Wed 07/07/2021 14:10 PM
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Relevant Items:
Primary Analysis
Historical Financials on Aggredium
EMEA Covenant Analysis
Forward Model, Waterfall


Reorg has produced a comprehensive financial and legal analysis of Pizza Express’ 2026 £335 million senior secured note issuance HERE. Full historical financials can be found on Aggredium by Reorg HERE. To request a trial, please email sales@reorg.com.

U.K. casual dining restaurant operator Pizza Express’ is marketing £335 million of 2026 senior secured notes, which, alongside cash, will be used to term out its existing post-restructuring capital structure. The new notes are supported by a sustainable post-restructuring capital structure with a moderate loan-to-value (LTV) of 51% under Reorg’s base case, with £318 million of equity value below the notes.

The issuance offers a reopening play to investors as near-term uncertainty about Covid-19 recovery is offset by expected long-term business stabilization and evidence of fast recovery to pre-Covid-19 levels. Reorg’s base case projections show that once business normalizes, the group has capacity to generate £30.5 million, £39.1 million and £39.2 million of levered free cash flow in 2022, 2023 and 2024 after leases and before growth capex, which includes spend on refurbishments and additional stores. Including the aforementioned growth capex, cash generation is limited to £5.7 million, £8.3 million and £13.8 million in 2022, 2023 and 2024.

Pre-IFRS 16 net leverage declines to 3.4x in 2024 compared with 8.8x at the end of 2019 and 3.8x at issuance which is being marketed using 2019 pro forma adjusted IFRS 16 EBITDA of £79.8 million, which includes a positive operational restructuring impact of £2.3 million.
 

The chunky low to mid-7% IPT on the SSNs, which offers a significant premium over other similarly rated sterling SSNs issued by U.K.-based companies, seems attractive given the moderate LTV level and the group’s cash generation ability once business normalizes. Compared to a median 5.5% yield on peers, the premium reflects Pizza Express’ recent restructuring history and low asset coverage compared to pub chains Stonegate and Punch. Reorg’s primary analysis of Stonegate is HERE and Punch is HERE.
 

Pizza Express’ issuance follows a number of other primary issuances in the customer discretionary segment which offered investors a chance to gain exposure to companies expected to recover from the reopening of the economy such as Punch Taverns, Stonegate, David Lloyd, TUI Cruises and Elior. Most of these issuances are trading above par and the yield on these have tightened after pricing. Reorg’s primary analysis of David Lloyd is HERE, TUI Cruises is HERE, Elior is HERE. (More detail is available in ‘Bond Comparables’ section in the full analysis HERE.)
 

Our forward model remains conservative, using a pre-IFRS-16 EBITDA multiple of 9x in 2024, which compares with current peers trading at around 10x pre-Covid-19 EBITDA. Under our base case, an exit multiple of 10x would lead to a LTV of 47%, with an equity cushion of £376 million. Meanwhile, a multiple of 8x would still provide an LTV commensurate with that of a B-rated issuer, with an LTV of 56% at 8x FY’24 EBITDA and an equity cushion of £260 million. This is further supported by our expectation that the refurbishment strategy will drive incremental same-store-sales growth, with various cost efficiency measures supporting margin expansion over the forecast period. (More detail on the assumptions driving Reorg’s forward model can be found in the “Forward Model, Waterfall” section HERE).

Trading comparables are below:
 


Reorg’s base case is below:
 


Some of the key risks include uncertainty regarding post-Covid recovery from longer term changes towards flexible working and changes in eating out trends. In addition, historically the group faced a decline in like-for-like sales, which fell 2% in 2018, followed by 1% in 2019, and which the group hopes to reverse via increasing average spend per customer and number of meals sold. However, this may be challenging amid fierce competition.

New restaurants and refurbishments are also part of the group's strategy to drive growth which keeps capex elevated over the forecast period. Although our projections show the group is marginally cash positive after accounting for growth capex, continued complications with reopening from lockdowns or other adverse impacts to the top-line may drive future cash burn. While the company does have the ability to dial-back growth capex under such a scenario, additional debt to fund capital expenditure or liquidity needs may prime the notes and could create an unsustainable capital structure, as happened prior to restructuring. See our legal analysis HERE for additional detail on priming debt availability at issuance

The company’s pro forma capital structure is below:
 
 
Key Credit Considerations
 
  • Reopening play, near-term uncertainty versus longer-term stabilization, evidence of fast recovery to pre-Covid-19 levels: Although the group has been and remains severely affected by Covid-19 - which led it to restructure in 2020 - there is evidence of a relatively fast return to pre-Covid-19 levels after the reopening. From May 17 to June 20, 2021, total like-for-like revenue represented 97% of 2019 pro forma revenue. Our projections show that once business normalizes, the group has capacity to generate £30.5 million, £39.1 million and £39.2 million of levered free cash flow in 2022, 2023 and 2024 after leases and before growth capex, which includes spend on refurbishments and additional stores. Including the aforementioned growth capex, cash generation is limited to £5.7 million, £8.3 million and £13.8 million in 2022, 2023 and 2024. Pre-IFRS 16 net leverage declines to 3.4x in FY’24 compared with 8.8x at the end of FY’19 and 3.8x at issuance using pro forma adjusted IFRS 16 EBITDA.
  • Moderate LTV post-refinancing: Pizza Express’ LTV pro forma for the transaction is 51% under our base case, with £318 million of equity supporting the senior secured notes at issue. The equity cushion is driven by our expectation of improving profitability per store following the refurbishment plans outlined by management, which we expect will moderately support same-store-sales growth and drive margin expansion through leveraging the fixed cost base. Reorg’s forward model remains conservative, using a pre-IFRS-16 EBITDA multiple of 9x in 2024, which compares with current peers trading at around 10x pre-Covid-19 EBITDA. Under our base case, an exit multiple of 10x would lead to a LTV of 47%, with an equity cushion of £376 million, while a multiple of 8x would still provide an LTV commensurate with that of a B-rated issuer, with an LTV of 56% at 8x FY’24 EBITDA and with an equity cushion of £260 million.
  • Attractive pricing relative to peers, yields on other reopening trades tightened after issue: The initial price talk on Pizza Express’ £335 million 2026 SSNs is in the low to mid-7% area. This offers a sizable premium to other similarly-rated sterling SSNs issued by U.K.-based companies related to the food and leisure sector which have a medium yield of 5.5%. The premium compensates for Pizza Express’s recent restructuring history and its low asset coverage compared to pub chains Punch Taverns. However, as discussed above, Reorg analysis shows that once business normalizes, the group would have capacity to generate positive levered free cash flow and the modest post refinancing LTV of 51% under base case makes the pricing relatively attractive. In addition, Pizza Express’ issuance follows a number of other primary issuances in the customer discretionary segment which offered investors a chance to gain exposure to companies expected to recover from the reopening of the economy such as Punch Taverns, Stonegate, David Lloyd, TUI Cruises and Elior. Most of these issuances rose above par and the yield on these have tightened after pricing.
  • The group’s core business strategy post-China disposal is expected to support its target of achieving above market same-store-sales growth: Historically, the group underinvested in the U.K. & Ireland businesses under previous management, instead using cash generated from these sites to invest in the group’s Chinese operations, which performed poorly and have now been divested as part of the restructuring. New significant investment into the existing U.K. branches is expected to drive incremental revenue growth through 2024, which we expect will provide a tailwind to EBITDA margins. We expect this will buck the trend of continuous same-store-sales declines, where same-store-sales fell 2%, 1% and 51%, in 2018, 2019 and 2020, respectively.
  • Strong position in U.K. casual dining segment: According to Savanta, Pizza Express is the second largest operator in the U.K. casual dining segment behind Nandos when looking at the number of outlets, and is by far the largest Italian dining player with 148 more outlets. It is significantly larger than other Italian chains such as Pizza Hut, Prezzo, Zizzi and Frankie & Benny’s. The group has the third-largest brand awareness in the U.K. casual dining market and as of December 2020, according to the group’s third-party research providers. Furthermore, although according to Euromonitor International, the U.K. food service market declined from £68 billion in 2019 to £43 billion in 2020, it is expected to rebound strongly once trading restrictions end. Euromonitor International forecasts that the market will increase to £61 billion by 2022, representing a 19% CAGR from 2020. Between 2022 and 2025, the U.K. food service market is expected to grow at a 5% CAGR.
  • Restaurant site diversification: The group has 363 sites located in the U.K. and Ireland which generated 87% of total revenue in 2019, 37 sites in Hong Kong and the UAE and 47 international franchised restaurants as of April 4. Sites are located across the U.K. and are split by customer type by the group, from city shoppers to commuter towns. Based on reported performance from May 23 to June 20 since internal dining reopened, the majority of these U.K. locations have recovered to or close to pre-Covid levels, however city worker, city shopper, events and other locations are still significantly below pre-Covid performance, although the level was not disclosed.
     
Key Risks
 
  • Uncertainty regarding competitive environment post-Covid, history of declining LfL sales: The pandemic led to a significant impact on sales with 2020 like-for-like sales declining 51% year over year and resulting in the group restructuring last year. The group has experienced strong revenue recovery from May 23 to June 20 to 97% of 2019 sales, based on which we expect a swift recovery to pre-Covid levels after full U.K. reopening on July 19, however there remains uncertainty about the long-term impact from more flexible working and changes in eating out trends. In addition, the group has experienced a decline in like-for-like sales each year since 2018, when they declined 2%, followed by 1% in 2019. Pizza Express hopes to increase average spend per customer and meals sold. However, Covid-19 has increased the proportion of consumers who utilized online food delivery applications, which increased the variety of competitors for Pizza Express, many of whom have a lower price point. As well as competition from smaller casual dining restaurants, Pizza Express also faces competition from supermarkets offering lower-priced products. As a result, the group’s aim of increasing average spend per head to drive revenue growth may prove difficult.
  • Execution risk related to expansion strategy: In order to generate growth the group plans to open 45 new restaurants over the next three years. The strategy exposes the group to execution risk in the face of promotional activities by competitors. This is offset partially by a short average payback period for both new site acquisitions and refurbishment expenditure, which is typically between 2.5 years and three years.
  • Capex plans require higher investment levels than historical period: The group said it believes that under the previous owner, Hony Capital, the U.K. restaurants were significantly underinvested and, as a result, have chosen to ramp up refurbishment spend as it attempts to improve customer experiences. We expect the group to refurbish the majority of its existing estate by 2024, with our base case forecasting 380 store refurbishments at about £145,000 per site, bringing total capex relating to store refurbishment to £53.4 million from 2021 to 2024. Notably, this would place refurbishment capex significantly above where it has been historically, as the group mostly used capex to invest in the China business. While we don’t expect this to cause wholesale cash burn, refurbishment capex alongside new restaurant acquisitions will limit levered free cash generation after growth capex under our base case.
  • Priming debt capacity, value leakage via dividends: Further increases in total debt risk creating an unsustainable capital structure, a specter faced by the company even before the liquidity crisis generated by Covid-19. For example, in September 2019, the group had 8.5x net leverage based on LTM EBITDA of £75.6 million, leading to questions at the time about the group being able to meet its 2021 bond maturity. While the post-restructuring capital structure is appropriate for the size of the business, there is a risk that the group may use priming debt to fund capex or other liquidity needs. Reorg analysis suggest that, at issue of the new bond, the group will have £5 million of additional super senior debt capacity excluding the £30 million RCF, £28 million of additional structurally senior debt capacity (as the group’s general debt basket of the greater of £28 million and 35% of LTM EBITDA can be secured on assets that do not also secure the notes). There may also be value leakage via shareholder payments or via unrestricted subsidiaries. Shareholder payment capacity under the new issue amounts to £29 million with capacity for leakage via unrestricted subs leakage amounted to £69 million.
  • Marketing off 2019 EBITDA and leverage: The deal is being marketed off £79.8 million of 2019 pre-IFRS 16 pro forma adjusted EBITDA, which leads to 3.8x net leverage through the senior secured notes. As per Reorg’s projections, leverage is projected to stay elevated in the near term until EBITDA normalizes from the effects of Covid-19. However, as per Reorg’s projections, leverage is projected to periodically decline to 3.4x in FY’24.
  • The group does not own material real estate: Pizza Express had 363 sites in the U.K. & Ireland, 37 equity sites in Hong Kong & the UAE and 47 franchised restaurants internationally as of April 4. The group says it does not own any material real estate, implying the group’s restaurants are mostly leased. This is in contrast to recently issued similarly rated £600 million 2026 SSNs by Punch Taverns, which were backed by material real estate and yield 5.6%.
  • Increasing labor costs could impact margins: Within cost of sales (COGS), which is the largest component of the cost base at 69.6% of LTM revenue, labor costs represent 31.2% of LTM revenue, with other variable costs of sales and food costs comprising 20.9% and 15.7% of revenue, respectively. Within COGS, the remaining amounts relate to fixed costs of sale, which historically amounted to around €90 million. The largest component, labor costs, faces two structural challenges: the availability of labor following Brexit, and government targets to increase minimum wage to £10.50/hour by 2024, from £8.91/hour from April 2021. We note that in April, the national minimum wage was increased from £8.72/hour to £8.91/hour and for the week ended July 4, the group had hired 1,883 new employees for roles for which they received 67,000 applications. Although the exact number of salaried employees versus hourly paid employees is not disclosed, the group notes a high proportion of hourly paid employees. The longer term structural pressure on employers to increase wages, pension contributions and other employment benefits thereby presents a headwind to a significant component of the group’s cost base.
  • Business strategy set to limit future promotional activity, partially offset by higher marketing costs in near term: The group is set to decrease its promotional activity as it seeks to replace excessive historic discounting with customer loyalty. We note that, as a result, the group’s marketing costs could rise, in line with its FutureExpress strategy. The strategy will seek to deepen customer engagement through increased marketing, as well as delivering new menus and new retail products and delivery solutions, and will likely be accompanied by an increase in marketing expenditure.
     
Peers

The selected peer group consists of The Restaurant Group, The Fulham Shore and Burger King France Group. The Restaurant Group owns brands such as Wagamama and Frankie & Benny’s as well as others, and as of December 2020 it had 397 outlets across the U.K. The Fulham Shore own two brands, the Italian diner Franco Manca and The Real Greek, together making up 72 outlets, which compares to Pizza Express’s 363 outlets in the U.K. While Burger King France is less of a casual diner and more of a fast food operator, it provides a peer with scale and brand strength that targets the same type of customers and is largely affected by the same industry trends, giving a basis of comparability.

According to Savanta, Pizza Express is the second largest operator in the casual dining segment behind Nandos when looking at the number of outlets, and is by far the largest Italian dining player with 148 more outlets. It is significantly larger than other Italian chains like Pizza Hut, Prezzo, Zizzi and Frankie & Benny’s.
 

When using pre-pandemic post-IFRS -16 LTM EBITDA levels, Pizza Express’s net leverage is lower than peers at 4.5x, where The Restaurant Group had a net leverage of 6x, The Fulham Shore of 6.3x and Burger King France of 5.7x. LTM net leverage for Pizza Express stood at 19.5x compared to 15.4x for Restaurant Group and 7x for Fulham Shore, reflecting the significant EBITDA impact due to Covid-19.

Pizza Express’ gross profit margin on an LTM to April was at 30%, significantly lower than Burger King’s 66.8%, around 8% lower than The Fulham Shore’s 38.1% margin. During the same period Pizza Express had an EBITDA margin of 15.2%, The Restaurant Group 11.6% and Fulham Shore 20% with Burger King having the highest margin of 32.6%.

It should be noted that the variations in the latest reported results have led to differing LTM periods. When taking this into consideration, Pizza Express’ LTM period to April 4 is largely comparable to Burger King’s LTM period to March 31. However, both The Restaurant Group and Fulham Shore financials are based on LTM to December 2020 and LTM to September 2020, which would have varied levels of Covid-19 impact.

A summary of operating peers is below:
 
Full Analysis
 
 
(For the full financial and legal analysis, click HERE.)
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