.
Could Tesco buy them all? Seriously, I dont know. But a bold move shouldnt be ruled out, Mr Lewis
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Alessandro Pasetti has no position in any shares mentioned. The Motley Fool UK has recommended Domino’s Pizza. The Motley Fool UK owns shares of Tesco. We Fools don’t all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.