Loungers – growth at a very reasonable price

(LGRS.L, $374m market cap, $0.5m ADVT but blocks likely available, 61% free float)

Personal note: Loungers has long been a top position, but I hesitated to share a write-up until now. This was partly due to low liquidity, but also because it seemed improbable that they could trade through the tough UK macro conditions without succumbing to a profit warning. Instead, the recent FY24 results were impressively robust, and left me with no further excuse but to write the company up.

I have spoken to management in preparing this report. All opinions and estimates are solely my own responsibility. Feedback is welcome as always.

Loungers is a world-class restaurant rollout story at an attractive valuation. Unknown internationally, the stock’s quality is also largely unrecognised by UK investors. This is because Covid drove a coach and horses through the crucial post-IPO track record period.

In this post, I aim to show why Loungers is special. A self-funded rollout and consistent strong LFL growth should see it compounding sales at 18% and earnings at 20% per annum through to 2030, offering a sustained c.20% IRR.

What is Loungers?

Loungers runs a UK chain of all-day café-bars that serve food and drink in a casual environment. At April 2024 they operated 219 Lounge sites in the high streets of small towns and suburbs across England and Wales. They also ran 35 Cosy Club sites, larger and more elegant restaurant-bars in city centres that provide a sense of occasion. Three Brightside roadside diners completed the estate.

For customers, a Lounge offers warm hospitality, freshly cooked food and excellent value. Everyone is made welcome: dog-walkers and families, builders and business executives, groups of friends. The kitchen is open throughout the day, and the mood morphs seamlessly from breakfast and brunch, to coffee and cake, to full lunch and dinner, to a pint after work or cocktails and tapas. Distinctive shabby-chic décor provides a home-from-home feel. Alternative gluten-free and vegan menus ensure all diets are catered for. I provide more details on the formats, with sample menus, in the annex.

For investors, this democratic inclusiveness translates into high levels of trade and low rents. The locations chosen are typically prime pitches within secondary towns where every site is cheap. Average unit volume is £1.45m, and average rent is just £64k, for an outstandingly low 4.4% rent-to-sales ratio.

Competition is limited. Most restaurant chains tend to stick to London and the major cities. Often a Costa coffeeshop and a JD Wetherspoon pub are the only alternatives nearby, neither offering the same thing as a Lounge.

Pescado Lounge in Whitby, Yorkshire

History

Loungers was founded in 2002 by Alex Reilley, Jake Bishop and David Reid. All had good jobs with other hospitality operators. Dave went traveling in Australia, and took inspiration from the informal, all-day cafes he saw that smoothly handled everything from breakfast to late-night drinks. He persuaded the schoolfriends Alex and Jake to join him in a new venture.

They opened their first tiny site in a Bristol suburb, funded by £30k of their own equity and a bank loan. Within a year they added a second, larger site nearby. Ever since then, they have carried on opening restaurants, largely self-funded by cash flow. They gradually entered new regions and spread across England and Wales, to reach 257 sites by April 2024, and 267 at the time of writing in late July 2024. My chart below shows the accelerating site growth.

A key milestone in 2012 was the exit of Reid from the business, as he sold his stake to Piper Private Equity to move to the South of France. Piper are specialist hospitality and consumer investors, who first approached Loungers about a transaction in 2007 and stayed in close touch ever since. Their influence spurred Loungers to professionalise the operation significantly, putting a resilient central structure in place to support the faster cadence of openings that followed.

The shareholder register after the Piper transaction was pleasingly tight: 24% each for the co-founders Alex Reilley and Jake Bishop, 6% for Nick Collins (who joined at the start of 2012 as Finance Director, and became CEO in 2015), and 45% for Piper.

Cosy Club in Lincoln

Management and shareholder structure

This core trio of owner-operators – Reilley, Bishop and Collins – continue to drive the business today.

The co-founder Alex Reilley is Executive Chairman. He is officially contracted to work three days a week, but appears to be far more committed than this would suggest. He “remains heavily involved in the branding and look and feel of the Loungers estate”, according to the official bio. He spends a lot of time on the road scouting for new sites. He is extremely well connected within UK hospitality, and acts as a champion for the industry in the face of government obstacles and neglect.

Fellow co-founder Jake Bishop is Commercial Director with responsibility for the food and kitchen operations.

CEO Nick Collins joined the business in 2012 when there were just 20 sites. His prior roles were CFO of the listed Capital Pub Company and founder of the Fuzzy’s Grub London sandwich chain.

I rate the entire team as highly motivated to keep growing the business, and expect them to remain in place for the foreseeable future.

The three each sold shares in December 2016, when Lion Capital bought out Piper and wanted majority control. They took more money off the table at IPO in April 2019. They now own 7%, 6% and 1% of Loungers respectively.

As for the PE investor Lion Capital, they currently hold a 26% stake, down from 39% immediately post IPO. They have sold no shares since December 2020, when they sold 3m shares at 215p. It is reasonable to assume that Lion remains a natural seller today, which provides a likely source of blocks for any prospective institutional buyer.

Ritorno Lounge in Bristol opened in July 2024, and is the biggest site so far

Strong like-for-like performance

The hallmark of Loungers’ success is its consistently strong like-for-like sales growth. This has averaged 5.2% since it was first reported in FY11 – see chart below. (The data for the three Covid-affected years is for the 44 / 13 / 13 weeks when trading was not impacted by lockdowns and restrictions.)

This 5.2% average LFL performance is well above listed peers and the broader market, as measured by the Coffer Tracker.

Volume rather than pricing has been the main driver of Loungers’ strong LFL growth over time. The management team drive a culture of continuous improvement. Warm hospitality, better food and drink and consistent speedy service are the key factors within Loungers’ own control.

Refreshingly, management do not tend to complain about the weather or pressures on consumer incomes. Instead, they have described LFL growth for the core Lounge business in particular as ‘metronomic’.

As a sense check, sales per site (average unit volume or AUV) gives another perspective on same-store growth. My chart below starts from FY07 with just five sites, and suggests the format took a while to find its groove. From FY10 onwards there is a 6.3% AUV CAGR, which corresponds well to the c.5% LFL growth plus an additional uplift from new sites gradually getting larger and more ambitious over time.

New site growth

Loungers has sustained an aggressive new site rollout programme for over twenty years now. Alex Reilley has described in podcast interviews being “addicted” to growing the business, and the evidence bears this out.

The table below summarises the pace of the rollout, which shows no signs of relenting.

The execution has been remarkable. Town and pitch selection, design, build and staffing of the new sites have all been on point.

The success of the rollout is evidenced by the tiny handful of duff sites that have needed to be closed. Specifically, only six mistakes have required early closure in 22 years. Haro Lounge in Formby was closed in January 2015 after 14 months of poor trading. Cambio Lounge in Bishops Stortford was closed in April 2016 after 13 months of poor trading. Most recently, Harrogate Cosy Club was closed in February 2024 after 17 months of poor trading. With hindsight it was simply the wrong pitch - upstairs on a daytime retail footfall pitch. Evening sales were very poor, in the face of tough competition in the town.

Additional evidence for the rollout’s success comes from age cohort analysis, with like-for-like growth continuing to be strong for each age cohort. See chart below.

Loungers opened 36 new sites in FY24, more than one every fortnight. They organise this via five build teams, each managing the design and build internally to standard specifications. Openings are deliberately spread across the country to avoid over-burdening any one of the eight regional operators at a time.

We are now three months into the new financial year. Loungers has already opened ten further sites, well on track to open another 36 or more this year, with 43 currently in the pipeline.

As soon as Loungers is comfortable opening and absorbing this number of sites per year, they will likely add a sixth build team and step up the pace again.

Loungers sees the potential for at least 600 Lounges and 60 Cosy Clubs, which implies a good decade of runway. Management have also suggested that 600 is a conservative figure. There are a lot of small towns and suburbs where the format could work. For reference, JD Wetherspoon currently trades from 800 pubs, while Costa has over 2,000 coffee shops. In my view, the Loungers story is still in the early innings.

Management structure and culture

Beyond the build teams, Loungers has a sound management structure to handle the operational complexity of the large and growing business. The country is divided into eight regions, each sub-divided into two to four areas of five to eight sites each. This creates a career pathway for ambitious team members to progress to site manager, then area operator, and possibly up to regional operator or head office.

Within this management structure, Loungers takes care to propagate the culture that makes Loungers special. Every year on a Monday in June, the entire business is shut down for Loungefest, an all-day staff festival held in a field in Wiltshire with food, drink and entertainment laid on. Loungers does not have to do this – and other hospitality businesses certainly don’t do this – but management believe it is the right thing to do. It goes a long way to achieving buy-in by the staff into the Loungers culture.

The drive for continuous improvement is a key part of the culture. Some investors have questioned why bother with Cosy Club and Brightside, when Lounge alone is so successful. But the management team sees the additional brands as a key opportunity to experiment, learn and improve.

Costs and profitability

Loungers presents several alternative profit margins, with different lease accounting and adjustments. While this is intended to be helpful, it can be confusing or off-putting to the casual investor.

I compare the different profitability metrics in my table below. Management focuses on IAS 17 EBITDA, which is a good proxy for cash flow. They have a plan to lift the margin from 12.6% back to the 13.5% level from pre Covid.

For valuation purposes, I prefer to focus on the statutory pre-tax margin and on free cash flow, before and after new site investment.

My chart below shows Loungers’ cost split. In FY24 food and drink was 23% of sales, and site labour (kitchen and serving staff) was 36% of sales, resulting in a 40.8% gross margin.

Below the gross profit line, total occupancy costs were 16%, including energy and business rates as well as all lease and depreciation charges. Central staff costs were 8%. All other costs, at 14% of sales, includes cash interest, impairments, and any other non-staff spending such as on IT and professional services, travel, etc.

The 3.2% statutory PBT margin is low. But this is after bearing the pre-opening costs of the site opening programme, worth 120bp in FY24, as well as a £2.5m impairment charge for the closure of Harrogate Cosy Club.

Loungers will also continue to benefit from operating leverage over fixed and semi-fixed costs as it scales, as well as improved bargaining power on its food and beverage purchasing. (One of the key suppliers is Bidfood, part of the $8bn Bid Corp of South Africa.)

I forecast Loungers’ statutory PBT margin to reach 5% within three years. This would represent a ROIC of over 12%, clearly revealing the value that is being created.

Site-level economics

Loungers has consistently delivered excellent unit economics, with >30% CROCCI (cash returns on cumulative cash invested) for Lounge sites by the third year after opening.

The slide below contains a recent worked example. 16 Lounges were opened from May 2019 to March 2020, and by FY24 these were delivering £31.5k gross average weekly sales, £290k average site EBITDA per year, and a 32.6% CROCCI on the £14.2m net cash cost of the sites.

While this four-wall calculation does not account for central costs, it does reassure that the new site opening programme produces a high and rapid cash payback.

Capex inflation is a potential challenge to the site economics. From IPO there were several years where average net new site capex stayed around £750k. But this rose to £835k in FY23 and £905k in FY24. Larger and more ambitious sites are part of the explanation. Management aims to cut average capex in FY25 as an area of focus.    

Free cash flow

As above, Loungers’ accounts are a bit tricky to decipher, due to Covid disruption, lease accounting and the effects of the rapid site opening rollout.

The proof of the pudding should be in the free cash flow. My chart below shows the ten-year track record of net cash from operations, after subtracting all lease, interest and share-based payment cash costs. The 23% CAGR is impressive, and the absolute figure reached in FY24 of £44m is highly material compared to the market cap of £287m. (There is a working capital benefit from new site openings within this, given that food and drink is provided on 60 days’ credit terms while customers pay instantly.)

Of course shareholders can’t eat operating cash flow, and in fact Loungers is reinvesting all of this into capex. Since FY18, we have data on the split of capex between new sites and all other purposes (maintaining and refurbishing existing sites).

Using this split, my chart below shows free cash flow before new site capex. Again, the record is impressive, with a 20% CAGR. The FY24 FCF of £35m on this basis would equate to a FCF yield of over 12%.

Loungers is rightly deploying all available free cash flow into the rollout, given the attractive returns this will generate. The chart below shows that Loungers reinvests whatever cash it makes, and a bit more, each year.

Loungers’ balance sheet is strong, with minimal net financial debt of just £9m. This excludes leases on balance sheet.

Total net debt on an IFRS basis is £161m, entirely driven by lease accounting. Loungers prefers to take on longer leases with around 14 year terms, compared to retailers who take short leases with early break clauses. The evidence to date strongly suggests that Loungers’ leasing model is appropriate for the business.

Estimates and valuation

Loungers is compellingly cheap relative to the growth path ahead. My estimates are shown below.

In the six years to FY30 I forecast a c.12% new site CAGR and a 5.2% LFL sales CAGR, driving an 18% overall revenue CAGR.

I model the adjusted EBITDA margin to gradually return to the FY19 level, as per the company’s guidance, driving 20% growth in that profit line. Cost headwinds in food and drink, labour and energy have been well managed to date, with a year-over-year margin improvement achieved in FY24 over FY23 despite these pressures.

PBT and EPS enjoy more rapid growth in my forecasts, given the depressing effect of the Harrogate impairment in the FY24 starting point.

The stock trades on 20x current-year P/E, which falls rapidly to 12x Apr’27E P/E. This is evidently far too cheap if my forecasts are achievable. The EV/EBITDA multiple is in the low single digits.

Compared to consensus, my estimates are only 2% ahead for the current year, rising to over 20% ahead for FY27. In my view, management are sensibly aiming to under-promise and over-deliver, so consensus should be beatable.

Why does the stock trade so cheaply?

Loungers encounters widespread scepticism as a UK restaurant rollout story. To be fair, this would normally be well justified at sector level. Without naming names, UK investors have seen many instances, from microcap to midcap, where a hot new rollout story has ultimately disappointed and inflicted significant losses.

Faddish formats, sloppy execution and fundamentally weak unit economics have all been culprits as the causes of failure. Often a format that originally worked brilliantly in London has faltered when the rollout is expanded to secondary locations. Worse, the original star sites then lose their novelty and fade as well.

I would argue that Lounges is and will continue to be the exception to these sad stories. The format is universal and evergreen rather than faddish, with over twenty years and counting of evidence to back up this assertion. The rollout has avoided London completely, and has flourished in what would appear to be unpromising provincial locations. The management team is exceptionally driven and determined to keep proving the doubters wrong.

In short, I expect the stock to outperform each time Loungers can deliver another sound update that defies the general expectations of disappointment.

Annex – further details on the formats and competitive environment

Lounges are casual neighbourhood cafe-bars that serve the whole community throughout the week. Each Lounge has a different name, and the branding is subtle: it is not obvious to all customers that they are in a chain restaurant at all.

Food and drink is ordered and paid for at the bar or from the table by app. It is then served to the table.

Sample food and drink menus are shown below. The prices shown are the total cost — there is no service charge in this format.

The company provides useful sales splits, as shown below. There is good balance across many metrics:

• food and drink is split 60:40

• breakfast (19%), lunch (42%) and dinner / late (38%)

• Mon-Thurs (43%) vs Fri-Sun (57%)

• within drinks, between alcohol (55%), hot drinks (25%) and soft drinks (20%).

Lounges can fit into a wide range of sites, including vacant former shops and banks, and can make use of upstairs space. This helps explain how such a low rent-to-sales ratio is achieved, which is crucial to success.

Cosy Clubs are more formal and elegant, with table service and great cocktail lists. They use spectacular city centre sites in larger, often university towns and cities. The format is continuing to perform well, but is not quite as consistent as Lounges in LFL performance. A project is underway to give Cosy Club a slightly more premium position, by elevating the food and drink offer.

The Brightside roadside diners are a nostalgic concept with retro style that recalls the Little Chef and Happy Eater chains of the 1980s. Motorists and holidaymakers are invited to break their journey for a pleasant meal as they drive to the West Country.

Brightside is very much still in trial phase. No further rollout will be undertaken beyond the four sites already open or in construction, until definitive proof of strong unit economics, which will depend on a successful summer of LFL trading. My expectation is that the project may sadly not get the greenlight for further expansion, if it turns out that the specific occasion and target clientele lacks the universality of the Lounge concept. It may simply not be possible to attract enough customers throughout the day to meet weekly sales targets.

I believe the street is on the same page as me on Brightside. Any announcement that the brand is to be curtailed will likely be treated as neutral or positive, as it would re-affirm the disciplined approach to allocate capital only to the proven formats.

The Brightside sites are freehold, so no lease impairment would apply to any decision to close them. One-off costs would be de minimis.

Competitive landscape

The Lounge format no doubt sounds simple, and as if it could easily be copied. However, in reality the opposite is true. Many have tried, and all have failed.

Below is the full list of the top hundred UK restaurant chains, with the number of sites for each as of 2023, as determined by the trade website RestaurantOnline.co.uk.

What is notable is (1) the complete absence of anything directly competitive to Lounge, and (2) how few scaled casual dining formats there are of any kind.

Once the food-as-fuel fast food chains are excluded, then only Nando’s, Pizza Express, Wagamama, Zizzi and the pub restaurant chains are left. None of these address the same broad demographic, secondary locations or set of occasions as Loungers. Nando’s with its £2.0m AUV and Wagamama with £2.8m AUV are the most impressive businesses; neither could be more different than Loungers.

The pub restaurant chains are more comparable in terms of demographic and location, but they are mostly contracting. Whitbread has announced a plan to exit 238 of its 434 branded restaurants (Beefeater and other brands) in favour of converting some to hotel rooms. Mitchells & Butler has not yet regained its pre-Covid sales level, and is reducing its total site count. Wetherspoon’s is classified as a pub rather than restaurant and therefore not shown on this ranking, but is also reducing its site count as it focuses on larger sites with no nearby locations to be cannibalised.