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In our recently published Leisure Sector Note, we took a close look at the small/mid-cap Leisure sector. Both categories have underperformed since 2016 and are trading near 5 year low multiples. This is not a major surprise given an average 64% UK sales exposure. This is particularly pertinent given scope for a sharp snap-back on a Brexit resolution. Clearly over 2019 some tolerance with volatility will be required until we get a clear direction of travel. We review 5 sub-sectors and screen stocks on various criteria.

Top-down overview

The Leisure sector is worth around £120bn (source: KPMG) making it a significant part of the UK Consumer sector which is valued at c.£620bn, with Retail being the largest component. Adjusting out tourism and betting the sector is valued at c.£66bn and dominated by the out-of-home eating and drinking market followed by hotels and family leisure.

The average UK family commits 22% of its weekly budget to leisure spending. This may not seem like a large figure but is almost double what British homes spend on housing each week. The consistent level of consumer spending over the years has provided a foundation for the sector to grow at around 2-3% per annum.

From a macro perspective the sector is cyclical with high exposure to UK discretionary spend and skewed towards mid-cap companies with a high domestic UK consumer bias.

The sector has evolved over the last 10-15 years and whilst not facing the same structural headwinds as the Retail sector, it is having its fare share of disruption and change as consumer preferences and spending habits evolve. Added to this  is the current uncertainty in the economy caused by a lack of clarity and direction surrounding Brexit and the impact this could have on consumer spend, food input costs and tourism/travel.

Experiential Leisure

Despite the macro uncertainty, the last 24 months has shown UK consumers are increasingly spending more time and money on frequent, habitual activities such as gym memberships, dining out, trips to the theatre or cinema, cultural experiences, home entertainment, socialising in bars and cafes, and a wide variety of live sporting events.

Effectively low-ticket categories are proving broadly resilient, with consumers searching for experiences – rather than ownership of goods – with their disposable income.

Sub sector 1: Pubs

We are broadly positive on pubs. The sector has successfully realigned capacity in the last decade and we are encouraged by the growing focus to deleverage balance sheets than expand. Companies also have more of a cost mind set to protect margins. This is helped by cost inflation easing over the last 6 months, except for labour. The current macro uncertainty is unhelpful but consensus forecasts are for modest, if any, earning growth in 2019. A favourable Brexit outcome thus has the potential to be a positive catalyst for the sector.

Sub sector 2: Casual dining / restaurants

We remain cautious on this area of the leisure market. Fundamentally the sector remains over spaced and not enough capacity is coming out. The sector is also unable to wean itself of all year round discounting to drive footfall. We expect another challenging year ahead with the winners to be those with a truly differentiated offering and playing to the consumer trends of healthy eating, value and experience. The main positive for the sector is that going into 2019 the LFL sales comps are soft at -1.5%.

Sub sector 3: Bowling

We like the bowling sector as it is an excellent way to play the experiential leisure theme. The market leaders are successfully evolving from bowling companies to operating one-stop Family Entertainment centres, with bowling as the anchor. This is helping to broaden the customer proposition, dwell time and spend. In the last 6 years the sector has been one of the fastest growing leisure categories and proved relatively resilient to macro headwinds. Going forward it has multiple levers to continue driving revenue growth and minimal exposure to rising costs (bar labour). It is dominated by two leading operators, Hollywood Bowl and Ten Entertainment both of which are providing superior offerings, adding other experiential leisure activities to the offering (darts, golf and escape rooms etc.) and importantly, appealing to families. Recent NPD in the form of HyperBowling has the potential to be the most significant sector innovation in the last 25 years since the introduction of automated scoring.

Sub sector 4: Gyms

We are becoming mindful of the low-cost gym sector given some early wrinkles appear to be emerging. Given the model is highly operationally geared to volume and price, recent commentary around tactical pricing to protect / stimulate volume is slightly worrying and needs to be kept a close eye on going into 2019. Fundamentally, with low cost gyms typically seeing >100% membership attrition in any given year, the pressure to continually maintain / grow volume cannot be underestimated. We sense a soft consumer backdrop and increased competition in some geographies is not helping. The fact that the sector does not give LFL sales metrics is never a good sign in our experience.

Sub sector 5: Cinema

We have mixed views on this sector. The fact that in 2018 the UK cinema industry witnessed the first decrease in average ticket price since 2001 is a worrying sign. We feel it signals a pricing response to competition from the likes of Netflix and Amazon Prime. Set against this is the fact that the film slate for 2019 is strong with potentially five blockbusters which should drive footfall. The last big blockbuster year was 2015. This is tangentially beneficial to leisure companies with operations on the same leisure / retail park as a multiplex cinema. From a quoted market perspective this would be Hollywood Bowl, Ten Entertainment and Restaurant Group.

To receive the full Leisure Sector Note, please contact Sahill Shan or email Research Entitlement.