Famous Brands buckles under expectation of greatness

The reminder by fast-food group Famous Brands to shareholders that its indigestion woes in the UK are far from over, wiped off R1.3 billion from its market capitalisation on Tuesday.

Famous Brands, the operator of eateries including Wimpy, Mugg & Bean, Steers and higher-end tashas and Mythos, is buckling under the weight of its UK-based Gourmet Burger Kitchen (GBK) business.

The R2.1 billion acquisition by Famous Brands of premium burger restaurant chain GBK in 2016 –  the biggest deal in its history – was meant to be a diversification game changer for a company that has rapidly grown from a family-owned business into an industry leader.

In the eyes of investors, Famous Brands has consistently exceeded expectations and defied tough trading conditions in its South African home market.

A year later, the beefy GBK hasn’t lived up to expectations.

After markets closed on Monday, Famous Brands in a trading statement for the six months to August 2017 said GBK recorded profit before interest and tax loss of £872 000 (or R16 million at the time of writing).

“This GBK is quite frankly catastrophic. Unfortunately, it’s yet another case of a highly successful SA company going overseas and trying an acquisition that is just simply not working,” said Wayne McCurrie, the senior portfolio manager at Ashburton Investments.

Famous Brands now joins the ranks of South African firms that have taken the heat from their UK expansion; chief among them Brait with its troubled New Look ladieswear brand.

Shareholders were not forgiving after this announcement as Famous Brands’ share finished 10.74% lower on Tuesday. So far this year, its share price has been down 32.59% – well below the 12.58% gains in the JSE All share Index over the same period.

This is a huge blow for Famous Brands shares that have remained remarkably resilient even though consumers cut their spending on eating out at restaurants.

“Every sector darling makes a mistake now and again. Even the most treasured company on the JSE at some stage is going to make a mistake. They get punished when high expectations that are built into the share price are not met,” said McCurrie.

Famous Brands’ mistake is that it went too big in the UK and took an SA cookie-cutter approach to business overseas, he said.

Brexit weighs

GBK is taking strain as consumer confidence has been hit by uncertainty over Brexit and competition among fast-food chains in the UK has intensified. As a result of this and the high cost of opening new GBK outlets, Famous Brands has taken the decision to scale back on opening new stores.

GBK, which has a network of 97 restaurants, might return to profitability in the next financial year (2018).

Famous Brands has taken on more debt than usual following the GBK deal, introducing about R2.8 billion worth of debt to its balance sheet. Net debt to equity stood at a whopping 165% for the year to February 2017.

It expects headline earnings per share for the six months to August 2017 to decrease by 54% to 63%, reaching a range of 153 cents/share to 187 cents/share compared to the 441 cents/share posted in 2016.

Bad track record

Electus Fund Managers has been negative on the GBK acquisition from the start due to Famous Brands’ checkered track record in the UK, said Damon Buss, the firm’s equity analyst.

Famous Brands acquired a 75% shareholding in Wimpy UK in 2007, giving it control of 197 Wimpy outlets in England, Scotland and Wales, and a further 20 that operated under a master licence arrangement in Ireland.

Buss said the company has shut about 65% of the outlets, ending its 2017 financial year with 69 Wimpy stores in the UK that generated revenue of R105 million versus R175 million in 2008; earnings before interest and taxes of R20 million in 2008 versus R19 million in 2017.

“Also all GBK stores are company-owned stores, which is a divergence from Famous Brands’ successful franchise model in SA,” he told Moneyweb.

Buss added that GBK requires significantly more capital expenditure of about £1 million per store to build and fit out, which will negatively impact Famous Brands’ return on invested capital (ROIC). Before the GBK acquisition, Famous Brands’ ROIC was mid-30%, which Buss expects to drop below 10% in 2018.

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