Where next for the hospitality industry?

The hospitality industry has been rocked by the pandemic. And just as things started to look like they might pick up again for the festive season, Omicron dashed those hopes. In the few weeks from 15 December 2021 to 5 January 2022, total business cancellations rose 16%. Within that, bar and restaurant cancellations were up closer to 50%.

So as we embark on a new year, and with a bit more positivity coming down the pipes, where do we think three of the UK’s biggest hospitality-facing stocks stand?

This article is not personal advice, if you’re unsure whether an investment is right for you, seek advice. All investments and any income they produce can fall as well as rise in value, so you could make a loss. Past performance isn’t a guide to the future. Ratios shouldn’t be looked at in isolation, it’s important to consider the bigger picture.

Investing in individual companies isn’t right for everyone – it’s higher risk as your investment is dependent on the fate of that company. If a company fails, you risk losing your whole investment. You should make sure you understand the companies you’re investing in, their specific risks, and make sure any shares you own are held as part of a diversified portfolio.

Diageo

There’s a reason we chose Diageo as one of our shares to watch last year. No matter what the disruption, its indomitable stable of alcohol brands has been very defensive.

The group owns Johnny Walker, Guinness and Gordons to name just a few. Owning household names means that even when bars and restaurants were forced to close, or faced subdued business as they are at the moment, some of the slack is picked up by supermarket sales.

Having impressive brands should hopefully translate into more reliable revenue streams.

We’re especially optimistic about Diageo coming into 2022. We think it could benefit from changing behaviours. People became more accustomed to drinking at home over the last 18 months, which could translate into a permanent increase in demand for shop sales.

At the same time, there’s increasing optimism about life getting back to a more permanent state of normal, as the world learns to live with the virus. That would likely bode well for the group’s sales to bars and restaurants.

Diageo’s enviable brand-hoard help feed into its prospective yield of 2.1%. Yields are variable and not a reliable indicator of future income.

The group’s valuation is a bit steeper than we’d like though. At a price to earnings ratio of 26.2, it’s at an all-time high. On one hand that displays the market’s optimism for the stock, but it does increase the risk of short-term volatility. The focus should be on the longer term rather than any short-term upside, and of course there are no guarantees.

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Whitbread

It’s hard to fathom how tough the last 18 months has been for the hotel industry. It would be wrong to suggest that any hotel chain is going to be fully back to normal immediately. But a good business going through a tough time doesn’t make it a bad business.

Whitbread fits within this trope. The group owns Premier Inn. It’s the UK’s biggest hotel chain and is growing in Germany. Revenue per Available Room (RevPAR), which is a core metric for hotels and looks at revenue from room rates as well as occupancy rates, isn’t expected to recover fully until later this year.

But we think the group is one of the most resilient in its sector. Business and short-haul travel is recovering well. That means cheaper, convenience-focussed, city-based hotels like Premier Inn are in a much better position than its luxury counterparts.

What’s impressive is that in the third quarter, there was UK accommodation sales growth of 10.6% compared to pre-pandemic levels, despite the impact of Omicron. That reflects the group’s ability to capture current leisure demand, as well as improving demand for business accommodation.

We can’t ignore the ongoing uncertainty though. While the threat of another harsh lockdown has faded, we can’t rule it out. This would be bad news for Whitbread.

Unsurprisingly, hotels come with an enormous amount of running costs. Whitbread employs around 28,000 staff, and we dread to think what the monthly linen-laundry bill is. The group warned earlier this month that it’s going to be affected by the ongoing cost of inflation. This is earmarked to be offset by cost savings and price increases, but the former can’t go on forever and the latter is dependent on no further travel restrictions. This isn’t a crisis, but something to be wary of. If things don’t go to plan, margins will suffer.

Demand in Germany is also less chipper than the UK. Occupancy levels are hovering around the 36% mark. In theory, when government restrictions loosen, this will start to get better, but it’s too soon to say.

Ultimately, Whitbread is in a better position than some. The less mature German market offers growth opportunities too once restrictions have lifted. But investors should be prepared to weather some ups and downs as the unhelpful cost and travel environments shake out.

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Mitchells & Butlers

We’ve heard from those in the business of selling drinks to pubs, but what about the companies selling that on to punters?

Mitchells & Butlers (MAB) owns several bar and restaurant chains, including All Bar One, Miller & Carter, Browns and Harvester. Like its hospitality peers, the pandemic was a nightmare for the group. Operating profits aren’t expected to recover to pre-pandemic levels of around £300m for another couple of years.

And the bad news keeps coming. Just when MAB was dusting itself off and seeing like-for-like sales creep upwards, Omicron fears hammered progress. In the most recent weeks, like-for-likes are down over 10%. For the first quarter as a whole, they’re down 1.5%.

The group’s also dealing with the pressures of having a large casual workforce. Minimum wage increases mean the group’s dealing with heavy cost inflation, which when mixed with falling sales, isn’t exactly a recipe for prosperity.

So when asking where MAB stands now, the answer is on shifting sands. Getting back to normal depends on how quickly customers come back in normal volumes, and it’s anyone’s guess exactly when that will be.

But there are reasons for some cheer.

We’ve seen that when MAB’s trading is going, it’s going well. That’s partly because of its well known, low-to-mid market offering, which is perhaps better placed to capture demand than more expensive offerings while inflation’s running high.

The group’s real superpower though is its property portfolio. MAB owns over 80% of its premises. That gives it enormous flexibility and adds a bucket load of assets to the balance sheet.

Ultimately, it’s a tough time to own bars and restaurants. Potential investors thinking the rebound in the industry is imminent and likely to be a sharp upwards run should rethink. That’s true of any hospitality stock at the moment. But for those prepared to accept the short-term external risks, we think MAB’s strong market position and freehold property portfolio make it an interesting name in the sector.

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Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Refinitiv. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Past performance is not a guide to the future. Investments rise and fall in value so investors could make a loss.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research disclosure for more information.